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We recently experienced Apple's (NASDAQ:AAPL) stock price falling rapidly in response to a rumor floating around, speculating that Verizon (NYSE:VZ) and AT&T (NYSE:T) were going to cut the iPhone subsidies. In response to that rumor, I wrote an article underlying Apple's true value to both Verizon and AT&T; now, though, I'll expand this to show how Apple is literally keeping Sprint (NYSE:S) alive.

These summary points are from my previous article Top 2 Growth Stocks, And 1 To Avoid, from which I will further elaborate my analysis on:

Why do Verizon, AT&T, and Sprint subsidize 75% of the iPhone cost?

  • The iPhone has the highest customer retention rate of all other smartphones, providing long-term value to service carriers
  • Builds up the bottom-line profitability
  • Sprint recently disclosed losses of $863m last quarter, but the CFO consistently emphasized the iPhone's importance to Sprint's long-term success
  • Of the 1.5 million devices activated, 44% were from the iPhone; 40% of the iPhone subscribers broke contracts with other carriers
  • Of those who signed up with the iPhone, 60% signed up solely because of the iPhone and wouldn't have come otherwise

Also, to note, although carriers pay a much larger subsidy for the iPhone, it pays off its value fairly quickly. The rate of customers exchanging their iPhones for other smartphones is half of what other smartphones are experiencing, signifying that customers who sign up with the iPhone are much more likely to stay with the iPhone because of its strong positive effect on the customer's experience. The iPhone also experiences among the lowest early-life customer service calls, which is crucial in building strong customer loyalty early on. In addition, Sprint just experienced the highest percent of customers on contract, largely attributable to the iPhone.

I found this research report to be extremely helpful in illustrating the economic impact of churn rates. Essentially, even a 0.1% reduction in churn rates leads to increasing profit tremendously. Another article illustrated that increasing customer retention (through lower churn rates) by merely 5% can lead to a 25%-100% increase in bottom-line profitability.

In a previous article, Why Apple's iPad May Soon Be Subsidized, I touted the possibility of the iPad being subsidized in the future. This would be a wise strategic move for Sprint in subscribing new customers and keeping them for extended periods. There's something called the "Apple Ecosystem" and it's the seamless interconnectivity of Apple products which, when combined, create a much greater user experience. By utilizing the Apple ecosystem, Sprint can use the subsidized iPad as another staple in creating a strong customer base while reducing churn rates. This flows perfectly in line with an economic theory called utility which illustrates the reason why we purchase products at certain prices; the reason being that even though the product is priced at $100, we may actually see $120 of value in the product; the additional $20 being our additional utility (value).

Here's where it gets very interesting. In the Apple ecosystem, where you have multiple Apple products working seamlessly together, there's an unaccounted additional utility created from the combination of products. Let's say you pay $200 for an iPhone and see $600 of utility in it, then pay $600 for an iPad and see $800 of utility in it. From the iPhone, you receive an additional 400 utility and from the iPad, an additional 200 utility. You would assume that when using the iPad and iPhone together, you'll receive 400+200=600 additional utility (value); however, that is not the case.

In combining Apple products, the summed utility becomes greater than the sum of the individual utilities. Instead of receiving the expected 600 utility, you may actually receive 800 utility. This is why you hear Apple "fanboys" raving about the Apple ecosystem; because everything, from the iPhone, iPad, and iMac to the cables and earphones, creates additional utility (value).

Traditionally, businesses would focus just on making a sale and moving on; however, studies have shown, time and time again, that it's much cheaper and much more profitable to retain old customers than to get new ones. The iPhone's ability to minimize churn rates while maximizing the customer experience with the wireless telecommunication company makes it a staple in generating long-term value.

With competitors like Verizon and AT&T, Sprint has to employ any means to bring in new customers and keep them. Fortunately, as the CFO stated repeatedly, the iPhone has become Sprint's light at the end of its tunnel. Additionally, I see the possibility of Sprint taking the first step in utilizing the Apple ecosystem in creating its strong customer base. This strategy will lead to decreased margins, but will lift Sprint's bottom-line profitability, effectively ending its source of bleeding profit.

Source: Apple: Sprint's Savior