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AT&T and the Red Queen’s Race

Published Jul 29th, 2013 3:40PM EDT
AT&T Earnings Analysis Q2 2013

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AT&T’s spring quarter had a bit of that “Alice in Wonderland” quality. The mammoth carrier beat Wall Street’s consensus by 10% by adding 551,000 new contract subs, up sharply from 320,000 in the spring of 2012. AT&T also sold 6.8 million smartphones, the best spring quarter result ever, and wireless data revenue soared by nearly 20%. Yet AT&T’s profit still fell by 2.1%. This company is running as fast as it can just to stay in place — and this is a sign that the American mobile market may be ripe for some big changes.

The old strategy of promoting smartphones aggressively and riding mobile data growth is no longer working. AT&T remains the master of luring Americans into upgrading smartphones at a relatively rapid clip and keeping most of its subscribers loyal. But that is not enough to deliver earnings growth anymore. The price of keeping the smartphone upgrade cycle humming and reeling in a small number of subs from rival operators is getting too high; marketing spending has started driving margins down.

AT&T’s wireless service profit margin plunged from 45.8% to 42.4% in just 12 months. This cannot go on — AT&T must find a way to bring its marketing expenses back in check very soon. This could mean trying to force handset vendors to shoulder a bigger slice of promotions. Or it could mean trying to persuade consumers to pay higher upfront fees for new devices. It is possible that the upcoming Lumia 1020’s $300 price tag is a taste of things to come. Perhaps it is one trial balloon to test consumer appetite for devices with a minimum price of $300. Of course, many consumers have paid that and more for iPhone models with a lot of storage in recent years.

But the problem here is that the pool of consumers willing to pay $300 or $400 up front for a high-end phone may not be large enough to help AT&T much, especially now that consumers are getting a taste of really cheap smartphones. And vendors struggling with their own dropping margins are unlikely to be amused by attempts to force them to jack up their marketing spend.

This autumn is likely going to give us some indication of how AT&T plans to stop its wireless margin erosion — and the chances of a new “Data Processing Surcharge” or “Monthly Tech Support Fee” could be substantial.

After launching mobile game company SpringToys tragically early in 2000, Tero Kuittinen spent eight years doing equity research at firms including Alliance Capital and Opstock. He is currently an analyst and VP of North American sales at mobile diagnostics and expense management Alekstra, and has contributed to, Forbes and Business 2.0 Magazine in addition to BGR.

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