AT&T's business model: why your mobile bill keeps going up

In my latest post on the Windows Phone 7 update brouhaha, I wrote one paragraph that I thought was perfectly uncontroversial:

Carriers don’t want to sell you a new phone. They want you to pay them a monthly bill, preferably a big one with a full data plan and a bunch of add-on services. New phones cost them money, in the form of subsidies they pay the handset maker in exchange for getting you to agree to a two-year contract to pay that big monthly bill. You pay off that subsidy over the life of your contract. When the contract is up, your carrier is perfectly happy if you keep paying the big bill.

I have now received a handful of e-mails and comments, most of them anonymous or using fake return addresses, from people telling me they think that my belief is "clueless" and "stupid" or that they heard someone else say that.

Well, the anonymity makes it impossible to continue the discussion directly. And playing the "stupid and clueless" card as part of your opening statement is not exactly a conventional debate tactic.

But I think the discussion is worth having, so let me add a few nuggets of good solid evidence for my argument. Mobile carriers want to ratchet up your bill by getting you to use high-margin data services. And that's not just my opinion; it's right there in published documents from one of the world's biggest carriers, AT&T.

AT&T is Microsoft's most prominent partner for Windows Phone devices in the United States so far, and the company has an exclusive partnership with Apple in the U.S. AT&T moves a lot of product for a lot of handset makers. This official statement from June 2009, part of AT&T's iPhone 3GS Frequently Asked Questions document, is refreshingly candid. I've boldfaced the interesting sections:

AT&T, like most U.S. carriers, offers a variety of phones that we sell below our actual cost when customers agree to sign service agreements. In general, the more a customer spends with us, the quicker they become eligible for a price break on a new device. For example, iPhone customers who spend more than $99 a month per line with us generally are eligible for an upgrade between 12 and 18 months into their contract. [emphasis added]

They sell the phone for below cost. The difference between the price you pay and the price they pay is a subsidy. They guarantee that they'll collect that subsidy by charging you an early termination fee if you try to back out of your contract before it officially ends. And you can't get a new subsidized phone until you've worked off the subsidy on your current phone. (In practice, few people pay the ETF. AT&T says their churn rate, or the percentage of customers leaving for other providers, was 1.32% in the most recent quarter, and it was even lower for the smartphone category.)

A little later in the same document, they cover the case of customers who still have a year left on their two-year contract:

Q. What about customers who bought in July, August, or September 2008 but don't spend over $99 a month?

A. We value the business of all our customers. Getting a new subsidized device is based on several factors including monthly recurring charges and having an account in good financial standing. In general, the more you spend with us, the less time you have to wait to get another device. This is a very fair system. That said, we do offer early upgrade pricing only for iPhone for those customers who don't want to wait. [emphasis added]

You can find similar evidence if you look in AT&T's financial statements, which talk about the value of "high-quality integrated device subscribers." Those are what the fast-food industry calls "heavy users." In this case, they love you if you spend over $99 per month and use lots of data. They love you today even if you're using an iPhone 3G whose contract has expired.

In the just-ended third quarter, AT&T reported "record integrated device sales," including, one would imagine, many iPhones of the 3GS and 4 persuasions. Again, I've boldfaced the interesting part

More than 8 million postpaid integrated devices were activated in the third quarter, the most quarterly activations ever. More than 80 percent of postpaid sales were integrated devices. (Integrated devices are handsets with QWERTY or virtual keyboards in addition to voice functionality and are a key driver of wireless data usage.) [emphasis added]

A little later in the report, under the heading "Wireless Margins," the company notes that activating all those new integrated devices resulted in "increased operating costs." However, the report notes that "growth in the company’s high-quality integrated device subscribers helped partially offset these costs." In other words, they have more people spending $99 per month or more per device.

Those specific statements are from AT&T, but you can apply the basic business model to every successful modern carrier. Update: In its just-concluded Q3 2010 financial results, Verizon bragged that its average revenue per user (ARPU) for data services was up 19.0% over the past year. The ARPU overall was up a mere 1.8%. As that example makes clear, getting you to pay for more data is where the carriers see financial growth. (And as an aside, it's going to get worse as carriers try to steer people into data plans with bandwidth limits, just as mobile media is beginning to take off. Keep an eye on that discussion in future financial statements from these companies.)

To repeat: Carriers don't care about the phone, except to the extent it allows you to use more of their services. They care about your bill, which is based on how much you use that phone. So, if you and I buy the same subsidized smartphone today, what will happen a year or 18 months from now? That depends. If you're a cheapskate on the bare-minimum data plan, you're not going to be offered an early upgrade discount. But if you've signed up for the top-of-the-line unlimited voice and data and text package, you'll probably get offered a special deal to upgrade.

This is why I'm still unconvinced by the argument that carriers will decide to block Microsoft from delivering updates to some devices. Every single current-generation Windows Phone being sold is an integrated device capable of using gobs of data. If you've got one of those devices, AT&T and its fellow carriers want you to use it more, not less.

Update: In the Talkback section, Orcmid makes an astute observation:

I also think that Microsoft is going to help with those products, and it is going to help by the superb quality of consistent service that every WP7 user will be able to call upon. As I unwrap my HD7, I see it in how Amazon Cellular is able to support discounts and the initial experience consistently for all of the Windows Phones it sells. I can see how this frees the carriers from having to provide increased support for the flexibility (and possible mess-ups) that users of expanded services may require, since so much of it can be in the common on-line support and buddy support that is growing around the WP7, from first-time users to developers.

This may be different than developers-developers-developers (but maybe not), but Microsoft as providing a consistent experience and an integration gateway between devices, applications, users and now carriers may have even better magic than what was accomplished in making the PC safe and appealing for users, manufacturers, and developers.

That didn't dawn on me until I started scrutinizing the purchase, delivery, and open-the-box experience of my HD7 acquisition. It will be interesting to watch.

That ties in very neatly with a conversation I had with a senior Microsoft executive back in June, before the first developer models of the Windows Phone had been released. This statement makes more sense in retrospect:

One of the important changes is who we think of as our customer. Previously, you could argue that we thought about the mobile handset and the operator and eventually the customer. Our primary customer now is the person using the phone.

There's no question in my mind that Microsoft is trying to remove that layer of friction by relieving carriers of the significant headaches of updates and support. Time will tell whether customers notice.