Overwhelmed by SIM-only, O2 demands handset innovation

UK market leader O2 is an extreme example of the polarization of cellcos' sources of revenue growth in developed markets - between high profile smartphones and low cost options such as SIM-only deals.

When it announced its most recent results the operator revealed that about one-third of its customers are now on SIM-only contracts, a massive leap from just 2% a year before. While these deals have been valuable as a short term boost for O2, it is now getting concerned about its future business being over-driven by such a low margin, low loyalty approach – and in the usual way of European cellcos, is putting the pressure on the phonemakers to redress the balance.

They must incorporate more relevant features into their designs at all levels, particularly midrange, to lure customers back to upgrades, subsidies (and lock-ins).

O2 UK's CEO Ronan Dunne said phonemakers must add "relevant functionality" to new devices to stimulate the moribund midrange handset segment. He told Mobile Today:

"People aren't saying that they aren't going to replace their handsets ever, they're just changing the phasing and timing of their purchasing. Unless they make real changes to a handset – not just changing the screen or the color – there won't be a real case for people to upgrade."

O2 stole a march on its rivals by blazing the SIM-only trail in the UK last year, and for a while this was beneficial as it reduced its costs in subsidizing upgrades for its customers – it actively pushed users to delay handset upgrades from the dark days of Q408 until early 2009.

The bulk of O2's new deals in the past three quarters have come from its Simplicity SIM-only proposition, which has been marketed heavily in-store because of its low customer acquisition costs, allowing resources to be diverted to hanging onto the iPhone exclusive.

O2 has also used Simplicity as a way to convert customers easily from prepaid to higher value postpaid, but the negative has been the association of Simplicity with cheap deals (in Q308, the first period of heavy SIM-only marketing, ARPU fell by 2.5% despite the iPhone being one of the highest ARPU generators among smartphones).

Overall in the UK, sales of SIM-only deals rose by almost 96% during 2008, according to GfK, but of the 143,000 SIM contracts signed, almost two-thirds were for less than £20 ($31) a month. The trend is now spreading around western Europe.

At the other end of the scale, About 40% of O2's data traffic is driven by smartphones, currently still ahead of mobile broadband on notebooks and dongles. "We'll start to see smartphone sections in stores, rather than handsets being grouped by individual manufacturers," Dunne said.