Why Apple's iPad May Soon Be Subsidized

| About: Apple Inc. (AAPL)
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I've written three articles already about Apple (NASDAQ:AAPL) iPhone's fundamental importance to wireless carriers, like AT&T (NYSE:T), Verizon (NYSE:VZ), and Sprint (NYSE:S). My first article analyzed the overall importance of Apple to Verizon and AT&T. In my second article, I took a game-theory approach in arguing against the iPhone subsidy cuts. Finally, in my third article analyzing Apple's crucial importance to the wireless communication providers, I took a deep analytical approach utilizing the effects of churn rates and new customer subscriptions. So, what's the next trend I see coming? iPad subsidies.

My analysis for this came from applying the customer lifetime value approach, which is a new shift in the business model, viewing customers in terms of how valuable they are in their lifetimes as loyal customers. Essentially, it's a simple finance question: finding the net present value of the profit per customer. This approach is a far cry from the traditional business model of making a quick sale and moving on and finding a new customer. Instead, as much research has shown, it's cheaper and more profitable for the firm to retain customers and "milk" them throughout their lifetimes. This approach has really gained traction in just the past two decades, as competition has become fierce.

So, let's look at this from AT&T, Verizon, and Sprint's point of view. As businesses, they want to maximize their profits over a customer's lifetime. How do they do this? They're fully aware that customers do not want to be tied down to contracts which force them to pay $50-$150/month; to sidestep this issue, carriers subsidize the cost of the mobile device, completely shifting the position of negotiation. Instead of customers saying "there's no way I'm going to pay $650 for an iPhone and another $90/month for a plan" it becomes "well, I always wanted an iPhone and for $200 it seems like a pretty good deal" while pushing off the monthly cost. What happens here is customers overlook the entire picture because they're focusing on the great aspect of the cheap iPhone.

Now, let's analyze why the iPad may soon be a subsidized product. In Verizon's last financial report, it reported that data revenue, as a percentage of total service revenue, increased from 38.1% to 42.9% quarter-over-quarter. This dramatic increase signifies the future of where service providers are heading to supply customer demand: data-plan servicing. As competition increases in the data plan market, capital expenditure will increase dramatically with it, in efforts to reduce their cost per gigabyte of data. This will become so fierce that large providers like Verizon and AT&T may have to give bonus products at cost to maintain their marketshare; consequently, pushing off the weaker players from the market. It's going to become the same situation as with the iPhone: subsidize tablets, hook the customers, and generate revenue by bundling other products and services until the providers can cut the cost of providing services to generate more profit.

This is the result of capitalism: it drives businesses to extremes just to stay competitive. It becomes highly beneficial for consumers as the data plan war rages, but also highly beneficial for tablet providers like Apple and Samsung (OTC:SSNLF). The Samsung tablets may or may not be subsidized because they don't provide the same life-long customer value Apple products provide: low churn rates, very high customer satisfaction, and strong customer loyalty. I'm fully aware that the idea of subsidizing the iPad hasn't been discussed yet and will be met with opposition, but before saying "no" just for the sake of saying it, think about this then respond. Historically, the iPhone has been the staple of all phone providers; being the leader in attracting new customers and retaining them. Now that every major mobile carrier is already subsidizing the iPhone, they'll start looking for other ways of bringing and keeping customers which I believe will be through the iPad. By subsidizing the iPad, carriers won't only be attracting new customers, but they'll be building on the Apple Ecosystem, which will become paramount in sustaining an extremely strong customer loyalty base. I'm currently writing another article titled "Apple: The Only Thing Keeping Sprint Alive," and in this article I take an even deeper analysis of Apple's deep intrinsic worth to mobile carriers; this article will be released later today and should be read in follow up to this article to have a well-rounded understanding of my analysis.

Five years ago, the idea of subsidizing $450 of the iPhone seemed ludicrous, but it was quickly adopted because carriers had to remain competitive. This can also be analyzed through a game-theory approach. Let's say in our competitive market, AT&T and Verizon have established marketshares, with new entrants trying to claim marketshares for themselves. In order for smaller telecommunication companies to compete against pre-established marketshares, they need to provide an incentive that is strong enough to move customers from one company to another. Keep in mind that customers don't like change and won't take the extra effort in switching over unless it's worthwhile. Now, let's assume that Sprint wants to claim marketshare from Verizon and AT&T, who have already invested far more in creating a strong networking infrastructure; in order for Sprint to create a customer base, it will deploy the very same business strategy used by Google (NASDAQ:GOOG), which is to sell and bundle its services at a far cheaper rate in order to penetrate the market. How will Sprint do this though? It's already providing the same subsidies on its phones and charging the same for its service plan that Verizon and AT&T are, so what can it really do? Its telecommunication infrastructure, brand image, and competitive edge are currently inferior to giants like Verizon and AT&T, so it's forced to employ a completely new tactic to gain marketshare. In my analysis, this will be through subsidizing the iPad.

By subsidizing the iPad in conjunction with the iPhone, Sprint can create an Apple Ecosystem for its clients. Essentially, the ecosystem is the seamless integration of Apple products together that creates a lasting positive impression on the customer. From doing this, Sprint can promote increased sales in other areas of its business and help increase its bottom line through customer retention and new customer subscriptions. What's even better is that customers who use the iPhone and iPad together with Sprint will have the lowest rate of churning to another carrier. This business strategy will be successful in helping Sprint achieve its most imminent business need: lifting its bottom line profitability by increasing its marketshare and customer retention. In the short run, the cost of subsidies will be extensive, but will pay itself over through increased buzz over Sprint's products and services.

This will lead to other small carriers implementing the same strategy and, when it becomes a threat to AT&T and Verizon's marketshare, they'll have to implement the same strategy as well. In the end, those who moved first in implementing this strategy, like Sprint, will profit at the expense of AT&T and Verizon's marketshare. Who, though, is really benefiting the most from this fight over marketshare? It won't be the large carriers who were forced into adopting the strategy, but rather, the small carriers who increase their marketshare, profitability, and customer retention through utilizing Apple's Ecosystem. In the end, the nash equilibrium results in wireless carriers adopting the subsidies to retain their marketshare, customer base, and bottom-line; even if it may not be the most profit-oriented strategy.

Disclosure: I am long AAPL, LNG. May initiate a position in Sprint.