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AT&T's (NYSE: T) second-quarter earnings came out Wednesday, and Apple's (Nasdaq: AAPL) iPhone was clearly the hero of the day. However, a potential villain also looms offstage: Apple's iPhone, which appears to be weighing down the carrier's profits.
The complicated nature of the relationship between device maker and carrier over the hot-selling smartphone was highlighted as analysts peppered phone company executives with questions about their strategy 
to subsidize each iPhone, and what happens when AT&T is no longer the exclusive carrier for the handset.
AT&T said it activated more than 2.4 million iPhones over the last three months, with more than a third of those being new customers. However, profits were down 15 percent as revenue dipped from US$3.7 billion in the year-ago quarter to $3.2 billion. The new iPhone 3GS was launched in mid-June, and AT&T is believed to pay Apple as much as $300 per phone for each higher-priced model, in the hopes it will make back the money over the course of a customer's contract.
However, there are now more smartphone competitors to the iPhone, and rival carriers are starting to offer discounted data plans, clearly hoping to entice iPhone users who tend to spend more time surfing the Web and checking email with their devices than other customers. Can AT&T keep up the pace?
The Cost of Smartphone Success
It's not just the subsidization cost that is eating away at AT&T revenue, according to 451 Group Research Director Chris Hazelton. Because most iPhone users are more aggressive consumers of data, "you also have the cost to the network, requiring that AT&T go out and upgrade their networks faster than maybe they had planned two years ago, when the iPhone first hit their network," he said.
The iPhone is more of a bandwidth hog than other smartphones because of its full HTML Web browsing and email capabilities. So while the carrier can take advantage of that with data plan sales , it's been a constant struggle to invest in and maintain a 3G network that keeps those customers surfing and pinging their iPhones.
"Before iPhone, the big data users were BlackBerry users, and Research In Motion (Nasdaq: RIMM) has worked a long time with carriers to make sure that their data use is very efficient," Hazelton told MacNewsWorld. "You actually have a lot of engineering in how BlackBerry uses its data. [RIM] were actually able to get away with EDGE or 2.5G networks for much longer than other devices."
When the Music's Over ...
Congress and the Federal Communications Commission are getting more pressure to look into smartphone exclusivity deals, wherein a particular model of phone is only offered by a single wireless carrier. AT&T executives fended off queries about that possibility by telling analysts the carrier could withstand non-exclusivity; many iPhone customers were already with AT&T before the smartphone was introduced, and the improvements to network performance will carry some weight with customer decisions, they said.
The two companies won't likely end their relationship anytime soon, Hazelton said, but "the ceiling that they're willing to pay for these devices is probably falling. You may see AT&T pushing more marketing dollars behind other devices, because Apple is already doing all the marketing themselves, either through TV commercials or through their own ability to have a huge brand awareness for Apple devices.
"The next go-round (with an Apple-AT&T contract), AT&T may take a strong, hard look," he added. "When the next device comes around, the iPhone 4G, AT&T may not have a 4G network ready and may not be willing to support another huge spurt of users."
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