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How much negotiating power does Apple have in wireless? Enough for Dan Hesse, CEO of Sprint, to bet his company on a partnership with Apple.

Last week the Wall Street Journal reported that in exchange for marketing Apple devices, Sprint agreed to buy at least 30.5 million iPhones over the next few years, at an estimated $20 billion cost.

As astounding as those numbers are, huge volume commitments are only one threat to a wireless operator’s bottom line these days. Another -- and potentially more dangerous threat -- is the steady encroachment of application players into traditional carrier revenue streams.

SMS is a case in point. Apple just released their IOS5 operating system featuring iMessage, a new and FREE messaging service that competes directly with SMS. Embedded in the core IOS5, iMessage will allow Apple users to text each other and totally bypass the carrier’s SMSC platform, a major source of carrier revenue.

How will iMessage Affect SMS Revenues?

SMS revenue is not only important to U.S. operators; it’s a highly profitable money-maker that pays the bills of other services. Craig Moffett, an analyst for telecom research firm Sanford C. Bernstein, claims text messaging generates a whopping $20 billion in annual revenue for U.S. wireless carriers. Verizon Wireless, alone pulls in $7 billion a year from texting, he says.

Apple isn’t the first device maker to get into the messaging game. For several years now Blackberry has offered a similar service to iMessage called BBM or Blackberry messaging. BBM is a completely separate service from SMS which required Blackberry users to monitor both applications. Not the most user friendly experience. Unlike Blackberry, iMessage is a consolidated offering which will determine if the message should be routed via Apple’s path or the Carrier’s SMSC path. If both paths are available iMessage will pick the Apple path. I’m pretty sure iMessage will become extremely popular within the Apple community when you combine Apple’s amazing marketing campaigns and their easy to use application interface.

IMessage could be a much bigger threat because of Apple’s smartphone market share and cultural clout. You can already see a richer user experience within the service with features like delivery notification. I never knew if my SMS messages were properly delivered, but I know today with iMessage. Features like this will do nothing but encourage more people to use the service and increase customer expectations.

IOS5 will support not only later generation iPhones, but also the iPads and the iPod Touch. It’s only a matter of time before Google follows up with an Android-based messaging service. Longer term, a cross-platform solution for Android, Apple, and Microsoft devices could leave carriers wondering “whatever happened to our lucrative SMS business?”

Is Flat Rate Unlimited SMS the Right Strategy?

This is a tough call. I can see how carriers could feel threatened by services like iMessage. Eliminating SMS usage tiers protects the carrier as more Apple users message via iMessage versus traditional SMS. But the reaction could also backfire. With stories in the news about a possible “double dip recession” will consumers opt for any possible way to reduce their monthly telecom expenses? Only time will tell.

An Alternative Strategy: Getting Smart about SMS Usage and Costs

So if a high flat rate for SMS is a questionable strategy, what else can be done to meet the iMessage challenge?

I think the first step operators must take is a more comprehensive understanding of SMS usage patterns and cost awareness. Yes, iMessage and other messaging cousins will eventually do some serious damage to SMS revenue, but that’s not going to happen overnight. Carriers will be forced to enhance the user experience within SMS while at the same time monitor pricing to maximize profits.

One of the problems with SMS is that the margins have been so high that people never seriously scrutinized their engineering and wholesale costs. In addition the user experience is pretty non-existent. That philosophy has to change because the days of strong margin text messaging are going to be pressured more than ever with iMessage and other 3rd party TXT applications. It’s hard to compete with Free and Apple’s keen awareness on the user experience.

The right approach to the SMS problem is the same as it’s been for voice: examine usage patterns in great detail, reconcile bills, negotiate with wholesalers, and adjustment plans accordingly.

So in the spirit of better traffic analytics and cost management, here are few basic tactics – things that wireless carriers can do to keep SMS profits rolling in as long as possible:

- Let Usage Analysis Guide Pricing Decisions. While $20 a month sounds high, a thorough usage investigation can determine the right flat or tiered rate that will boost revenue without scaring users away to a competitor.

- Reconcile Bills. Carefully verifying wholesaler bills may be the single largest benefit: few carriers today know if their SMS bills are correct. But our experience at Connectiv is operators who put their usage data under an analytic microscope like our netCLARUS platform discover big cost savings.

- Negotiate with Inter-Carrier SMS Clearinghouses. Over the years, companies like aggregators have made a lot of money connecting SMS service from one carrier to another. But if you know where your customers are texting, you can identify opportunities for SMS peering and can thereby reduce the need for wholesaling.

- Conduct Fraud Analysis. Checking high volume users and high-risk country destinations can pay dividends by finding fraudulent users of SMS.

- Engineer SMS Infrastructure to Save CAPEX. Traffic analytics is a powerful architecture and planning tool. You can view peak hour stats, total MDAs, even MDAs per second by market. In short, you’ll have all the data you need to reduce unnecessary SMS CAPEX.