With the signing of DoCoMo (NYSE:DCM) in Japan (60M customers), T-Mobile (NYSE:TMUS) in the US and soon China Mobile, home of 750M subscribers, Apple (NASDAQ:AAPL) has put in place an expanded retail channel that should ensure healthy double digit iPhone growth for the next two years. When combined with its high performance positioning of the 64 bit A7 processor that I outlined in my previous article, Apple has set the stage for further long-term gains as it creates a worldwide level playing field, forcing cellular carriers to compete with each other and retail in their bid to secure new customers while poaching those of competitors. It's a recipe for channel commoditization similar to how Microsoft (NASDAQ:MSFT) and Intel (NASDAQ:INTC) in the 1990s commoditized PCs and thus pulled a disproportionate amount of profits away from the consumer. Apple is now in this position with the caveat that its own retail will act as an added forcing function.
The research firm Kantar reported at the end of September that in Japan Apple's iPhone had 48.6% of the market vs. 47.4% for Android. After years of denial, the market share numbers speak of an urgency for DoCoMo, the largest Japanese carrier, to not just sign on with Apple but to do so with a robust sales and marketing plan to win back lost customers.
In a recent WSJ article, DoCoMo was noted to be offering the iPhone 5S for free (dropping the $199 price) to customers who signed a two-year contract. We are not sure exactly how much of the $199 is buried in a data plan but it is unlikely to be the whole discount. KDDI (DDIF.PK) and Softbank (OTCPK:SFTBF) responded by offering users discounts to counter the move. As noted in the article, DoCoMo added more customers than it lost in August as it attempted to make a strong stand with Samsung (OTC:SSNLF) phones, however over 145,000 users left to its competitors based on the lack of an iPhone in its lineup. This was after losing millions of customers in the previous years.
Signing on with Apple was a difficult move for DoCoMo as part of the terms of the agreement, according to Nikkei, was a requirement that it agree that 40% of all new contracts be iPhone subscribers. Given that iPhones are nearly 50% of the market today, the prospects are that Apple could soon dominate the market in Japan with Android dropping off dramatically.
Similar scenarios are likely to take hold in other regions of the world as the iPhone 5S comes off allocation later this year. Virgin Mobile recently announced it is going to cut the price of the iPhone 5S and 5C by $100 and thus incentivize people to shop for the hardware first and data plan second. Moving the iPhone to the forefront, emphasizing how low cost it can be to buy one is no doubt at the expense of other phones. However the marketing doesn't stop there as carriers ramp up their trade in programs for older iPhones that can more than replace the initial cost of the iPhone 5S.
The news several months ago that Apple would put in place its own trade in program can be seen as another plank in the strategy to further flatten an already level carrier playing field. Funneling customers into Apple stores and away from those of the carriers disallows the latter to sell its floor space and SPIF the sales guys with Samsung market dollars or the Chinese made house brand. In other words, Apple is trying to suck the oxygen out of the carriers' nicely attired showroom floor and deny them any advantage not to mention the sales of high margin accessories.
The buyback program, which offers over $300 on a used iPhone 5 and over $200 on an iPhone 4S means existing customers no longer have to pay the upfront $199 cost on a new iPhone every two years and that these customers going forward become more loyal to shopping at Apple. A reduction in the cost to upgrade every couple years is very similar to how BMW and Mercedes arrange 3 year leases on new cars while flipping the used model to middle market buyers who otherwise might buy a new American car. High resale values have enabled the brand to go downmarket without damaging its image -- unlike what a $300 phone would have done.
While many analysts fretted over the decline in Apple's margins over the past year and proclaimed that there was further to go, especially if the company went down market with a $300 device, the truth is that there are many fungible dollars swirling around the carrier and retail channels that need to be run through a wash board. Apple's early carrier partners had exclusives that allowed rich data plans to be put in place. If one looks at the margins of AT&T (NYSE:T) and Verizon (VZ), they are significantly higher than Apple's and has allowed them to fund not only the 4G LTE build out but also a very high dividend to its investors.
Apple's plan to draw customers into its stores, allowing Walmart (NYSE:WMT), Target (NYSE:TGT) and other retail players to offer discounts of $50 or more and to expand the cellular carrier to beyond AT&T and Verizon to the no contract companies like Virgin Mobile are all designed to commoditize the carriers and thereby likely to lead to higher iPhone sales and margins. It will be interesting to see how this all plays out in the coming quarters.
Disclosure: I am long AAPL. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.