More Smartphones, Lower Prices Drive Competitive Change

One extremely important element in the future of the smartphone market is, of course, how much devices will cost. On one level, that’s a self-evident statement. But precisely how the world of pricing evolves -- and whether the customer eventually pays the entire cost or today's system of subsidizing end-user costs continues -- will be far from simple.

Apple jumpstarted the smartphone business with the introduction of the iPhone. The device itself was revolutionary. What also was unprecedented was that it was sold to AT&T subscribers without using the subsidy system upon which the cell phone business was built, and to a great extent still operates.

That’s ancient history in the world of mobile electronics. For one thing, the exclusive AT&T/Apple arrangement seems to be in its final stages. Clearly, the system in which carriers pay vendors a subsidy won’t go away. But it could change.

The price of the device subscribers are asked to pay is only one variable. ABI Research has released interesting research in this area. The press release says that in 2007, 18 percent of smartphones were commercially available for less than $200. This year, the percentage is 27 percent, and that is expected to reach 45 percent by 2014. The release suggests that a competitive battle between the lower-priced iPhone 3G and other devices, including the Motorola DROID, the BlackBerry Storm 2 and the HTC Hero, will continue to depress pricing. The downward pressure will make the use of loyalty-free operating systems such as Android more attractive.

The other variable is how much the device really costs to make. This depends on a number of things besides whether or not a royalty-free OS is used. For instance, the continuing integration of processes – squeezing a higher percentage of the functionality into fewer chips – is a traditional route to savings. There also may be changes in the cost of device powering as ways are sought to drive smartphones longer. The point is that the equation has a couple of variables: the actual changes in the cost to build a smartphone and shifts in the strategy and tactics of how much of the freight customers are asked to carry.

Sprint Nextel will continue to use subsidies to capture new subscribers, according to this FierceWireless analysis by Lynette Luna. The piece quotes a Goldman Sachs analyst's assessment that subscriber additions were driven by increased subsidies and heavy promotion. The tactic will continue: CEO Dan Hesse said that subsidies will continue as the company rolls out 3G/4G devices. Luna points out that this is a difficult path for Sprint Nextel, which had a disappointing third quarter. The Financial Times notes that competition is heating up in the smartphone sector and that the ability to "drive a harder bargain on subsidies” will be one of the tools network providers will use.

The bottom line is that the smartphone category is expanding rapidly. A new competitive dynamic – one that is far more sophisticated than the era in which a very small number of devices dominated – is quickly taking over. Subsidies will be a key part of the tactical battle going forward.