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Wireless Carriers’ Dream Come True: The End of the Phone Subsidy; T-Mobile May Start Trend

Phillip Dampier December 11, 2012 Competition, Consumer News, T-Mobile, Wireless Broadband 8 Comments

Riding away with your phone subsidy.

T-Mobile USA has thrown down the gauntlet, announcing it intends to end the kind of phone subsidies that have allowed customers to pick up pricey smartphones like the iPhone for as low as $99, with a two-year contract.

Wireless subsidies have been part of the North American wireless experience for nearly two decades. In an effort to bring new customers on board, carriers wanted the upfront cost to consumers to be as low as possible. Until expensive smartphones arrived, consumers were assured they could get a new, cutting-edge phone at contract renewal time for very little money. Carriers tolerated the subsidy even for existing customers because the difference between the company’s cost and the amount consumers paid wasn’t large enough to negatively affect a carrier’s balance sheet.

Companies gradually earn back the subsidy over the course of a typical two year contract by artificially inflating prices for service plans and add-ons. Because wireless rates have been set with the assumption a customer has received a subsidized phone, it made sense to keep getting new equipment every two years, because customers pay for it on each monthly bill.

In most countries outside of North America, it works very differently. Most customers either pay for a phone outright or agree to finance its purchase through a wireless company, paying monthly installments for smartphones that often cost more than $600. Some companies offer more aggressive discounts if one agrees to a 1-3 year contract, but buyers still cover much of the cost themselves. In return, wireless companies abroad typically charge much lower rates for service and do not force people into lengthy contracts. Customers also find they can switch companies as easily as replacing a SIM card, activating an old phone on a new carrier’s network.

There are pros and cons to the subsidy model:

PROS

  • Consumers get the latest phones at a reduced up-front cost up to every two-years;
  • The subsidy win-back is collected gradually over the course of 24 months;
  • Carriers aggressively compete on huge subsidies for popular phones;
  • The reduced price of a subsidized phone brings reticent consumers into the market;
  • Carriers have increased control over the equipment that is used on their network through price incentives;

CONS

  • The subsidy model gives carriers an incentive to lock discounted phones to their network;
  • Customers pay artificially higher prices for service, whether they take advantage of a subsidized phone offer or not;
  • Consumers don’t realize the true cost of the phones and expect them to cost less than $200 regardless of their retail price;
  • Customers are locked into lengthy contracts with stiff early termination fees to protect the subsidy win-back structure;
  • Without a subsidy, equipment manufacturers would face natural market pressure to cut costs to remain affordable;

Legere

T-Mobile announced last week it was ending its phone subsidy program next year, and customers will be expected to bring their own phone, buy one at an unsubsidized rate, or finance a full price phone with the carrier. In return, customers will get a lower priced T-Mobile calling and data plan.

Some in the tech press are heralding the announcement as a consumer victory and a breakthrough for lower priced service plans. But before throwing the confetti, consider this.

T-Mobile is making customers bring or buy their own phones, but will still lock them into a two year contract with a $200 early termination fee.

T-Mobile’s retention of its contract plans might delineate the postpaid side of its business and its month-to-month, contract-free, prepaid business. But that does not mean much for customers.

John Legere, the new CEO of T-Mobile USA hinted the measure is designed to reduce customer churn — customers coming and going. Locking a customer in place with termination penalties assures shareholders customers are more likely to remain with T-Mobile for the life of their contract.

That represents a win for T-Mobile, but not for customers. Legere explained the benefits to investors:

“[We are going] to have a lower device subsidy obviously and overall value,” Legere told attendees at the Capital Markets Day Conference. “[… because of the] device margin — $200 to $250 — which we do not have to eat. Over a 24-month period [we get] a customer life value that is the difference between $550 on a Classic [traditional subsidy contract] plan and $600 on a Value [no-subsidy] plan.”

In other words, T-Mobile doesn’t have to front a device subsidy, still holds a customer with a two-year contract, and despite the lower-priced service plans, comes out $50 richer when the contract expires.  T-Mobile is essentially admitting it does not return the entire value of its former subsidy back to the customer.

What is more, T-Mobile may pave the way for other carriers to also drop handset subsidies, keep the traditional two-year contract, and only slightly lower prices.

Nothing peeves Wall Street more than the huge subsidy costs carriers pay up front to discount the latest smartphones. Getting rid of subsidies while only mildly adjusting prices could be the next hidden “price increase,” the perfect gift for an investor that demands higher revenue from every customer.

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Scott
Scott
7 years ago

AT&T and Verizon couldn’t have asked for a better deal, they’ll both be following suit shortly after exchanging a few comments publicly to signal to each other what they’ll be doing. This is a horrible deal for consumers, as with European customers there’s absolutely NO reason for you to be forced into a 2 year contract to save a meager $18/mo off your bill. For example, if you were on an ‘inexpensive’ T-Mobile Smartphone plan for $80/mo, that would reduce it to $62 not including taxes but lock you into a 2 year contract for no reason and require you… Read more »

Greg
Greg
7 years ago

T-Mobile has short memory. Sprint tried this around 2000 and eventually switched to subsidized phones. Also, if there’s no phone subsidy, what is the purpose of the contract?? I thought the only reason for the contract / early termination fee (ETF) is to justify the subsidy.

KL
KL
7 years ago

Oh, come on, the one rare time something good happens in telecom, you still see the dark side. I’m on T-Mobile’s unsubbed Value plan, and I’m on it because I explicitly picked it over the subbed Classic plan. The Value plan is way cheaper, by about $20 per month, so over the course of a 2-year contract, I’ve saved $480. Rarely does the phone subsidy reach that high of a level! So if I want a lower-end smartphone (ones that cost between $100 and $200, unsubbed), the subsidy model royally screws me. Actually, in practice, I save a whole lot… Read more »

Conan Kudo (ニール・ゴンパ)

From what I saw from Vodafone Spain and Movistar Spain, the problem was that the retail price was mentioned as the “price to pay”. T-Mobile USA’s version of the system mentions the “down payment” on the sticker, not the full retail price. Vodafone and Movistar allowed the sticker shock to kill everything, while T-Mobile is being very careful about how it is being implemented here. As a result, T-Mobile has had much more success with the Value plan than Vodafone and Movistar had. Also, T-Mobile does not allow you to choose how much of a down payment you can make… Read more »

Scott
Scott
7 years ago

The termination fee has always been in place to allow the Cellular provider to recoup the cost of the phone they gave you via the subsidy should you leave before your contract is up (and the phone has been paid for). They’ve stated and made this clear themselves, AT&T was one that increased the termination fee specifically for Smartphone’s. There’s absolutely no reason or justification for them to retain the contract requirement or termination fee when they’re no longer subsidizing the phone provided to you for using the service. So far these changes are purely there to satisfy Wall St.,… Read more »

KL
KL
7 years ago

Okay, I agree that the 2-year contract seems weird and out-of-place for an unsubbed plan. Personally, I’ve never worried about it because I have no intention of leaving any time soon. I think it might just be a vestige of the classic plan, that it’s something that they just never bothered taking out when they started to experiment with the value plan. It’s possible that if they move towards making the VP the primary plan, that they’ll do away with the contract. Because, you’re right, it doesn’t make sense, and ETFs are the kind of annoyances that Legere wants to… Read more »

Jason
Jason
7 years ago

I agree There should Not Be 2 Year Contracts!! Take an example from http://solavei.com/graber

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