At a time when nine out of 10 Americans have a cell phone, the country’s top two operators are getting creative about finding growth opportunities in an increasingly crowded wireless market.

AT&T and Verizon Wireless are betting heavily on embedded devices, from tried-and-true telematics solutions to wirelessly enabled dog collars. If their expectations hold true, the incremental revenue brought in by nontraditional cellular connections could be the next growth spurt for the wireless industry, helping to offset an inevitable slump in the rate of subscriber growth.

The head of AT&T’s Emerging Device segment, Glenn Lurie, believes the addition of machine-to-machine (M2M) and wirelessly enabled devices could take the U.S. wireless penetration rate from about 90 percent to 500 percent. “There are a certain number of customers with a handset in their hand. This space is absolutely going to dwarf that,” he says. “There are going to be a lot more connections and a lot more customers in the emerging device space than there are today in the current space of mobility.”

The number of M2M and wirelessly enabled consumer electronics on AT&T’s network more than doubled in 2010, hitting 5.78 million in the first quarter from just 2.8 million last year. More than a million of those connections were added in the first quarter alone.

The number of embedded devices on Verizon’s network is even higher. The company said it had 7.3 million “other connections” in the first quarter of this year, the first time Verizon publically disclosed the information to investors.

Tony Lewis, vice president of Open Development at Verizon Wireless, says the opportunities of embedded devices “remain limitless” but he disagrees that the company is pursuing the space to offset a penetration-related slowdown in wireless subscriber growth. 

“We’re happy with where penetration is today because it allows the market to continue to grow and to give consumers more choices with more features, more functions and better utilization of the devices,” he says. “I don’t have to try to drive the connections to offset anything. It’s another growth pattern.”

IDC says the market for cellular chipsets for non-phone applications will grow at a compound annual growth rate of 9.3 percent between 2009 and 2014, eventually outpacing growth in the mobile phone market. The research firm predicts that cellular chips used in M2M, laptops and other embedded devices will comprise 16 percent of total chipsets by 2013.

Similarly, Strategy Analytics expects global mobile broadband subscriptions on phones, computers and consumer electronics would rise from a base of 300 million in 2009 to 1.3 billion by the end of 2014.

Embedded devices are particularly attractive to carriers because they don’t threaten legacy businesses.

“This is the first time in my 25 years in business that it’s all incremental,” Lurie says. “I’m not cannibalizing any other space; it’s all incremental revenue and operating income for the company.”

The diverse nature of the market also frees carriers to explore different business models, models they might have ignored before due to pressures to maintain ARPU and churn rates. “I’m not handcuffed by thinking it has to be a certain ARPU or churn,” Lurie says. “The old world of wireless where those were the almighty metrics is gone here.”

The amount of money brought in every month by non-subscriber devices varies widely depending on their application. Modules embedded in security cameras streaming live video to law enforcement could bring in substantial amounts of money each month, whereas an application sending minute amounts of data may only generate single-digit sales. 

Growth in enterprise applications of M2M technology remains a hot spot for operator’s embedded device segments but expansion of the technology into consumer electronics faces a less certain future as manufacturers struggle to sort out the business model for individual devices.

At issue is deciding who pays for connectivity. Some models, like Amazon’s Whispernet, include the cost of wireless connectivity in the content. Others may charge users a monthly fee for access to an operator’s wireless network while different models could be based on the amount of data consumed.

So far, it’s unclear whether consumers are willing to pay a premium for cellular connectivity, a key attitude needed to accelerate consumer adoption of wireless-enabled gadgets.

“It’s not technically difficult to embed modules; it’s the business model that’s hard,” says ABI Research analyst Jeff Orr. “There hasn’t been a willingness by the consumer to pay a premium to get a connected device knowing they’re going to have to pay for a service on top of that.”

3G modules are still relatively expensive and negotiating the business model for connectivity is unfamiliar territory for consumer electronics manufacturers, which must figure out a way to pay both for the hardware itself and the cost of wireless service.

“I think we’re maxing out the disposable income of the average consumer. They’re making choices about what devices they connect and the business model is being stressed,” says In-Stat analyst Jim McGregor.

McGregor brings up an important point: Cellular connectivity is not always the best type of wireless connectivity for devices. Home networks are dominated by Wi-Fi; short-range connections are best suited for Bluetooth; and ZigBee is good for low-power applications with minimal data use. Routing data through a base station and over a cellular network just doesn’t make sense in some cases.

“You’re not going to connect every device you have over a 3G or 4G network. I’m hard-pressed to bet against Wi-Fi being the primary technology for internal home networks,” he says. “Cellular connections are the best solution for anywhere, anytime connectivity. That’s a critical aspect when considering connectivity for these solutions.”

ABI Research analyst Dan Shey says he expects sales generated by embedded devices to have a gradual effect on operators’ bottom lines. “Will they be able to increase revenue? They have an opportunity. Will growth shoot out of the water over the next year? No,” he says. “You’re going to see incremental growth.”

Operators have a vested interest in getting as many devices as possible connected to their networks but may be pushing to enable the market ahead of consumer demand for nontraditional, wireless-enabled gadgets like connected appliances.

Shey says that “for now, it sounds like the operators” are more interested in launching the more radical types of connected devices than consumer electronics vendors are, in no small part because of the uncertainties around viable business models for the devices. “They’re operating in uncharted waters, and it’s tough,” he says.

That hasn’t stopped AT&T and Verizon. They’re pushing hard to boost adoption of M2M and the embedding of cellular modules in non-traditional devices. Both operators have highlighted the technology at conferences and both have an open door policy for companies that want to launch devices on their networks.

Comparing Verizon’s “other connections” segment to an “incubator business, Lewis says the company will “walk down any path that allows us new opportunities” when it comes to the embedded device space.

“We are in a wonderful position to really be able to help these companies look for the best ideas and get them all the way through certification, the economic model, design and distribution channels… We get involved as they want and have the capability to help them every step of the way,” he says. “This is a very broad business and there are a huge amount of opportunities here.”

AT&T’s Lurie shares the same enthusiasm, saying the embedded device market will be “absolutely huge.”

“We have to look at this differently; it’s not business as usual,” Lurie says. “It’s all about how you bring operating income to the business.”