Insanely Savvy

Why Verizon’s decision to pass on the iPhone six years ago is looking better and better.

The Apple iPhone

Six years ago, Steve Jobs, the reality-distorting founder and CEO of Apple, held a series of secret meetings with executives from top telecom companies. Apple executives were preparing to dip their toes into the cell phone market with the Rokr, a Motorola smartphone with iTunes software. But they were also preparing to plunge in with a bigger and better product of their own. Jobs wanted carriers to help develop a new smartphone—what we now know as the music-playing, touch-screen-sporting, video-streaming, app-launching iPhone—in exchange for an exclusive five-year revenue-sharing deal. Verizon said no. Cingular, now known as AT&T, said yes.

For Verizon, the decision became infamous, the industry equivalent of passing on Michael Jordan in the NBA draft. It was an “incredibly bad decision,” as one blog put it succinctly. Verizon has been forced to watch as the breakaway success of the iPhone pushed legions of profitable smartphone customers to AT&T. Although Verizon remains the largest wireless carrier, with about 8 million more subscribers than AT&T, AT&T’s wireless business has grown faster than Verizon’s in the past few years—due in no small part to its exclusive deal with Apple.

Since 2007, AT&T has picked up millions of new contracts from customers coming just for the iPhone. In its most recent annual report, it gloated, “Compared with our closest U.S. competitor, twice as many smartphone users have chosen AT&T—one of the key factors driving wireless revenue growth of nearly 9 percent.” Asymco, a mobile app developer and analysis firm, concluded simply: “The iPhone has stolen Verizon’s growth.”

But soon AT&T’s exclusive contract with Apple for the iPhone will come to an end. Tuesday, Verizon is widely expected to announce that it will become the second U.S. carrier to offer the iPhone, at a big press conference at Lincoln Center in Manhattan. (Even if Verizon has, for some strange reason, decided to punk the press and does not make the announcement Tuesday, it has confirmed that it will be offering the product at some point in the near future.)

Any way you look at it, that is great news for Verizon (it gets to compete for the iPhone market!) and bad news for AT&T (it has to compete for the iPhone market!). And with Verizon finally getting on the iPhone action, it’s time for a reassessment of its fateful decision six years ago to pass on the Apple product: Was saying no really such a bad thing for Verizon? With the benefit of hindsight—and the prospect of a Verizon iPhone on the horizon—the decision hardly seems as horrible as it once did. There is a silver lining to that five-year-old, earnings-dulling gray cloud.

Most importantly, when AT&T threw its lot in with Apple, it really threw its lot in with Apple. The company offers a broad range of smartphones, but has nevertheless developed a wireless business dependent on the iPhone for both sales and margin. As noted above, most of AT&T’s new smartphone customers come not just for the company’s service, but for Apple’s product. With that product now available elsewhere, if Verizon offers better or cheaper plans or service, AT&T’s customers might abandon it.

And AT&T depends on the iPhone not just for most of its new customers, but for its most lucrative customers. The “iPhone exclusive continues to deliver high-value subscribers with [average revenue per user] approximately 1.6 times higher and churn rates significantly lower than the company’s overall postpaid subscriber base,” AT&T itself said—fatefully—in a 2009 quarterly report. (It later stopped breaking out the iPhone’s average revenue per user, instead folding it in with all smartphone data.) Verizon, in contrast, depends less on any one business relationship or product. (For instance, it runs a healthy business selling phones running Google’s Android software—and Droids just overtook iPhones in total market share.) And iPhone sales, for Verizon, will be gravy on an already profitable business, rather than the core of a profitable but newly shaken one.

Moreover, by waiting, Verizon has had a chance to learn from AT&T’s mistakes. The most prominent mistake, of course, is its purported failure to develop a network that could fully handle all of the iPhone traffic. Ever since the debut of the iPhone in 2007, users have complained loudly and persistently about AT&T’s spotty service, dropped calls, and insufficient bandwidth. Those complaints have been particularly loud in tech-savvy cities such as New York. And they have been downright raucous at major technology conferences—where the all-important gadget press has repeatedly trashed AT&T for failing to provide decent coverage. People, frankly, hate AT&T’s service.According to Consumer Reports, the company gets lower cell-phone customer satisfaction scores than any other U.S. carrier.

That reputation for poor service bodes well for Verizon’s plans to woo some iPhone fans from AT&T. Investment bank Credit Suisse, for instance, found that about one in five AT&T iPhone users would consider switching to Verizon. Davenport & Co. reportedly estimates that as many as 40 percent of AT&T’s subscribers might jump ship when offered the chance. And presumably Verizon will attract a healthy number of new iPhone customers as well.

The 61.5-million-subscriber question, of course—that’s the size of the U.S. smartphone market—is whether Verizon can learn from AT&T’s mistakes. But it is certainly trying. Verizon has worked to complete development on its fourth-generation LTE network, now available in 38 U.S. cities, before the iPhone announcement, while AT&T has been playing catch-up with its upgrades. Verizon also is reportedly going to offer popular, loss-leading unlimited data plans when it brings the new product on.

So even though it has lost out on the iPhone boom for the past few years, Verizon may be well positioned to compete for smartphone customers in the future. This is not to say that Verizon will start trouncing AT&T immediately. For one, AT&T has raised exit costs for its iPhone customers, upping the early termination clauses on many contracts from $175 to $325. It has also worked to lock customers into longer deals—meaning defections, when they happen, will happen slowly. And it has encouraged many users to sign up for business or family contracts, ones with lower churn.

But nevertheless, after almost four years of an iPhone monopoly, AT&T will have to deal with a bigger, more diverse competitor. So maybe Verizon did the right thing by passing on that hotshot CEO’s pitch in the 2005 cell phone draft.

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