The hidden cost of the UK iPhone: £269 + £252?

[Update: last weekend, I had a chat with the local O2 store manager. It turns out that some of my assumptions about unlimited data, and how they will be rolled out to customers, might be wrong. Some of the more spectacular claims made below should be taken in that light.]

I perform a lot of speculation on this blog. I think my record speaks for itself. With that pinch of salt out of the way, I dug into O2‘s pricing structure, and noticed a few things.

First off, let me state my bias: I am an Apple fanboy. I wanted to be excited about the O2 launch of the iPhone. From an Apple-partisan point of view, I think that O2 flubbed the launch. The carrier’s intentions are clear, and somewhat understandable, but to someone who wants to see Apple technology in lots of people’s hands, it was a disappointment.

The £269 price was as predicted. It sounds high when converted to USD, but it’s in keeping with what the local market could conceivably bear, and is consistent with Apple’s pricing here, and in relation to the rest of Europe. The British Pound is extremely strong, but there are no guarantees that it will stay that way. Apple cannot afford to be punished should the US economy unexpectedly recover.

No, the disappointment lies in the premium prices for the subscriptions. O2 left no doubt that it sees the iPhone as an exclusive product meant to attract and capture high-end consumers from all other networks. They’re not interested in disseminating the iPhone as widely as possible: they want to get high-tariff customers on the network, and to keep them for at least 18 months (which is now the standard “long” contract in the UK — the market is in transition from an earlier 12-month lock-in period for contracts).

Unfortunately for O2, we can quantify the premium they believe they can place on the iPhone. O2 is refreshingly open about their tariff policy, and has a “Simplicity” tariff that is a pay-monthly SIM-only tariff: if you don’t want to upgrade your phone, you can put it on the Simplicity plan and be locked in at a much-reduced rate. If you want a non-Apple phone to go with your monthly tariff, you typically pay £10 extra, which we can take as pure phone subsidies.

In other words, if you buy a phone from O2, you should expect a discount of approximately £180 from the hardware cost. O2 knows how to profit from its network whether you do this or not.

Interestingly, the current Simplicity tariff corresponds exactly with the voice and text portions of the iPhone tariff:

iPhone tariff£35£45£55

The iPhone has been raising a lot of eyebrows because it’s “unsubsidised”: consumers are willing to pay a full retail price for the unique, full-featured phone, and flock to the exclusive network for the privilege. The premium that customers typically pay for a new phone is pure profit, shared by the carrier and Apple, in a mutually beneficial agreement. As we can see, the difference between O2‘s price for the iPhone tariff and a tariff unattached to a phone is £20. The only differentiators are the unlimited data and the unlimited Wi-Fi.

The unlimited Wi-Fi partnership with The Cloud was a smart move by O2: The Cloud is well-respected and a market leader. Partnering with them automatically pushes iPhone users’ most demanding data needs away from O2‘s anæmic EDGE network. A consumer could subscribe to unlimited Wi-Fi with The Cloud for £6.99/month. I could imagine that a corporate partner of The Cloud could easily cut a deal for wholesale prices of £5–£6 per bundled user, per month.

I think a tactical error from O2 was pre-announcing unlimited data for all of their consumers. As the Guardian reported:

Will the unlimited data package be available for other users?

[O2 CEO, Matthew] Key: We’ll roll them out on October 1 to our other tariffs.

Boom. Unlimited data for the iPhone is taken out as a differentiator, and explicitly absorbed into O2‘s cost of operating their network. Ultimately, this is probably a good move on the part of O2 in finding customers, but it doesn’t help sell iPhones one bit.

[Aside: I believe the fair-usage policy of “1,400 internet pages per day” equates to 100MB per day, but the wording is spectacularly vague on that count.]

I was shocked and surprised at the rumours reported by the Guardian that surfaced on Monday that “O2… will return to Apple as much as 40% of any revenues it makes from customers’ use of the device.” Put in the context of O2‘s tariffs, though, it starts to be plausible. Forty percent of £35 is £14.

I believe that the lion share – fourteen pounds per month – of the £20 iPhone premium (over O2‘s SIM-free fees) is dedicated to paying Apple. Nearly all of the remaining six pounds of the premium go toward paying for the Wi-Fi access partnership. O2 might see a pound or so extra income per iPhone user, but it seems entirely plausible that they’re making all their ongoing profit on the base network fees. O2 will also earn some retail margin on the iPhones that they sell in their shops, which probably strikes the carrier as a tidy bonus.

[edit: I didn’t make it clear: since the “iPhone premium” stays the same for all tariffs, I believe the profit sharing with Apple stays at a constant £14/month, no matter which of the £35, £45, or £55 tariff the customer chooses.]

So, in addition to whatever wholesale margins Apple gets on the iPhone, they get £252 in profit sharing per customer. That’s plenty of reason to break the hearts of other potential carriers. O2 clearly feels amply rewarded in making this deal, gets a lot of buzz, and captures desirable customers. Will consumers go for it? I think they will, but not to the same extent that they did in the US.