Apple (NASDAQ:AAPL) continues its relentless run at Asian markets with its DoCoMo deal and an imminent agreement with China Mobile (NYSE:CHL) if we are to believe the rumors. SA Author Ed McKernan has written an excellent recent article that sets out how Apple is using carrier agreements in Japan and China to offer users competitively priced iPhones while maintaining its high margins. Like the Verizon, AT&T and Sprint deals in North America, the approach is to have the carrier highly subsidize the iPhone in return for a contractual commitment of two or more years with the carrier betting that data usage fees will more than offset the cost of the subsidy and the strength of iPhone demand making it worthwhile for all parties.
I had a sense of déjà vu when I read his article. It seems that was the approach Apple took in North America over the past few years extracting very favourable terms and volume commitments from Verizon, Sprint and AT&T in granting them the right to carry the iPhone at its peak of popularity.
Last July there were numerous press reports that Verizon had a $14 billion commitment to Apple for unsold iPhones and a lot of speculation as to how both Verizon and Apple would deal with the issue. About a year ago, there were similar reports about the problem Sprint faced with a $15.5 billion commitment to Apple. At the same time, reports suggested AT&T had an unfilled commitment of about $3.8 billion, nowhere nearly as formidable but not chump change either.
What became of these obligations? There has been very little coverage of the issue since last July and I could not find any announcements as to resolution of the problems.
Fast forward to the recent underwhelming introduction of the iPhone 5C which did not set the user world on fire with demand. Not much more than a colorful iPhone 5 in a plastic case, it did little to stimulate price conscious consumers to line up overnight to get their hands on one. Best Buy, Wal-Mart and RadioShack are now offering the iPhone 5C at $50 or less with a two year plan from any of Verizon, AT&T or Sprint.
Maybe this is the exit door for the carriers. By shifting their emphasis to the lower priced iPhone they are helping Apple move a lackluster product and at the same time working off their obligations. Does it seem likely they will enter into similar long-term contracts with Apple in the future? If it is, they are keeping it pretty quiet.
At the same time, for all the claims that the iPhone is the premium product in the industry, Verizon is offering the popular iPhone 5S for $199 with a two year plan, a price below its $299 offering of the Motorola Droid MAXX and Samsung Galaxy Note 3 and on par with its price for the HTC One and the Moto X. Sprint is offering the iPhone versions at prices from zero to $99, less than it charges for the HTC One or even the BlackBerry Q10. AT&T has priced the iPhones more normally with the iPhone 5S priced between $199 and $399.
Could it be that Verizon and Sprint are pricing iPhones to move volume and meet their massive purchase commitments? It seems that is the case. If it is, the law of unintended consequences may prevail because it is pretty clear that while iPhones may be "premium" they are no longer "top of the line". Regardless of volume, I haven't seen a Mercedes S class priced below the top of the line Cadillac or Lincoln and I would short Daimler stock the day I did.
It is likely that Wal-Mart and RadioShack will move a lot of iPhones over the holidays. I am not so sure that is good for Apple. Simply put, they are not the retail channels I associate with the premium brands. A new iPhone for $50 does not seem to capture the essence of luxury any more than a Hermes handbag would if sold for $249.99.
Maybe the pricing will work out well for Apple, but maybe it will water down the world's most valuable brand. Time will tell. What goes around comes around.
I am short Apple calls expiring January 2014 at a $500 strike.
Disclosure: I am short 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.