iPhone will test loyalty of cellular customers

Editor’s Note: This story is reprinted from Computerworld. For more Mac coverage, visit Computerworld’s Macintosh Knowledge Center.

Sprint Nextel recently lowered online music prices and introduced a feature-rich but low-priced music phone. Verizon Wireless is allowing potential subscribers to try its network for free for 30 days. Phone vendors are announcing a steady stream of flashy music phones such as the Samsung Ultra Smart F700 and LG’s Prada.

Many believe there’s one reason for this burst of activity: the iPhone. Few have seen Apple’s forthcoming phone/media player, which AT&T/Cingular says it will release in June, but it has been the topic of frantic, sometimes fanatical online discussion. And other cellular operators appear to be busily preparing themselves for its release.

Another word, loyalty, sums up the reasons for the strong response from AT&T’s competitors. Some analysts say that AT&T is attempting to use iPhone to radically change the loyalties of cellular subscribers. These analysts note that, while most subscribers aren’t very loyal to their cellular operator, many people are fiercely loyal to Apple and its iPod media players.

“We did a survey and we found … carrier loyalty wasn’t a big issue. People aren’t that loyal,” said Miro Kazakoff, director of the wireless practice for market research firm Compete. “So [AT&T] is trying to transfer loyalty to the device, not the carrier.”

In other words, Kazakoff said, AT&T is using the iPhone to create customer loyalty where little loyalty exists. That, in turn, would translate into more subscribers who are less likely to leave the AT&T fold. Seen in this light, iPhone is a potentially powerful marketing tool that AT&T’s competitors can’t ignore.

Nonchalant competitors

Superficially, Verizon Wireless and Sprint, the second and third largest cellular operators in the U.S. behind AT&T, are nonchalant about the potential challenges presented by iPhone.

“Publicly, they’ve adopted the dual stance of being nonchalant about iPhone and trumpeting their own music offerings,” Kazakoff said. “But they’re working to build out their services to compete. They’re not really nonchalant at all.”

Verizon Wireless didn’t return calls requesting interviews for this story. However, Alana Muller, Sprint’s director of wireless data marketing, said that her company would have lowered prices, from $2.50 a song to 99 cents, and introduced new music phones even without iPhone’s imminent entry into the market.

Having said that, however, Muller drew a sharp distinction between Sprint’s offerings and those of AT&T/iPhone. In particular, she spoke about Sprint’s recent introduction of the Samsung UpStage music phone, which, at $149, is far less expensive than the $500 iPhone. And, unlike iPhone, UpStage can download songs over the air, she said.

“We’re putting music in the hands of the masses,” Muller said. “We have nearly a dozen devices that can access our online music store and we have a lot of great devices. The UpStage is very cool and the price can’t be beaten. I see no reason for a customer to leave our service.”

The high stakes

While AT&T’s competitors are trying to be nonchalant, the stakes are unquestionably high for all operators, including for AT&T itself. Working with Apple to develop iPhone is so resource-intensive that the project required approval by AT&T’s board, executives acknowledged in January when iPhone was announced. Board approval for introducing a cell phone is unheard of in the cellular industry.

That puts a lot of pressure on AT&T to successfully sell a lot of iPhones and to use the device to attract new customers. Verizon Wireless obviously didn’t think it was worth the gamble, claiming it turned down the opportunity to sell the iPhone because Apple was asking so much that selling the device was not a sound business decision.

Then, there’s the real issue behind loyalty: money. A cadre of new and loyal customers would mean a lot of new, ongoing revenue to AT&T and a corresponding loss of customers by AT&T’s competitors. In the jargon of the cellular industry, AT&T is trying to use iPhone to create churn among its competitors’ subscribers and minimize churn for itself, said Derek Kerton, principal of The Kerton Group, a telecommunications consultancy. Churn refers to a subscriber leaving one cellular operator and signing on with another.

“So far, there haven’t been many phones or devices or content that can churn a customer from one carrier to another,” Kerton said. “Nobody ever left [cellular operator] X because Y had a 50 Cent ringtone and X didn’t. The reason that Verizon and Sprint may be scared is that, at this point, iPhone might actually be the product that can churn a customer.”

Interestingly, however, some of that churn may not translate directly into sales of iPhones, said Tole Hart, a research director for Gartner.

“The iPhone will have a halo effect that will bring people into the [AT&T] store,” Hart said. “It makes AT&T a cool brand.” But that doesn’t necessarily mean that those new customers will fork over $500 for an iPhone, Hart said. Once they’re attracted to the AT&T brand, they could just as easily buy other, less expensive models, Hart noted.

The music business

Yet another reason AT&T’s competitors should be concerned, Kerton said, is the carriers expect to make a lot of money selling music but haven’t yet succeeded. iPhone could give Cingular a leg up in the potentially lucrative mobile music market, he said.

“The concept of a mobile iPhone demolishes Sprint’s and Verizon’s concept of an online music store,” he said. “When they started [selling music], people asked, what does Verizon or Sprint offer that Apple didn’t? The answer was mobility. You could get a song [while mobile] when iPod couldn’t.”

But, Kerton stressed, at $2.50 a tune, the cellular operators charged too much compared to 99 cents charged by iTunes. At those lower prices, people were perfectly happy to download music to their PC, then “sideload” it to their iPod, Kerton noted.

“Sideloading was firmly established as cheap and easy,” Kerton said. “Spend $2.50 for a download? There was no way. Apple and the iPod made [sideloading] brain-dead simple.”

With sideloading well-accepted by digital music users, iPhone’s inability to download music over-the-air won’t hurt it much and will help AT&T gain revenue from music, Kerton said. In particular, that revenue will come from selling data plans to iPhone users, he said.

Despite these challenges, Verizon and Sprint should be able to compete against AT&T and iPhone, particularly given iPhone’s steep initial price, Kerton said.

“[Sprint and Verizon] will have to accept sideloading and they’ll have to pressure their phone vendors to produce mobile music phones with a lot of the functionality of iPhone,” Kerton said. “The good news for them is that, to prevent churn, they don’t have to be quite as good [as iPhone]. But they can’t be too far behind, either.”

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