Here's Why the Blackberry 10 Won't Change Much for RIM
Even if BlackBerry 10 succeeds, it still probably won't reverse Research in Motion's profit decline.
On Thursday it became clearer just how tough a spot RIM is in.
The company reported earnings that were less disastrous than many expected. Revenue came in at $2.73 billion, better than the $2.66 consensus. Loss per share was 22 cents instead of 36 cents. The average selling price of devices even held pretty steady, at around $235.
So the stock initially popped in after hours trading. Then it tanked.
The reason it sank after the initial euphoria? Investors began to realize that the most profitable piece of RIM's business is on shaky ground.
The Trouble With Services
That piece is service revenue. At RIM, that means the payments it collects from carriers and businesses for providing messaging and security, among other features. (Read More: RIM Stock Drops as Services Fee Changes Worry Analysts )
On CNBC Friday morning, I asked CEO Thorsten Heins about his statements on the analyst call suggesting the structure of service revenue would change as BlackBerry 10 launches — specifically, carriers might end up paying lower service fees for consumer and small business BlackBerry owners, with enterprise customers most likely to continue paying full freight. (Read More: RIM CEO: Service Revenue in Place, Not Going Away )
"That service revenue isn't going to go away," Heins said. "That stays intact and we're still selling Blackberry 7 devices into the market and we will continue to do so because they are pretty strong in the entry level segments and lots of regions and we will continue to do this over the next month. So the transition period from Blackberry 7 to Blackberry 10 is probably going to be one and a half to two years and that gives us really time to move from Blackberry 7 to Blackberry 10."
This implies that a major shift in service revenues will occur only as BlackBerry 10 takes off, and that continued sales of BlackBerry 7 (and the existing subscriber base of BlackBerry users) will keep those revenues healthy. But the more I dig into the numbers, the more I'm convinced that's not the case.
Watch the Subscriber Number
Think of it this way: The size of RIM's subscriber base is a rough proxy for the direction of its service revenue. The company makes that clear in last quarter's earnings filing:
"The growth in international markets was offset by continued weak results in the second quarter of fiscal 2013 in the United States where a 12 percent decline in the subscriber base has caused service revenue to decline by 12 percent."
Subscribers down 12 percent? Service revenue was down the same amount. Pretty straightforward.
Where Things Are Headed
So what's likely to happen to RIM's subscriber count going forward? Well, people are counted as RIM subscribers only as long as they're actively using BlackBerry phones. If they switch to another platform, no more service revenue.
In the U.S., where RIM is losing the most share, that means as the millions of BlackBerry users who bought phones two years ago buy new phones this holiday season — many of those Apple iPhone 5s and Samsung Galaxy SIII phones, no doubt—RIM's services revenue is likely to gap downward precipitously. To make up for that, RIM will need to sell discounted BlackBerry 7 phones into emerging markets.
But here's the problem with that: Emerging market subscribers don't bring in as much service revenue as U.S. subscribers do. And RIM is finding it increasingly difficult to sell even discounted BlackBerry 7 devices into emerging markets. As RIM put it last quarter:
"Outside of North America, overall performance was negatively impacted by pricing pressure due to competitive market dynamics and the aging of the Company's in-market product portfolio, making growth in international markets increasingly more challenging."
Blackberry 10 Won't Fix It
Selling new BlackBerry 10 devices is unlikely to help. Why? In the U.S., where RIM is losing the most share, and where the first device shipments will land, it's very unlikely for the company to suddenly start selling millions of units per quarter. But even if RIM does ship quite a few, those units won't command the same service revenues its predecessors did.
That will have some impact on revenue— but it will have a far bigger impact on earnings. New phones are always more expensive to make than old phones, so the launch of BlackBerry 10 devices will naturally compress margins. The erosion of service revenue from lost U.S. market share will also compress margins.
But here's the kicker: Even a wildly successful BlackBerry 10 launch would compress margins.