Overbuilt and underutilized
carriers were desperate to attract business and stave off financial disaster.
As such they competed aggressively on price, and gave their biggest
near-monopolistic customer – the one that they could not imagine living without
-- a very significant price subsidy in order to each maintain their market
share and stay solvent. In turn, the near-monopolistic customer played the
carriers off one another, and sucked all the profit out of the ecosystem.
Finally, the carriers formed an alliance amongst themselves and collectively
raised prices, believing that if they acted together the near-monopolistic
customer would have no choice but to pay more.
Does this sound familiar? While the first part sounds like the story in
the past six years of wireless carriers (ATT, Verizon, T-Mobile) and Apple (as
the near-monopolistic customer), it is actually history in a different time and
in a different industry. In the 1870s, the handful of major railroads had
overbuilt their rail networks and faced the above situation. Commodore
Vanderbilt (the wealthiest man in America) promised a huge discount to John D.
Rockefeller to transport all of Rockefeller’s oil over Vanderbilt’s railroad.
Soon after, Tom Scott of the Pennsylvania Railroad brought his protégé Andrew
Carnegie to meet with Rockefeller to promise an even lower price; Rockefeller took
the lower price and switched. But eventually the railroads were hurting so much
that Scott and Vanderbilt agreed to stand firm and raise prices together – thus
sharing the Rockefeller oil business.
Could this happen today for Apple? Perhaps. It is certainly possible that the
wireless carriers could act more or less in unison to reduce or eliminate the
iPhone subsidy, since the initial reason for the subsidy (ATT’s exclusive
arrangement) is no longer a factor. How openly they would act together is more
constrained today due to tougher laws against monopolistic behavior, but
directionally they could signal their intention to reduce the subsidy and then
perhaps each individually negotiate better deals. The advent of better
alternative Android phones from Samsung and Google (Motorola), as well as the new
Nokia/Microsoft models, gives the carriers a better position from which to
negotiate. And the wildcard in this is whether Google continues its strategy of
low pricing as it begins to introduce new phones from Motorola with tighter
integration of software and hardware (emulating Apple) – that might give the
carriers an opportunity to shift the economics and profit split. Estimates of
Android subsidies are already about $100 less than Apple’s, and with growing
competitive parity it is reasonable to expect that either Android subsidies
will increase or Apple’s will decrease. The part that is already starting to
happen is an increase in the contract period which must pass before carriers
offer subsidies – for the first few generations of iPhones it was 1- 1.5 years
and now it is 2 years.
Back to history. What happened
next in the 1870s is quite interesting. Rockefeller considered the railroads’
collective price increase as an act of war, and took the bold step of
conceiving and building his own network of pipelines connecting the oil fields
of Ohio and Pennsylvania to his refineries, thus cutting out the railroads.
This caused financial panic and widespread bankruptcies amongst railroads. So
maybe the wireless carriers should think twice before opening their own Pandora’s
Box? With $120 billion of cash on the sidelines, Apple could make an
infrastructure play perhaps with a new technology such as satellite phones
(coupled with WiFi or WiMax and IP telephony for indoors reception) and bypass
the wireless carriers with Apple’s version of Rockefeller’s “pipeline”.
The stakes are huge. Most
analysts estimate that Apple’s subsidy is about $400+ per phone, and if Apple
sells about 50 million iPhones in the current quarter, that is as much as $20
billion in profit in just one quarter (although some countries do not have the
subsidized business model).
Is the analogy with railroads and
oil in the nineteenth century a perfect one? Of course not. But it is something
to think about.
As George Santayana said, "Those
who cannot remember the past, are condemned to repeat it."
No comments:
Post a Comment