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Thursday, May 14, 2009

Can mobile operators revenue-share with handset vendors?

Interesting article in last week's edition of the UK Mobile trade magazine, Mobile Today. Apparently O2 is considering a revenue-share plan with handset vendors, where they would only pay 50% upfront for devices, with the remainder geared into actual customer expenditures over the life of the contract.

Presumably this would be intended to encourage vendors into loading features into phones that are service revenue-generative, rather than which work standalone (eg camera, memory) or "independent app provider" fashion (eg Ovi).

I'm very doubtful about how this might work in practice, and I'm struggling to think of any other (physical product) industry in which a similar model works, as clearly manufacturers have to pay their own suppliers, and getting bank loans to cover a 12-24 month gap between costs and cash seems highly doubtful to me. I can't see EasyJet telling Boeing it would only pay for 737's based on future passenger load & revenue figures.

In fact, I can see this type of move drastically backfiring - it could well tip the balance to device vendors switching to an Asian-type distribution strategy, where customers buy handsets through separate channels to their SIMs and service strategy. While this would reduce pressures on operators to pay out in subsidy, it would reduce the ability of operators to supply customised handsets with their favoured applications and UIs.

If handset vendors are going to face a cashflow hit, they might as well just offer consumer finance themselves for handset purchases - "Buy your Nokia XYZ in 18 convenient payments of £10 a month - comes preloaded with Skype, Ovi, Facebook and Music - just add a basic SIM with voice and data access".

There might be a very few cases where there is a win-win from this scenario, but I'm struggling to think of any off the top of my head.


worma said...

But isn't Apple doing the same with AT&T in US (and perhaps other operators around the world)?

The difference might be in the numbers (upfront payment and revenue share percentages), but essentially the model already works well for Apple.

Even otherwise, I think device vendors might not be too averse to this idea, if it's done universally across all device all operators. I think this model can help them get better prices, hence better margins in these troubled times.

Oh and Nokia does have the 'installment' payment method in some markets.

Matt Millar said...

Hang on though. Traditionally OEM margins have been around the 40% mark.

So if this becomes O2 pays 60% up front, and downstream shares a margin on the O2 revenues from that device, then the OEM gets paid at cost for the marginal cost of producing the device, and their gross margin then arrives over the lifetime of the device usage with O2.

Now the practicalities of this are interesting (sim swapping between devices, what share goes to what manufacter etc)

But given the relatively predictable nature of operator revenues this seems perfectly reasonable, and indeed securitisable (back when banks could create derivatives from these sorts of predictable mass scale revenue flows)

The nice thing for O2 here is that this completely aligns O2's business objectives (derive more O2 revenue from the devices) with the OEM's goals avoiding the market distortion problem I discuss hereRegarding the cashflow hit - maybe finance companies (if there are any left) will step in to fill the gap here.

Dean Bubley said...

Matt - well in the past they might have been 40% gross margins, but not at the moment. In Q1, Nokia was on 33% and SonyEricsson was on 8%.

Also, operators device-specific revenues are only really predictable for postpaid contract phones - what happens when a tourist comes to London, buys a cheapo prepay phone and then just bins it after a week? Hardly the manufacturer's fault.

It could be that this proposed scheme is only intended for postpaid, subsidised handsets.

The whole thing is also going to be a nightmare to track - not just with SIM-swapping but also with other revenue streams. Would the operator give the same rev-share on on-net roaming vs. offnet roaming, for example? What about mobile commerce revenues where the operator only takes a cut of the gross amount anyway? How would it work where you get family bundles with 3 different phones?

Worma - I think it works the other way around, with Apple taking an extra share of AT&T / O2's revenues, not in lieu of upfront payment for the device.

I also think this puts device vendors in an invidious position with regard to end users, as it forces them to focus on "service" functions rather than embbeded standalone value.


Matt Millar said...

Dean - I agree 100% on the tracking problem. That feels "not thought through"

However if you place conditions on this - say:

1. Post paid only
2. Premium products (those with a 40% gross margin!) only

So you target the devices that do drive more service revenue from the higher end and risk share with those - then I can see the point.

Ultimately this depends on whether your view as an operator is that you are an integrated end-to-end experience provider (e.g. Apple with iTunes) that derive value from the integrated experience.

Or whether you are a "smart pipe" that enables people to derive value from the capital infrastructure you've built (in which case you should be focussing on enabling providers of devices/applications/services to provide value to your customers by leveraging your services)

I'd assert that most european operators would be better focussing on the latter, than trying to build the former.

Anonymous said...

>>But isn't Apple doing the same with AT&T in US (and perhaps other operators around the world)?

Was --- only for the first generation iphone.

The revenue sharing was a disaster --- and it was drop completely for the 3G iphone.