Is it time for a new model on handset subsidies?

It's easy to look back and understand why mobile operators got into the business of subsidising handsets--attracting new subscribers and retaining them on a fixed-term contract are the two foremost.

But times are changing, and it's less easy today to understand why this model continues given that the operators are struggling to maintain margins when their voice revenues are declining, regulators are demanding price reductions and investment needs for next-generation network technology are mounting.

The beneficiaries of this arcane subsidy model are no longer the mobile operators, but the handset vendors--and in particular Apple with its all-conquering iPhone.

Accepting that the iPhone has revolutionised the mobile industry, some claim that Apple has become immensely rich by demanding operators charge rather excessive subsidies on each iPhone sold to a contract subscriber. This is damaging to the operator and some are said to be looking to promote alternatives to the iPhone in an attempt to regain margin and indicate to Apple that the game is changing.

Apple CEO Tim Cook addressed the issue during Apple's recent earnings conference call and said operators "want to provide what their customers want to buy. The subsidy is not large relative to the sum of the monthly payments [users pay] over 24 months [of their service contract]."

Cook also said the iPhone provides a number of benefits to wireless operators, including lower churn. ("That has a significant, direct financial benefit to the carrier," he said.) Cook said the iPhone is more efficient with data than other, unnamed smartphone operating systems. Indeed, Sprint Nextel CEO Dan Hesse has said iPhone users consume less data than Android users. Finally, Cook said the iPhone encourages people to upgrade from feature phones, which gives carriers another reason to subsidize the cost of the iPhone. "I think some of these factors are missed in the general discussion of subsidies," Cook said.

However, Keith Bachman from the investment banking firm BMO Capital recently suggested that Apple has dominated the profit pool in high-end handsets for some years, at the expense of other handset vendors and operators, and that this situation that will not continue for perpetuity.

While Bachman doesn't believe operators will take concerted action in the short-term on iPhone subsidy levels, he does warn that the likelihood of this happening is the number one risk to the Apple success story. Of note, Apple made 70 percent of the smartphone market's profits in 2011.

Earlier this month, Walter Piecyk, an analyst with the New York brokerage firm BTIG, said that he expected some of the major U.S. and European mobile operators to report lower iPhone sales as they move away from offering expensive upgrades to newer iPhones for existing customers. He believes that this move could benefit Nokia's high-end Lumia range, which the struggling vendor would do almost anything to sell in volume.

European operators have the added opportunity to do something different: to not subsidise any LTE handset. With the exception of Germany and Scandinavia where LTE is already available, the door is open for operators to sell LTE handsets on their technological benefits, and stop paying this tax--because that's what a subsidy is--to avaricious smartphone vendors. --Paul