Why all the fuss about the potential end of phone subsidies?

Why all the fuss about the potential end of iPhone subsidies?

With AT&T reporting its financial results this week the media is buzzing about comments they (and others) have made to the effect that smartphone subsidies may eventually come to an end. The theory being floated is that future mobile phone buyers will be aware of exactly how much how much their smartphone costs. This new financial awareness will somehow prompt fewer people to pony up for an expensive iPhone.

I find the whole thing laughable. It's a financial shenanigan that really has no effect on the consumer at all.

To explain my point of view I want to invent a scenario where Apple controls all phone sales through its own retail channels. Let's pretend carriers don't sell iPhones anymore, but they are happy to sell iPhone owners a monthly plan.

In this scenario the carriers would have to compete with each other on network quality, monthly service pricing and creative offers. What kind of creative offers? They would buy your loyalty in the form of discounts or cash back.

A carrier might offer you $400 cash back if you sign a two year contract. The carrier gets a guaranteed revenue stream and you get what amounts to a subsidy on the new phone you just bought. It isn't called a subsidy, but it's the same thing.

Another carrier might not offer cash back, but instead offer you a $15 monthly discount over two year period if you activate your phone on their network. If you're thinking that this sounds a lot like the carrier helping the customer finance his new phone, you'd be right.

Let's now turn back to the models carriers are using today. They do sell hardware. And the financing plans have become more complicated such as the AT&T "Next" plan that looks more like a hybrid rental / financing plan. There are only so many ways to skin this cat. A carrier can help you finance a phone by adding a monthly fee to your bill. This fee may be transparent to you, or it may be a built-in premium in return for a device subsidy. Other carriers may offer you a discount on your monthly plan if you bring your own phone, which is the same thing as subtracting the monthly premium the carrier has added to its rates to make up for the device subsidy.

The carriers can spin this any way they like, but I don't think anything has changed. At the end of the day customers are still going to want to use the best phones they can afford, and there will still be financing arrangements that help people spread out the monthly payments to make the phones seem affordable.

Speaking of expensive phones, the Wall Street Journal mentions that the Apple iPhone costs more than a low-end laptop computer. They say this as if to imply that a mobile phone is a lower class of product than a laptop. This is nonsense. Over the last 5 years we have witnessed mobile traffic on the web go from almost nothing to a very significant portion of the total. We are in a world where a large number of people spend more time on their phone than they do on a traditional PC. And the trend is only going to continue.

The more our phones dominate our electronic lives, the more we're going to justify paying high prices for them. Don't get me wrong. There will always be a market for budget phones, and the low-end is clearly growing. But just like any market for any product there is a spectrum of people with differing needs and budgets. The existence of a low-end market does not mean less people will buy expensive products. And the financial shenanigans around hardware prices and monthly rates are unlikely to alter who buys what device.

One day carriers may stop selling phones just as cable companies don't sell TVs. But until that day comes the world of data plans, phone subsidies, financing plans, discounts and rebates will all seem like a big confusing mess to most people.

I think the better journalists out there can help more by educating readers rather than publishing sensational headlines that only serve to obfuscate the truth.

Chris Umiastowski

Chris was a sell side financial analyst covering the tech sector for over 10 years. He left the industry to enjoy a change in lifestyle as an entrepreneur, consultant, and technology writer.

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There are 30 comments. Add yours.

Jas00555 says:

Chris, there's one thing that isn't making sense to me. It should be a fairly obvious statement that the more money that carriers get, the less consumers get, and vice versa. In your first scenario where the carrier just pays money back to the consumer, wouldn't they still be losing (or in their case, not gaining as much) money as they were before? That wouldn't be any different than it is now, it would just be called something different.

Your second option that sounds like T-Mobile's plan sounds interesting though...

Chris Umiastowski says:

You have to assume that in the hypothetical case of a carrier giving $400 cash back, that carrier is charing more per month than a competing carrier who doesn't offer any cash back.

When carriers give you a subsidy, they are baking that subsidy into the lifetime value of the monthly payments. When customers sign contracts, I think carriers are willing to give up some value because they get a predictable cash flow stream for the life of the contract. But with most contracts (these days) tied to subsidies, the carriers don't need to give up much. They make out like bandits.

Premium1 says:

Not to mention you get no discount bringing your own device so carriers are getting more from you, especially if you don't or can't(unlimited data) upgrade.

Nicholas Kathrein says:

I think in general people will be less likely to want to pay $700 for a phone when they realize they can pay less per month. At the moment it's not obvious to most people how much they are really paying for their phone. Only T-Mobiles plans make it clear that you can get the same service for a lower price if you buy your own phone. If AT&T and Verizon had plans out in the open people would be more likely to buy 300 to 400 dollar phones than the iPhones they have been buying. This is where the problem starts for Apple. Currently people don't realize that some of the carriers have these low cost plans. They really think they only are paying $200 for the phone.

luimende says:

But people that buy iPhones aren't going to want a 300-400 phone, it may hurt the phone manufacturers more, if they aren't selling 30 million per quarter, if I pay $700 (and I will) I'm keeping my phone til it breaks, or sell it to pay off my balance and get a new one. Meanwhile the carriers have lost nothing.

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Nicholas Kathrein says:

I think the iPhone buyers in the U.S. are split between wealthy people who can drop $700 on an iPhone and normal people making 30 to 50 thousand a year who are currently getting an iPhone because it seems like they are only paying $200 for the phone. They don't realize if that they could buy a phone outright and pay $20 or more dollars a month less by bring your own device. My friend makes over 100k a year which is a lot more then most people and once I told him he could get a nexus 5 for $350 off contract from Google and get a new phone plan with the same stuff just not paying extra for the phone and he changed out his and his wife's phone. His plan went down like $50 a month or more. I don't remember the exact amount but he loves his new phone and can't imagine why he should be paying all that money when both the iPhone and Nexus 5 are great phones. Again a huge % of iPhone sales are from less wealthy people who if were told you can buy your own phone for $200 or $300 off contact and then pay $30 less per month they would go with the cheaper phone. US market share would drop for sure. Don't forget many people are buying the cheaper iPhones as well. Currently the carriers are paying Apple for these products. That won't happen like it currently does. People will see the monthly price and say "I can pay how much less going with this cheaper Android phone?" "Sh**, I take that."

angermeans says:

I partially agree with your statements, but you are implying that Android phones are cheaper than than iPhones and besides the Nexus 5 (which Google has clearly shown they can't make enough of) all Android devices are within $100 of iPhones. What you aren't taking into consideration is apple does sell the 5C and would surely meet the market demand if subsidies left for good. Not to mention iPhones keep their value for much longer than android devices. An iPhone 4s is still worth 300-400 (he'll even the carriers will happily give you a 300 credit to trade them in). Take an android phone sub has the Droid Razr which is worth $29 right now. Consumers are smarter than you give them credit for and the used smartphone market is booming. People that want iPhones will buy iPhones because they don't get the same experience from an android device (and I've used them for years). Yes, the nexus 5 is an excellent value and great phone, but the average consumer will be turned off by not having any support whereas apple takes care of their users for years. The only reason I see apple ever decline in market share (at least in the coming future)is if people see the value of keeping their phones longer, but cheap android phones have been around for years and aren't making a dent in apples market share. iPads sell extremely well and people gladly pay a premium when they could eadoly get a $199 nexus7, but they don't. That's a tablet how much more will people pay for their iPhone?

Nicholas Kathrein says:

The prices for good android phones are coming down. You can also get the Moto G for only $200 or less. That is a steal. When the next version of the Moto X comes out the current one will drop in the $300 range. Again another steal. My point is that Apple makes a lot more money from the carriers per phone than even Samsung does. When / If the U.S. dumps subsidies Samsung won't have a problem dropping the cost from $650 to $550 or even $500 because they weren't getting as much money from the carries so Verizon and AT&T are really only giving them $400 to $500 a phone. Apple is at least making $100 to $150 more per phone and their deals include a guarantee to buy a specific amount per year. If they don't need them it's to bad. This is why it's going to hurt Apple the most. When it comes to money even if you want Apple and iOS the vast amount of Americans aren't going to pay the premium it will cost off contract. The reason a tablet will sell for more is because people actually view them as a computer. They see the size and say "I can justify spending $500 on this. It's my new computer. If I have to use my old computer to do something this can't it won't matter that it's old. I'll only use it a little bit." This is what most Americans will say. Now I not normal. I build my PC,run Roms on my 2 year + Phone, and a new Nexus Tablet. I am not the norm. iPad Marketing is another key reason iPads Sell so well. They got out there first with really good ads. Many people bought them and the straggerlers are buying iPads because their friends and family have them. They don't know about Google Nexus Tablets. They only know what they've seen. This is really an area that benifits from the 1st one out starts a snowball and more and more people buy the product. Apple's newest numbers show tablet sales fell a lot this last quarter. People don't need to replace them all that often. Again they see the tablet as a Computer. Once Touch ID is in the next version of the iPad there won't be much reason to buy another tablet for 4 or 5 years unless Apple decides to do something in software that makes it "not" update able." Basically Apple has to sell hardware for a big profit. That is what they do. If the carriers stop Apple is in big trouble. Their profits will have to come down. Carriers won't sign deals to buy a specific amount of iPhones because they will sell a lot less once they are full price.

SchiffyM says:

I think this is right. These comments always seem to amount to "C'mon, my fellow carriers! Let's all stop paying for these phones! Okay? Are you with me? Was that a yes?" It's sort of like how baseball GMs periodically make noise about stopping to pay extravagant prices for free agents -- it only works if nobody succumbs, but somebody always succumbs.

PopeJamal says:

Going into a store and spending $800 on a mobile phone will NEVER be the dominant way that Americans acquire their phones. Most Americans don't have that kind of money lying around. It doesn't matter how they do it, but the cellular industry has no choice. If they don't give people an easy way to make monthly payments for their phones, they'll never sell more than a meager amount of handsets that cost more than $300 tops.

The iPhone would not be the phenomenon it is today without subsidies and/or the monthly payment model.

DrostSteven says:

True and the logic can be extended to all large purchases. Homes, cars, furniture. Credit is the way most purchases are made in developed countries.

Nicholas Kathrein says:

Also lets not forget people will be happy if you tell the customer their monthly fee is also $20 or $30 lower because they purchased that cheap $200 or $300 Android phone. Your not going to get most people excited by the lower monthly fee if they have to pay $700 for a phone.

angermeans says:

I disagree and iPads prove it. Yes, you might see a decline, but apple would still sell iPhones hand over fist every year. People forget that you can only get a subsidized iPhone every two years. I'm willing to bet a large amount of sells come from full cost devices just like people pay 500-1000 for an iPad when they can just buy a $199 nexus 7 or any other number of cheap android tablets that have no where near the market share.

I do agree the popularity of the iPhone wouldn't have been as great, but now that apple has people addicted to their iPhones consumers will pay what they need to get and keep one.

Nicholas Kathrein says:

iPads don't prove it. iPads are looked at by most as their computer replacement. They say "my computer costs $500 to $800 to replace. I buy this and I have a new computer. The few times I can't do something I'll use my old computer. No big deal." The majority of iPad buyers don't replace them every year.

niss63 says:

It's a mess, to be sure, but you really can't accurately call it a subsidy when it costs the customer more to buy the subsidized phone than the phone costs out right.

I just encountered this sticker shock last month when I decided to upgrade all of our phones. Most of our phones had an immediate out of pocket cost in the neighborhood of $300/phone. For seven lines, that gets your attention. But at the end of the transaction, we're going over the fine print and I find out our subsidized phones will cost an additional $25/month/line for 26 months. Math wasn't my strongest study, but it's easy to see that I'm getting taken to the cleaners. $300 + $650 is a lot more than the $700 price tag on these phones.

We cancelled that deal, right then. I spent the next two weeks wheeling and dealing phones. Everyone now has a new phone and I paid ~ $2k out of pocket for 7 phones.

We're on AT&T ... I think they'll start missing some of that revenue, when more people do like I did, or worse yet, move over to some carrier that will give them a subsidized phone - assuming they notice the rate increase. The cash back incentives are nice, but people like to hold onto nice, new shiny things. Carrier's shouldn't forget that.

FWIW, I don't know if the cable company analogy really works. Mainly because, around here, cable companies never sold TV's with their services.

I know one thing, this has changed how I view my carrier and my bill. Now, I'm all about driving down the cost of ownership. I'm much more likely to switch carriers to get a cheaper price on the service, since I'm no longer tied to the subsidized phone loop.

streamlined says:

People are forgetting that as the smartphone market grows, the cost of phones will drop. $800 smartphones will soon be a thing of the past. Well, outside of Apple anyway. And Apple will continue to shrink in the US market as Android phones will sell for under $500 with no-contract.

rogifan says:

What high end Android phone is selling for under $500 off contract? And what Android OEM is successful and profitable selling cheap phones? A 16GB Galaxy S5 sells for $650 unlocked at AT&T. That's the same price as the iPhone 5S. The "subsidies" are the same too - $450. An unlocked HTC One is $10 cheaper. This myth that iPhones are more expensive but are masked by so-called "subsidies" is BS.

streamlined says:

I said IN THE FUTURE. Of course they don't, yet. As volume picks up component costs will come down. The combination of subsidies going away, volume going up, and cutthroat competition will eventually cause phones to come down just like laptops. And yes, I am a financial analyst. Even worked with Gateway Computers and it was Dell's volume that killed Gateway.

Jonas Slough III says:

And how that work out in the end for Dell? Apple is the most profitable PC maker right now.

Caleb Pelton says:

I got my 32gb Nexus 5 from Google for $400. There is a high end android device for under $500.

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Nicholas Kathrein says:

Currently the Moto X and the Nexus 5. When the next Moto X comes out it will still be cheaper than an iPhone 5s. Android makers will sure come down in price faster than Apple will. Apple gets the most money from the carriers on a per device basis. If the subsidies disappear then the lowering the real cost of the phone isn't as big as an issue since Verizon and at&t weren't giving them a lot of money when they promoted their phones. Again Apple get more money per phone and guaranties that the carrier will buy a set amount per year. No other companies get that and if this goes full price Apple looses big.

pappy53 says:

You're mistaken. Apple's U.S.market share has been increasing for a couple of years. So, how can they "continue to shrink"?

streamlined says:

Ok, world wide. The US is just a small piece of the puzzle.

rjholmes123 says:

I don't want to pay $700 for an iPhone when I only pay $500 for an iPad, my HP laptop was $750, to pay that for a phone is ludicrous, I like the way it is now and I only pay $200 for the upgrade let the carriers eat the rest they can afford it.

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rjholmes123 says:

Brain Freeze!!!!, what a Cluster Fuck!

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randian says:

That $500 iPad doesn't do phone calls or mobile data.

elmtube says:

The US consumer 'awareness' is seriously lagging behind. In Norway, pretty much only companies buy carrier phones. All private consumers buy off contract and the fight between carriers is mostly on extra features between them. Not price so much.

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Didier Ouzaid says:

Getting like that in France, too, since the Free Mobile offer launched. They drastically reduced monthly plan prices for the same kind of service (more or less) and obviously decided not to subsidize phones. They drove away millions of consumers from the mainstream carriers. So much so that the latter have had to spin off low cost subsidiaries to compete.

Free does offer easy terms of payment for high end smartphones, but that is done through striking a deal with a financial/credit institution and is clearly separate from their offer. It's still cheaper than carrier-subsidized phones (their deal offers a low - if not 0% - interest rate), but the customer knows he's buying smth on credit, not bundled and hidden is a myriad of carrier details (data plan, free this, free that, etc.). Somehow it's a psychological barrier many arent ready to cross since many people have chosen to pay for their phone upfront, albeit settling for cheaper smartphones. Google's Nexus is a popular choice for that, and so is Samsung to an extent, since their high end flagship prices seem to decrease faster than that of iphones (you could find GS4 at a 25% markdown only 3 to 4 months after they were released - iPhone prices remain stable).

Nathan Bael says:

That is all well and good, but how many carriers do you guys have? Here we basically have two main carriers, two not-so-good carriers, along with a sprinkling of local carriers that don't really count if you ever go beyond your home city/state. Carriers do subsidies and then charge people more. If they were to cut out the subsidies, they would still charge people the same. T-Mobile is my favorite provider as far as pricing goes, but their coverage (sadly) sucks unless you are in a major city 24/7.

chriswicke says:

I haven't read all the comments, but it seems that you are missing the point. If I have to buy my phone and get some kind of subsidy directly, ideally in the form of a smaller monthly payment, then I am much less likely to upgrade my phone after two years. I'll happily hang on to my old iphone if it's working fine for quite a while after I've paid it off. There's no incentive to upgrade. If I'm paying for that subsidy in the form of my monthly payment, then I'm encouraged to upgrade to at least take advantage of the better phone since I'm essentially paying for the privilege already. I did exactly this with the iphone 5 when I was able to sell my old phone back for essentially the price of the upgraded phone.