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How mobile carrier subsidies became Apple’s secret weapon

The iPhone’s true price is obscured for buyers by handset discounts from wireless providers

Apple CEO Tim Cook unveils the sixth-generation iPhone. (Justin Sullivan/Getty)

Apple CEO Tim Cook unveils the sixth-generation iPhone. (Justin Sullivan/Getty)

Apple announced some whopping first-quarter results on Tuesday, with $74 billion (U.S.) in revenue and $18 billion in profit. That’s the biggest quarterly profit of any company in history.

Much of the record results were driven by the iPhone, which accounted for 70% of revenue.

The incredible performance is easily explained: Apple tapped into a huge well of pent-up demand last fall by introducing iPhones with bigger screens.

Consumers had been asking for larger displays for years and many had voted with their wallets by going with Android devices that delivered on that desire.

Not surprisingly, chief executive Tim Cook told analysts during a conference call on Tuesday that the iPhone 6 and iPhone 6 Plus attracted many of those people back, drawing the highest number of Android switchers in three years.

That bumped the company up to nearly 75 million iPhones sold in the quarter, up dramatically from 51 million units in the same quarter a year earlier.

Aside from the demand spike, the higher prices on the two phones look to have added even more pure profit. The average selling price of an iPhone in the same quarter a year ago was $637, versus $687 this year, representing an additional $50 in revenue per device.

To summarize: lots of phones sold at a higher price equals record profits.

It’s at this point that it becomes worthwhile to ponder how much of a role wireless carriers are playing in Apple’s success.

The overwhelming majority of iPhones aren’t sold at their full asking price; they are instead subsidized by carriers in exchange for consumers signing term contracts.

Apple doesn’t disclose what percentage of devices are sold at full price off-contract, but Cook has said in the past that about 20% of iPhones are activated in Apple stores.

Many, but not all of those are likely to be contract-free, so a reasonable estimate is that somewhere between 85 and 95 per cent of iPhones are sold with a carrier subsidy.

This means that whenever Apple raises prices, those increases get passed on to the large majority of consumers by carriers.

Typically, that takes the form of a higher up-front cost—say $250 plus a two-year contract, rather than $199—or higher monthly service fees, sometimes both.

Other manufacturers don’t want their products to be seen as inferior so they follow this pricing lead. The result is that nearly all phones are priced artificially higher than they should be.

Wireless carriers get much flak for their prices, policies and customer service – some of it is undoubtedly well earned – but some sympathy in this case is also deserved.

The non-transparent way in which phones are sold, where the device’s true price is hidden from the consumer, is benefiting Apple immensely.

The company is able to use the system to boost its profitability, leaving carriers on the hook for expensive phones. Carriers have their own shareholders to cater to, so they raise prices to maintain their own profitability.

It’s true that many carriers are pulling in their own healthy profits but the system also nets them a healthy dose of criticism from consumers, which ultimately results in the attention of regulators and governments.

Apple, meanwhile, gets to continue enjoying its do-no-wrong image while reaping incredible profits.

It makes you wonder what the market might look like if subsidies didn’t exist.

Would Apple still be charging as much as it does for its phones, and would the company be posting eye-popping financial results? In both cases, probably not.