By ANTON TROIANOVSKI And THOMAS GRYTA
The iPhone ended the year with a blowout quarter in the U.S. market. But underneath the big numbers at the largest U.S. carriers are signs Apple Inc. faces a rapidly changing marketplace that could erode its dominance.
AT&T Inc. said Thursday it activated 8.6 million iPhones in the fourth quarter, while selling a total of 10.2 million smartphones. The popularity of the iPhone at the No. 2 carrier echoed a report this week from market leader Verizon Wireless, which said about two-thirds of the 9.8 million smartphones it activated in the fourth quarter were Apple devices.
Those results support recent surveys that show the iPhone remains the country's most popular smartphone. But Apple may have to do more to persuade shoppers to buy its priciest models.
Verizon reported Tuesday that more than half of the iPhones the company sold in the fourth quarter were older models that sell at deep discounts. Dane Scism, a Verizon dealer with nearly 600 stores around the country, said many of his customers settled for the iPhone 4 and iPhone 4S, because they didn't see a value in paying up for the iPhone 5's faster cellular connection—one of the new device's marquee features.
His customers also bought lots of competing phones that run on Google Inc.'s Android software, as well as new Nokia Corp. phones powered by Microsoft Corp.'s operating system.
"A lot of people, maybe, anticipated that Apple would absolutely dominate the smartphone market," said Mr. Scism, who is based in Knoxville, Tenn. "We're not seeing that."
On Thursday, Apple shares tumbled 12% to $450.50, as investors were disappointed by its quarterly results, which showed flat earnings despite 18% sales growth.
To be sure, observations from a slice of the U.S. market can't be adequate proxies for Apple's global presence. Apple Chief Executive Tim Cook told investors Wednesday that around the world, the mix of sales of the latest and older iPhone models was similar in recent months to a year earlier.
While Apple likely makes less money on sales of older iPhone models, the profit margin is likely similar, said ISI Group analyst Brian Marshall. And Apple has argued that sales of any of the company's devices often lead to more Apple purchases down the road.
In addition, Mr. Scism said the iPhone 5 was in limited stock for much of the holiday shopping rush due to supply constraints. In January, when availability improved, most of the iPhones he has been selling are the newest model, he said.
AT&T activated more iPhones than Verizon, but the company lagged in the race for new subscribers. AT&T added 780,000 contract customers in the fourth quarter, bringing additions to around 1.4 million for the year.
In comparison, Verizon added 2.1 million in the quarter and 5 million for the year.
Smartphones have all but taken over the U.S. cellphone market, accounting for 89% of all phone sales to contract customers in the fourth quarter for AT&T. Apple's decision to let carriers sell its older model phones at discounts or even for free has helped get iPhones in the hands of more users. AT&T didn't break out how many it sold of each.
Apple's iPhone challenge is already becoming apparent globally, where demand for cheap smartphones is huge.
The global smartphone market increased by 39% last year in terms of units shipped, according to a preliminary estimate by International Data Corp. But sales of the iPhone—at 47.8 million last quarter—rose by 29%, marking the second time in the past year that the growth rate of Apple shipments dipped below the rate of the global smartphone market's growth.
Apple is under pressure from South Korean giant Samsung Electronics Co., which is putting its huge marketing muscle behind phones across price points, as well as manufacturers in China and elsewhere that are churning out low-cost devices.
Even in the U.S., Apple faces increasingly tough competition. Phones running the Android operating system have proven popular, and Samsung's marketers have been successful in creating their own smartphone brand with the "Galaxy" devices.
Mr. Scism says Microsoft has gained traction with its effort to reenter the mobile market. He said that the Nokia Lumia 822, which runs Microsoft's smartphone operating system, garnered 17% of sales at his stores the weekend after Christmas, thanks in part to a price cut.
Apple's success in the U.S. has been driven in part by the willingness of carriers to heavily subsidize sales of its expensive phones. But under pressure from investors, carriers are increasingly trying to change that.
No. 4 carrier T-Mobile USA, owned by Deutsche Telekom AG of Germany, says it will stop subsidizing smartphones this year and offer interest-free financing to buyers instead. The largest U.S. carriers have yet to follow its lead, but AT&T CEO Randall Stephenson said Thursday he commended T-Mobile for going that route. "It's something we're going to be watching," Mr. Stephenson said.
—Ian Sherr contributed to this article.Write to Anton Troianovski at anton.troianovski@wsj.com and Thomas Gryta at thomas.gryta@dowjones.com
A version of this article appeared January 25, 2013, on page B1 in the U.S. edition of The Wall Street Journal, with the headline: Fight to Unseat iPhone Intensifies.
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