Can Apple and Verizon Push Tech into a New Age?

Today we had the interesting combination of Apple and Verizon quarterly reports, and it’s worth looking at the two in synchrony because of the (obvious, we hope) linkage between the service provider space and the premier provider of consumer mobile technology.  There is in fact likely a bit more synchrony than you’d think.

Verizon slightly beat on revenue and slightly missed on earnings, but the most interesting contrast was between wireless services (up 7%) and wireline (down 0.8%).  It’s clear that for Verizon as for most of the big telcos, it’s wireless that’s making the money.  Verizon is also talking about its capex focus on capacity augmentation for 4G LTE, rather than about how much more it’s spending on FiOS or wireline in general.

For about a decade, carriers have found revenue per bit higher in the wireless space for the simple reason that wireless users pay more for broadband bits than wireline users.  As long as that’s true, money is going to flow more into wireless, but it’s also clear when you look at global trends that all of the factors that have driven down revenue per bit on the wireline side are already pushing at wireless.  Unlimited usage plans, even with data metering to prevent users from running amok, can only do for wireless what they’ve done for wireline years ago—commoditize bits.

In some countries, notably the EU, we’re also seeing regulatory factors pressure wireless.  Roaming charges have been a way for wireless carriers to make their own services more sticky, but the EU has been at war with higher roaming rates and so that factor is both putting revenue at risk and also creating competitive churn at a higher rate.  You don’t see as much of that in the US of course, but were there to be a major shift in neutrality policy that enveloped wireless services, it’s possible there might be a similar regulatory-driven impact here.

The churn thing is where Apple comes in, I think.  What all wireless operators want is for their customers to renew contracts by habit, but in most cases the renewals are tied to handset upgrades.  Apple users are the most likely to upgrade their phones, and so Verizon and others have tended to focus their new plans on Apple.  Verizon rival Sprint, for example, has a new plan that offers low-cost unlimited usage for iPhone 6 only.  Apple is essentially building the prizes in Crackerjack boxes, and so of course they’re riding the wave of carrier churn management.

Underneath the current situation are a couple of complications for both companies, and some unique ones for each.  Top of the joint issues is what I’ve called the “Novell problem”, which means that users can’t be made to upgrade constantly unless you can radically grow utility with each upgrade.  That, we know from other experiences in tech, isn’t likely to be possible.  However, churn-driven upgrade policies could be curtailed even before users succumb to feature boredom if competitors like T-Mobile and Sprint stop putting the pressure on the major providers by promising special deals to users who upgrade their phones.

Most operators are already reporting ARPU growth has plateaued or even reversed, so only increases in wireless TAM or market share will help drive up revenues.  Clearly those sources aren’t going to contribute to radical shifts at this point.  LTE build-out is nearing maturity too, which means that capex augmentation in wireless will be less likely.  Wireless is becoming less a growth business, less a driver of infrastructure change, for the simple reason that it’s just another bit-based service and will surely be impacted by the same forces that have already hit wireline.  To my mind this tamps down speculation that Verizon might spin off its FiOS business, which I’ll get to in a minute.

Apple’s challenge, then, is what happens when one of the forces that are driving handset upgrades begins to lose steam.  It’s unlikely other forces will emerge, and so over time iPhones will taper.  Apple’s tablet numbers were a disappointment and it’s clear that the Mac isn’t going to drive the company to double-digit stock price appreciation either.  That makes Apple dependent on new markets, such as the wearables that its watch offering represents.  The fact that Apple indicated it would not break out watch revenues once the product becomes available suggests it’s worried that lack of hockey-stick growth there will sour investors.

Verizon’s challenge is similar.  Its major revenue growth comes from the consumer side; revenues from non-consumer sources were off.  All the forces we’ve talked about make it unlikely that consumer revenues will grow forever; wireless market shares will plateau and FiOS penetration has slowed as well since Verizon isn’t entering new areas.  It’s this force that is putting pressure on capex.  If you can’t raise revenues every year to justify stock price increases, you have to cut costs.  While network equipment vendors don’t like this equation for their customers, they apply it relentlessly in their own businesses.

What I think is indicated here is the exploration of a more valuable relationship between mobile devices and mobile services.  This has to go beyond the simple substitution of payment by iPhone for payment by credit card, too.  The question is what the service might be, and I think it’s likely that it would involve combining user presence/context in the broadest sense with voice-based personal assistant technology like Siri or Cortana.  The challenge in this transition will be daunting, though, and not for technical reasons.

If you combined personal assistant technology (speech recognition) with improved AI-aided contextual search, you could generate something that could approach the movie “Her” in sophistication and utility.  However, this is a marriage of cloud and handset and that means there’s likely be a war to determine where the most valuable elements of the relationship would be hosted.  Apple would obviously like the differentiation to be in the handset, but operators like Verizon would rather it be in the cloud.  Further, hosting complex analysis in the handset would mean pumping more data out there, which would in an unlimited-usage mobile world raise carrier costs.

Apple was up slightly, pre-market.  Verizon was down slightly.  No big movements, because there’s no big news.  The question for investors, and for those of us who watch telecom overall, is whether the forces that have driven the two in semi-synchrony will now separate them, and whether that separation will then contribute to tech under-realizing its potential even further.