Recently I attended the Food & Wine Festival at Epcot. While Florida was graced with a cold front, making it enjoyable to walk around without suffocating from humidity, I encountered major network issues with my iPhone.

Not to beat a horse to death, but come on AT&T! Text messages were slow coming through, applications didn’t run smoothly, phone calls were choppy despite having several bars of service and opening web sites – forget about it!? So, not only did the mass amount of people at Epcot make it hard to keep a comfortable bubble of personal space, but they kept me from Tweeting!

CNET recently published an article, “Is the iPhone Hurting AT&T’s brand?” in which Rob Adler, vice president at Vantage, was quoted as saying, “AT&T can say that there is nothing wrong with their network all they want,” he continued. “But when someone is experiencing dropped calls and no access to the 3G network every day, they take it very personally. And it is very frustrating.”

Frustrating enough that after seeing the “iDon’t” ads from Verizon Wireless and reading this article from The New York Times though, I’m starting to wonder if people will sacrifice the Apple brand for Verizon/Google/Motorola Droid.

Just like the Mac vs. PC commercials, Droid’s ads continue to poke fun at Apple. While I wouldn’t give up my Mac at home, frankly, these AT&T network issues are quite a drag and joining Matt Marshall as a soon-to-be Droid user isn’t sounding too shabby! Consumers want reliability in any product they purchase. If you pay $200-$300 for an iPhone, plus the elaborate service plan each month, you want a network that works – and AT&T just isn’t cutting it these days.

Recently, the Wall Street Journal reported that AT&T is looking to extend its exclusive deal with Apple to sell in the United States until 2011. This news is not particularly surprising considering the company’s business model for the popular handset.  AT&T’s iPhone business model is like a crack addiction. It delivers a short term high, then sinks into an addiction and ends badly.

The High:Selling iPhones for less certainly helps increase Apple’s sales volume and AT&T’s short term bottom line. There were 1.6 million new iPhone subscribers on AT&T’s network in Q1 2009, with 40% of  those customers new to AT&T. According to the New York Times, iPhone customers are particularly valuable because their average bill is 60 percent higher than the company’s overall customer base. The Times estimates that iPhone exclusivity generates $700 million per year in operating profits.

The Addiction: Where’s the problem in millions of profitable new customers?  As I discussed in AT&T’s Value to iPhone Users: Negative $400/phone?!, these customers are really Apple’s  with little loyalty to AT&T.  AT&T’s business model is based on subsidizing the cost of the iPhone and making its profits from high monthly fees over the life of a 2 year contract. The Wall Street Journal estimates that it has spent upwards of $1.3 billion to discount the iPhone.  So the company relies on higher service fees that is supported through exclusivity.

Given this business model, you would expect that AT&T would make its customers feel like they get great value and service from the carrier to mitigate the effects on the eventual loss of exclusivity. Unfortunately, they do exactly the opposite.  Despite claims of the fastest 3G network,  a Gartner research study found that AT&T customers often receive half the advertised data rate.  Contact from AT&T is pretty much limited to the bill and text messages upselling higher priced services. The popular applications come from Apple and not AT&T. So customers get cheap phones and applications from Apple, and poor service and high fees from AT&T. Not surprisingly,  iPhone customers love Apple. AT&T? Not so much.

 It Ends Badly:  So, what happens when the exclusivity ends? On this issue, iPhone customers fall with three categories: customers who will leave AT&T as soon as they have an alternative, customers who might stay with enough incentives, and AT&T employees. Without customer loyalty, the company will take a significant revenue hit both from lost customers and additional subsidies and lower monthly frees that will be required to keep existing customers.

So AT&T is left with two expensive choices. To feed the addiction caused by its business model, it can pay Apple dearly to extend the exclusivity. Also, Apple will likely hold AT&T’s feet to the fire regarding expensive service upgrades to its 3G network.  Still, this only  staves off the inevitable. Eventually, exclusivity will end. At that time, profits will drop through defections to other providers and lower monthly fees. Cutting corners on communications combined with a poor business model always is very expensive.

The value of AT&T’s service on the iPhone has been set at negative $400/per phone. This valuation is not from over-entitled iPhone users. It comes from AT&T and Apple.

Recently, AT&T and Apple started selling iPhones without a service contract for a $400 premium. Given the recent high profile problems at the SXWSi trade show and complaints from the media, apparently the two companies feel there is a market for iPhone users willing to pay a premium to not have their world delivered by AT&T.

Why This is News: Apple is coming out with a new generation of the iPhone, and wants to clean out the existing inventory. Typically, when a handset model is about to be replaced, the price drops significantly. Sometimes, the buyer even gets paid to take the phone (with a  contract).  It is interesting that rather than discounting the handset, AT&T and Apple think they can clear out inventory at a premium by losing AT&T. In a bad economy, this speaks volumes about AT&T’s perceived value.

Why This Matters: Presently, AT&T has the exclusive right to sell iPhones in the United States. But its exclusivity will eventually end. AT&T  should be using its exclusivity period to build customer loyalty and ensure that they keep customers once they have the choice of carrier.  Best case scenario for AT&T would be happy customers  that would want to stay with AT&T even if it did not have the iPhone.  However, it would probably be good enough if customers thought that AT&T was an important part of the the iPhone experience that they will stay with AT&T when they upgrade their iPhone.  If  customers are not loyal to AT&T, it risks a serious price war on the cost of the handset and monthly service on newer versions of the iPhone.

The Bottom Line: Right now, it seems clear that customer loyalty lies with Apple.  AT&T has announced upgrades and investments in its network that will become available later in 2009. Only Apple and AT&T know when the exclusivity period ends.  So perhaps, AT&T will clean up its act before the end of that period.

But, I suspect that its real ace in the hole is the fact that even after the expiration of the exclusivity period, customers  will only have a limited number of choices for wireless service providers. Moreover, the other three 3G service providers are likely to follow a similar short-term business model when they sell the iPhone.  As typically happens when marketing and customer service are ignored, it won’t end well, as we will see my next post: This is the iPhone’s Business Model on Crack.

Traveling for 2 weeks on business taught me a lot about my iPhone.  The big lesson from my recent European trip is that the iPhone is not a viable mobile phone for business use. Here are a few simple changes for iPhone 3.0 that could go a long way to making the iPhone an effective business tool.

E-mail:This is the part where recovering Blackberry users usually gripe about the lack of a physical keyboard. But having tried the Android, combining a full screen and keyboard leads only to confusion and a fat phone.  The fix here is much simpler. Simply allow use of the e-mail keyboard in landscape (wide) mode. This will allow more space between the keys and avoid fat finger mistakes.  Typing on a touchscreen is slow enough. Typing every third word twice is unbearable.  Landscape capability already is offered is Safari. There also is an application called TouchType, however you need to work in the application and then upload to e-mail.

Keyboard Short Cuts: Cut and paste has to be at the top of the list. The ability to avoid typing large tracts of text would go a long way to alleviate the worst pain from the small keyboard.  A few standard Blackberry features would also help.  An option to delete the previous text from a reply e-mail is a really handy method of avoiding adding multiple names from scratch.  Also, the Blackberry feature where holding a letter capitalizes it would speed typing.

Background Processing: When the iPhone first came out, it was considered amazing that web applications could even be performed on a mobile phone.  However, the recently announced Palm Pre has upped the ante with  the ability to run multiple functions simultaneously. Apple has resisted adding this capability, claiming it would drain the battery.

The battery is the Achilles heel of the iPhone. If you see someone who walks in the room looking at foot level, he is an iPhone user looking for an elictric outlet or a foot fetishist. Even without using Wi-Fi, my phone can’t make it through a full day of regular use. The prospect of even less battery life inspires only dread.

While a new battery won’t be a part of iPhone 3.0, if Pre-envy is what it takes to get Apple to improve the battery on the iPhone, bring it on. Otherwise, trust me, the person holding the iPhone really is looking for an electric outlet.

The best part of a global show like Mobile World Congress is that you get tuned in to how the rest of the world lives. When it comes to mobile phones, most Americans expect to carry one phone and sometimes will carry a Blackberry for e-mail and regular handset for phone calls. After watching one person after another pulling out a never ending variety of handsets over the course of the day, I started polling people as to how many handsets they were carrying.

The typical person from EMEA or Asia was carrying a minimum of three phones. One person pulled out four, jokingly said (I think) that he had one for each wife. The typical explanation was a Blackberry for e-mail, an iPhone for applications, and then a Nokia or three depending on countries (and marital status). This could explain the relative health of the mobile phone space.

As for iPhones, universally, they were jail broken (manually “adjusted” to allow it to used on any mobile carrier’s network). People looked at my AT&T iPhone with a mixture of pity and disgust usually reserved for naive children. Invariably, they would show me a great application, then shake their head and say that I can’t get it because my phone was “on network.”

Social networking on mobile phones seemed to be in the early adopter phase. While I saw plenty of tweets and Facebook updates, I did not see many people using their phones to deliver them.

As the next major wireless show, CTIA, starts in less than a month, we will report back if there is a major difference in phone habits from the U.S. based attendees in Las Vegas.

Over the weekend, T-Mobile sued Starbucks over the coffee company and its new partner, AT&T offering free in-store Wifi. The details can be found at GigaOm and Rich Tehrani’s Blog

One aspect that has not been covered is the PR implications of the lawsuit. I think that T-Mobile is underestimating the PR hit that they will take if they are successful. Consider that every time a Starbucks Wi-Fi user logs in, they will be reminded T-Mobile took away their free WiFi.

The other interesting point is that if T-Mobile is successful, they would have to prove damages. In doing so, they would have to provide a public look at the profitability of the Starbucks arrangement. Since that arrangement is going away regardless of this lawsuit, the bottom line effect of the loss would become public knowledge. So winning the lawsuit would have a price.

On an unrelated issue, it definitely is cool having a blog tag on Rich Tehrani’s blog.