A shift from device subsidies to financing could bring disruption - and be good

Phil Goldstein

LAS VEGAS--I've asked almost every company I've met with so far here at the 2014 Consumer Electronics Show the same question: How would a shift in the U.S. market from device subsidies to device financing affect your business and the wider market?

The responses I've received, mainly from handset companies, tended to indicate that if such a shift does take place, the onus will be on OEMs to provide value, either in terms of price or innovation--or both.

I don't think the prevailing model of the U.S. market--a subsidized device in exchange for a two-year contract--is going away anytime soon. However, there is clearly the beginning of a push by U.S. carriers to move toward device financing.

That shift will cause disruption in the handset market and likely produce sticker shock for some consumers. But it will ultimately make the handset market a healthier one, where handset makers are forced to innovate and prove their worth--and not hide behind or benefit from carrier subsidies.

The shift, which was started in earnest in 2013 by T-Mobile US (NYSE:TMUS). The device upgrade programs that AT&T, Verizon Wireless (NYSE:VZ) and Sprint (NYSE:S) launched last summer following T-Mobile's introduction of its Jump program all are based around the idea of cutting a carrier's subsidy costs by getting customers to pay for their  phones in installments--with the benefit to consumers of being able to upgrade earlier. In most cases, customers are also receiving a discount on their monthly bills for agreeing to engage in the program. The irony, of course (and a cruel irony for consumers), is that carriers eagerly used subsidies to get smartphone customers on their network with the promise of "$200" smartphones--and now they want to reduce their subsidy costs now that they have so many smartphone customers.

"The history of subsidization has led to a perception of, 'I'll pay $500 for a digital camera but my phone shouldn't cost more than $99,'" noted William Plummer, Huawei's vice president of external affairs.

That mentality likely will make it difficult to move away from the traditional model. It will involve a gradual shift in perception, and will require both carriers and handset makers to educate customers on the true cost of devices--that $200 iPhone 5s a consumer gets with a two-year contract actually costs $650.

High-end smartphone makers like Apple (NASDAQ:AAPL) and Samsung Electronics could have the most to lose. They have built up positions in the premium end of the smartphone market and could see their fortunes tumble when consumers realize how expensive their phones actually are.

A corollary is that a shift away from subsidies should benefit companies that have traditionally played in the low-to-mid segment of the smartphone market, like Huawei and ZTE. If their unsubsidized prices are several hundred dollars lower than those of their higher-end competitors, that difference could bring them more customers if the specs and user experience of the phones are similar enough.

ZTE USA CEO Lixin Cheng said the company has traditionally focused on "affordable premium" smartphones that have lower price points. But he said the company tries not to skimp on specs and the user experience. (Cheng, for his part, doesn't think subsidies are going away in the near future.)

I think the most notable result of a shift away from subsidies is that it would level the playing field among handset makers more--they will no longer be able to hide behind a carrier's subsidy that makes all smartphone cost virtually the same.

Jo Harlow, Nokia's (NYSE:NOK) executive vice president of smart devices, said a shift away from subsidies would increase the need to "bring real innovation that justifies that level of expenditure" on the part of consumers. "If the next flagship is just a small variation on next year's flagship, consumers will wait."

As I said, I don't  think the subsidy model will wither away soon. But a shift is definitely under way. It likely will bring business to device resellers and companies interested in financing device purchases. The biggest disruption though will be for handset makers, which will have to prove that their devices are worth consumers' money without the safety net of a subsidy.--Phil

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