Apple, AT&T: Bosom buddies or odd couple?

The corporate pair that launched the iPhone shares much in common. They also have plenty of conflicts as they push competing digital music businesses.

Marguerite Reardon Former senior reporter
Marguerite Reardon started as a CNET News reporter in 2004, covering cellphone services, broadband, citywide Wi-Fi, the Net neutrality debate and the consolidation of the phone companies.
Marguerite Reardon
8 min read
AT&T is straddling a precarious line between partnering and competing with Apple in the mobile music market.

AT&T's exclusive deal to sell Apple's iPhone for use on its network in the United States has been the envy of the wireless industry for more than nine months. But managing its own mobile music strategy while working with a tight-lipped and controlling partner like Apple is proving a challenge for AT&T, particularly as Apple launches new products and services that may compete with AT&T's own.

Like many partnerships in the tech industry, the Apple-AT&T combination is increasingly looking like "co-opetition," a term used to describe business partners that also compete. Apple, of course, is no stranger to co-opetition: For years, Microsoft, to name one company Apple works with, has sold software to run on the Macintosh operating system despite its own, more dominant Windows OS. Now AT&T is learning that the blurring of self-interest and cooperation is the price of doing business with a fast-moving outfit like Apple.

"With this deal, AT&T thought like a traditional phone company, focusing mostly on driving subscriber growth," said Michael Goodman, director of digital entertainment for market research firm Yankee Group. "But the partnership with Apple won't make AT&T a successful provider of digital entertainment."

"With the iPhone, Apple decides what products and services to load on the device. It's a completely different business model."
--Mark Collins, vice president of consumer data services, AT&T

AT&T is no stranger to mobile music. The wireless company, which until the merger of AT&T and BellSouth was known as Cingular Wireless, introduced its first music-capable phone, the Nokia 3300, in July 2003. Two years later, it introduced the Motorola Rokr, the first iTunes-enabled cell phone. But the phone (which was panned by critics for its 100-song capacity and was upstaged by the simultaneous unveiling of Apple's iPod Nano) is considered a flop.

Motorola stopped including the iTunes software on new versions of the Rokr. Instead, the company replaced it with a media player built by Motorola that is compatible with Windows Media Player formats. Most big online music stores, such as Napster, handle music in this format.

In late 2006, AT&T launched its own branded music service. Competitors Verizon Wireless and Sprint Nextel had established their own music stores more than a year earlier. But unlike these competitors, AT&T partnered with existing music service providers--Napster, Yahoo and eMusic--to bring together a collection of music that would be branded as the AT&T music store on its mobile phones.

Initially, the music service only allowed users to download songs to music-enabled phones via their PCs. But this summer, the company announced a deal with eMusic to make its 2.7 million song library available for purchase and download over AT&T's 3G wireless network.

Apple by far outpaces sales of all three major cell phone operators who sell music to mobile subscribers. In fact, all three carriers--AT&T, Sprint Nextel and Verizon Wireless--sold as much music for all of 2006 as Apple sells on average in three or four weeks, according to Yankee Group's Goodman.

Around the same time as the eMusic deal, AT&T launched its partnership with Apple, the leader in the portable music market with its popular iTunes music store and iPod music-playing devices. Under the contract, AT&T is the only carrier in the United States to provide cell phone service to the iPhone.

But unlike other phones sold by AT&T, the iPhone is largely controlled by Apple. And while it supports Apple's own iTunes software, it does not work with AT&T's own music store.

A 'unique' relationship
This fact alone sets up some competitive tension between the two companies, each of which is hoping to generate as much revenue as possible from its own service. But even though AT&T gets no revenue from iTunes sales to iPhones, the company says it doesn't view Apple's music store as competition.

"One of the things we've demonstrated is that we can offer multiple sets of choices to our customers," said Mark Collins, vice president of consumer data services for AT&T's wireless unit. "AT&T is a market leader in wireless and Apple is the market leader in online and portable music. So it was a natural fit for AT&T and Apple to make a product available to our customers."

Still, Collins admitted that the relationship with Apple is "unique."

"With other handsets, we decide the applications that are used and how to define the service offering," he said. "But with the iPhone, Apple decides what products and services to load on the device. It's a completely different business model."

The competitive waters have been muddied even further with a couple of recent Apple product announcements. First, Apple announced that it had Wi-Fi-enabled its iTunes software, which to some looks like an assault on AT&T's new over-the-air music downloading service from eMusic. Just like with eMusic, iPhone users will be able to purchase and download music wirelessly directly to their phones.

Apple did not make this functionality available via AT&T's cellular network even though the iPhone is Wi-Fi-enabled, but instead struck a deal with Starbucks and its Wi-Fi hotspot provider T-Mobile USA that allows any Wi-Fi-enabled device running iTunes to automatically recognize the wireless music store without a connection fee.

Collins wouldn't comment on whether iTunes music downloads would eventually be available via AT&T's cellular network, but he did point out that AT&T itself waited until it had a sufficient 3G network footprint before it offered the service via eMusic. Currently, the iPhone operates over AT&T's 2.5G EDGE network. Collins said the music-downloading experience is markedly better over a faster 3G network.

In another move that could heighten competition between the two companies, Apple announced last week that it was allowing iTunes users the ability to transform songs they purchase or already own into ringtones for an additional 99 cents. AT&T, along with other cell phone operators, generates a significant portion of its data revenue from the sale of ringtones. In 2006, U.S. operators generated about $873 million in revenue from ringtones, according to Jupiter Research.

Nonetheless, Collins said that ultimately AT&T is focused on its subscribers.

"It's a competitive market," he said. "We have a relationship with Apple, and whether our customers are buying content via the iPhone or some other mobile device, we want to give them the service and content they want, however they want it."

"I haven't seen a deal yet where Apple hasn't come out of it smelling like roses and its partners have had to bear the brunt."
--Michael Goodman, director of digital entertainment, Yankee Group

Apple also announced several new models of its iPod music player, including the new iPod Touch, which is essentially an iPhone without the AT&T voice and data service. This means that iPod enthusiasts who love the button-less design and sleek iPhone interface can get most of the features they love on the iPhone without spending $60 a month on the AT&T voice and data service.

In one respect, the iPod Touch itself doesn't compete directly with the iPhone. It doesn't offer a cellular voice and data service that allows nearly ubiquitous wireless coverage over AT&T's 2.5G EDGE network. And it doesn't offer the ability to add a voice over IP client, such as Skype, so the device couldn't be turned into a phone.

"The iPod Touch and the iPhone share some innovative features," said Natalie Kerris, a spokeswoman for Apple. "But one is a phone and one is not. So I would disagree with an interpretation that these products compete."

That said, the iPod Touch, like the iPhone, does offer Wi-Fi connectivity, which is many times faster than AT&T's regular network. And with 50,000 Wi-Fi hotspots in the U.S. and 170,000 hotspots worldwide, it offers consumers who may not need continuous Web access an alternative to the iPhone and AT&T's data package. Because it doesn't require a service contract, the iPod Touch could be especially appealing to people who already have cell phone plans with other carriers in the U.S.

As a result, the iPod Touch could weaken the strategic appeal of the deal with AT&T, which has been banking on iPhone exclusivity to drive new subscriber growth.

"The best that AT&T could hope for from this deal with Apple is adding new subscribers," Yankee Group's Goodman said. "And my gut feeling is the iPod Touch will have a negative impact on iPhone sales at least in the U.S."

Mark Siegel, a spokesman for AT&T, said the company, which together with Apple has sold more than 1 million iPhones since the launch in June, doesn't expect the iPod Touch to impact iPhone sales. He said AT&T is well aware of Apple's product road map and has found the company to be a cooperative partner.

"We aren't concerned about (the iPod Touch) at all," he said. "Apple is a very good partner. The longer we work with them, the more that is confirmed."

That said, Apple doesn't have a strong track record when it comes to partnerships. For example, the company has had a contentious relationship with the music industry in the last couple of years. At first Apple was viewed as a trailblazer for digital entertainment. But two years after the company launched its iTunes music store, music executives were grumbling that Apple had too much power over pricing and digital rights management.

Instead of selling songs for 99 cents a pop, record label executives wanted to be able to charge higher prices for more popular songs. And Apple's refusal to license its antipiracy technology, called FairPlay, to rival MP3 player makers, also angered music industry execs, as they viewed Apple as fragmenting the marketing and limiting distribution.

Earlier this year, Steve Jobs, Apple's CEO, urged major music labels to ditch copying restrictions from music sold online. In April, Apple announced that EMI Music would make its entire digital catalog of music available for purchase DRM-free.

Then, of course, there was the failed partnership with cell phone maker Motorola. The two companies announced in July 2004 that Motorola would create a new mobile phone loaded with Apple's iTunes software. But when the device, called the Rokr, was introduced in 2005, it was panned by critics who found the traditional cell phone interface and design disappointing. What's more, the device's memory was limited to storing only 100 songs.

"The bottom line is that Apple is not a good partner," said Yankee Group's Goodman. "They have tremendous products and marketing. But if you're a partner, you'd better put your hand on your wallet. I haven't seen a deal yet where Apple hasn't come out of it smelling like roses and its partners have had to bear the brunt."