Slow but steady: How the iPhone is changing the phone industry

Every time Apple enters—or seems to even think about entering—another market, we’re barraged with noise about how the company should, or must, or can’t reinvent this industry. Why all the attention? Because Apple has a remarkable track record of having reinvented industries before, and the reward for a job well done is—surprise—another job.

The critical backlash to Apple’s involvement, or rumored involvement, is frequently immediate and vehement: Nothing’s changed! Apple’s failed!

Because it’s not just that people expect these markets to change—it’s that they expect those changes overnight. But these shifts don’t usually happen immediately or catastrophically; more often than not, it’s a gradual, tectonic erosion of the established norms.

At the launch of the iPhone, then CEO Steve Jobs did not hesitate to proclaim, in his usual hyperbolic fashion, that the handset would reinvent the phone.

But Jobs prefaced the introduction of the iPhone by discussing two of Apple’s previous revolutionary products:

In 1984, we introduced the Macintosh. It didn’t just change Apple, it changed the whole computer industry.

In 2001, we introduced the first iPod. And, it didn’t just change how we all listen to music. It changed the entire music industry.

Moving directly from those to announcing the iPhone, Jobs’s implication was clear: This product wasn’t just about changing the phone as a device.

In the months leading up to the announcement—and in the years afterward—there have been more than a few rumors that Apple might extend its different-thinking ways to the cell phone industry itself; say, by becoming its own carrier, perhaps by selling rebranded service as a mobile virtual network operator (MVNO).

To date, Apple hasn’t taken these steps—nor do I think it intends to. But its influence has still unquestionably been felt in the wireless industry at large. And while you might not be able to draw a single, direct line of causation, it seems clear that the rise of the iPhone and other smartphones are nudging the industry onto a new path, whether the industry likes it or not.

The beginning of the end of subsidies

In 2007, Apple struck an exclusive deal with AT&T (then Cingular) to distribute the iPhone, a situation which lasted until early 2011. As part of that initial deal, AT&T would not subsidize sales of the handset—instead, Apple got a portion of the carrier’s subscriber revenue.

That was in itself unprecedented, but it didn’t end up benefiting Apple as much as the company might have hoped. At a time when people could pick up less capable phones for free or cheap—as long as they signed up for a two-year contract—the subsidy-free $500 price tag was too costly for many mainstream consumers.  Apple ended up cutting the price, and since the subsequent introduction of the iPhone 3G in 2008, Apple has operated on the same subsidized model as everybody else.

But in the last six years, the smartphone market has become more and more established; unlike in 2007, when the iPhone was an unknown quantity, people are now familiar enough with these devices that they’re willing to invest more money upfront, instead of paying it out over the course of a 24-month term.

Take the iPad, for example. At $459, even the 16GB version of the cellular-enabled iPad mini costs a pretty penny. But it brings with it the option to sign up for a monthly cellular data plan without any long-term commitment, allowing you to cancel at any time. (Of course, you can’t really switch your iPad to a different cellular network, but more on that in a bit.) The cheapest of those plans is just $15 per month—far less than what you’d pay for a monthly cell phone plan.

That’s not the only indication of change, either. Late last year, T-Mobile announced its plan to drop both subsidies and contracts. Though that will result in higher upfront costs for handsets, it also stands to lower monthly service costs, since the company won’t have to recoup the handset subsidy over the lifetime of a customer’s two-year contract. Given T-Mobile’s spot as the smallest of the major U.S. carriers, it’s no surprise that it’s the first to forego this time-honored practice—of its competitors, it has the least to lose and the most to potentially gain.

Of course, there’s no guarantee that this trend will sweep across the board: It’s a much riskier proposition for the likes of Verizon, AT&T, and Sprint. But this does open up a hole in the traditionally locked-in cell phone field. Now, if T-Mobile doesn’t have you under contract, you can leave without having to pay an early termination fee—if, of course, you have an unlocked phone that can switch networks. Which brings us to another point …

Unlock and load

It’s not only legal documents like contracts that keep us tethered to a particular carrier. Technology is likewise used to make sure that we customers don’t stray from our one true carrier. In the past, the use of different network protocols and radio frequencies made it impractical to jump from carrier to carrier. These days, the increasing prominence of world phones and convergence on standards like LTE have reduced some of the friction of changing carriers, but in the U.S. most phones remain, by and large, still locked to individual carriers.

Even worse, though it’s not hard to find a way to unlock phones, the process of circumventing that restriction is currently illegal for any phones purchased since the beginning of the year. Which is a bit like selling a TV that only works with a single cable provider.

There are already signs, though, that a shift is underway. Some handset makers are selling unlocked phones, though the lack of carrier subsidies means that the prices are much higher. For example, an unlocked 16GB iPhone 5—which only works on certain networks in the U.S.—costs $649, making the subsidized $199 figure seem like pocket change; even the original, unsubsidized iPhone was less expensive.

At those prices, the device itself becomes a significant investment. And it’s an investment that many consumers will want to hold onto, even if they decide they want to switch carriers. Like the iPad mini, they don’t want to be bound into an expensive contract when they’re already paying so much upfront for a device.

Surprisingly enough, there are actually indications that the carriers have slowly begun to loosen some of these strictures. AT&T will now generally unlock iPhones if they’re no longer under contract. The Verizon iPhone 5, meanwhile, has a SIM slot that is unlocked by default, though the phone itself isn’t compatible with AT&T or T-Mobile’s LTE networks in the U.S. Even more recently, Sprint announced that out-of-contract devices could be ported to MVNOs that use the carrier’s network, like Virgin Mobile and Boost Mobile.

And even though the Library of Congress did not renew the DMCA exemption allowing customers to unlock phones, the White House this week  responded positively to a public petition, calling the ability to unlock phones “common sense, crucial for protecting consumer choice, important for ensuring we continue to have the vibrant, competitive wireless market that delivers innovative products and solid service to meet consumers’ needs.”

In and of itself, the administration can’t change the existing law, but movement is already afoot from several corners to introduce new legislation allowing for phone unlocking. Of course, the wheels of government often grind exceedingly slow, but this is one of those drops in the bucket that presages the bucket running over.

This is page two of two. Read page one.

Micro message machine

For those who argue that the carriers are too deeply rooted for real change to ever happen, the microcosm of text messaging provides a useful object lesson.

Text messaging has long been a staple service of carriers, because they can charge through the nose for it despite the fact that it costs them next to nothing for you to send a single text message, or even a thousand text messages. Regardless of whether you pay per-message or for a monthly allowance of messages, you can rest assured that the carriers are raking in a healthy profit.

But with the advent of smartphones, there are suddenly a number of other options. You can send an email. Or download an instant messaging app. Or, perhaps most damningly, use the built-in private messaging features of social networking services like Twitter and Facebook.

Suddenly, there are dozens of popular messaging apps looking to supplant the text message. Even the platform makers themselves have waded in, with the likes of iMessage and Google Voice, which provide traditional text messaging features but use the pipes of the phone’s data network instead of the voice network.

And as entrenched as text messages might be, there’s already been a dent: At the beginning of 2012, text messaging was down globally, but still growing—albeit at a slower rate—in the U.S. Before the end of the same year, text messaging had started to decline in the U.S..

It’s no wonder that the carriers moved to preempt this by “streamlining” the text messaging packages they offered, as AT&T did in 2011—it’s about bringing in as much money as possible before that revenue stream dries up completely (or, as they say in business lingo, “managing for profit”). And while the text message remains the lowest common denominator of phone-to-phone communication, its long-term prospects position it somewhere north of the fax machine.

Switcheroo

Historically, the power has been firmly in the hands of the carriers: They dictated which phones a customer could buy, which ones would work on their network. As a result, the phones themselves had become largely commoditized, and with a captive customer-base the cell phone networks themselves had very little reason to improve what they were doing.

There was a decided lack of counterweight to the carriers’ influence—phone manufacturers had a limited number of venues for their product, and, due to contracts and locked phones, it was an uphill slog for consumers to put one’s money where one’s mouth was by switching carriers.

So what happened?

Despite former Palm CEO Ed Colligan’s infamous insistence that the “PC guys are not going to just figure this out,” that’s exactly what ended up happening. The smartphone revolution didn’t come from Motorola, or Sony Ericsson, or Nokia, or even Palm itself—it came from Apple and Google. They made devices that attracted the consumer, and which weren’t simply interchangeable with the millions of other phones already out there.

And so the balance of power has begun to shift in favor of the companies making the actual phones. While some customers will undoubtedly continue to make their purchasing decisions based on the service available in their area and the quality thereof, many parts of the country are saturated in wireless offerings; in those places, which include many of the most profitable, concentrated markets, the game is now about which device the consumer wants.

It’s possible that the carriers may try to curb the influence of the manufacturers—that’s ever the case with middlemen who have grown used to their comfortable position. But in doing so, the wireless providers now actually run signficant risks.

AT&T

Smartphones aren’t just a niche product anymore; they now make up an overwhelming percentage of the handsets that the carriers sell. According to Verizon, 87 percent of postpaid devices sold by the carrier in its most recent quarter were smartphones; both Sprint and AT&T reported the same statistic at 89 percent. And the iPhone’s a big part of that—according to Verizon, 53 percent of its smartphone activations in 2012 were some model of Apple’s handset, and Verizon’s iPhone sales are lower than AT&T’s.

Customers clearly want smartphones, and taking measures like throttling their data usage or breaking out features like tethering and messaging into additional costs is tantamount to the carriers cutting off their nose to spite their face. Or, to paraphrase an old favorite: The more they tighten their grip, the more customers will slip through their fingers.

In truth, the carriers have run up against the fundamental problem of their business model: They own the streets, but they don’t make the cars. And other than paying their taxes to make sure they stay open and pothole free, people don’t really care much about their streets.

Think about it. Few, if any of us, really love our wireless carriers, any more than we love the roads we drive on. When carriers and streets work, we don’t think about them; when they don’t, we start concocting ways to switch to other, better maintained avenues.

Freedom, that’s what I need now

Imagine that you didn’t have to deal with the illegalities and technical finagling of unlocking your phone and taking it to another carrier. The competitive landscape sure starts to look a lot different in this not-unreasonable fantasy world: Carriers will have to work harder to differentiate themselves, and that means offering more to customers, whether it be options like unlimited data, cheaper costs for adding on features like tethering, more cost-efficient family plans, or other incentives.

This seems to be what T-Mobile has up its sleeve, though the company hasn’t yet disclosed all the details of what its contract- and subsidy-free future looks like. But I imagine that both its rivals and consumers will be watching the experiment with interest.

Right now, the state of the industry reminds me a bit of the slide we saw with Digital Rights Management in the music business just a few years ago. The snowball’s rolling downhill, momentum is growing, and it seems only a matter of time before it achieves critical mass and bowls over the established players.

And just as Apple started that ball rolling with the abolition of DRM (on music, anyway), the company’s done the same here, if more subtly. Steve Jobs’s proclamation that Apple was going to reinvent the phone may have been overtly aimed at consumers tethered to their BlackBerries and dumbphones, but it was also a message to the carriers that their days of influence were numbered.

So, alongside the notches in its belt for its revolutions in computing and music, Apple can now add one more. Or, to put in a more Jobsian fashion: In 2007, Apple introduced the iPhone. And it didn’t just change the phone—it changed the entire telecommunications industry.

Updated at 6:28 a.m. PT to clarify status of Verizon iPhone 5 SIM slot.

Updated at 6:39 a.m. PT to clarify current laws about unlocking.