The brewing iPhone war: It's Apple vs. the carriers

Ma Bell and the Cupertino Colossus are prepping for a bloody fight over iPhone prices and subsidies -- it won't be pretty

It's been a marriage of convenience. They never loved each other, but Apple and the cellular carriers made buckets of money by convincing people that they weren't really paying as much as $650 for a "$199" smartphone -- and (secretly) $200 more per year for every year the user keeps that iPhone after its subsidy is repaid.

Carriers are tired of that game. Apparently, they're convinced they can make more money by not paying Apple the higher subsidies it commands over other smartphone makers due to iPhone buyers' fiercer loyalty to the carriers they choose, perhaps because their high dependence on data coverage makes them choose carriers more carefully upfront.

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As a result, we're facing the very real possibility of a war between Apple and the U.S. carriers. (Carriers don't subsidize smartphones in much of the rest of the world, though there are exceptions such as China.)

If there's one factor driving the sea changes in the wireless industry it's this: The smartphone market is becoming saturated. None other than AT&T CEO Randall Stephenson says that 75 percent of cellular customers already own smartphones, and that number will soon increase to 90 percent.

At the same time, hardware innovation in smartphones has reached a plateau. Snark aside, the digerati who dumped on the iPhone 5s and 5c had a point -- neither they nor Samsung's Galaxy S 4 knocked anyone's socks off. Sure, the next iterations of the leading devices will be better, but the changes will be incremental.

What does all that tell you? Competition among the carriers and the device makers is going to be different in 2014, more cutthroat and more about price than innovation. Having watched T-Mobile thrive after it did away with contracts and subsidies, the other carriers want, as Apple once said, to think different. But someone's standing in the way of the carriers' plans: Apple CEO Tim Cook, whose job it is to defend his company's rich profit margins.

Bye-bye smartphone subsidies? Not so fast

Speaking at an investor conference in New York last week, AT&T CEO Randall Stephenson said the era of device subsidies is coming to an end. "When you're growing the business initially, you have to do aggressive device subsidies to get people on the network," Stephenson said. "But as you approach 90 percent penetration, you move into maintenance mode. That means more device upgrades. And the model has to change. You can't afford to subsidize devices like that."

Subsidies are the difference between what a person pays for a phone (along with a two-year contract) and what it costs a carrier to buy it from the device maker. That $199, 16GB iPhone 5s you bought recently would have cost $650 if you'd purchased it unlocked. How much it costs the carriers is a well-kept secret, but various sources suggest that Apple charges them $575 to $600. Until quite recently, Samsung was thought to offer the carriers better terms (a discount of $100 to $200 on high-end smartphones), which means Apple has been fattening its margins at the expense of its carrier partners.

Not that there's any reason to feel sorry for AT&T and the rest. You repay them every month via an invisible item on your bills, but when they've repaid the "subsidy," their bills don't get smaller. At that point, the hidden fee becomes pure gravy for the carrier. That hidden cost is about $15 to $20 per month. One indication for that figure: AT&T recently said it would drop $15 from the monthly bill for users once their two-year subsidized contract had ended or if they brought in a fully paid smartphone. Other reports say that covers most smartphones' subsidy costs, but the actual iPhone subsidy is closer to $20 per month, which is made up by the higher-priced data plans the typical iPhone user springs for.

If everything was above board, we'd be calling that subsidy what it really is: a high-interest loan that is only repaid when you buy a new smartphone and essentially enter into another loan.

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