Apple's iPhone Upgrade Program should worry carriers for 1 big reason: it makes them less relevant

Phil Goldstein

The biggest news from Apple's (NASDAQ: AAPL) announcement of its new iPhone 6s and 6s Plus phones yesterday was not the phones themselves, which largely conformed to the leaked specifications that had been circulating for weeks, but rather Apple's decision to launch its own equipment installment plan to let customers pay for the devices directly from Apple. The new program should worry carriers because it makes them much less relevant to consumers, enhances Apple's relationship with customers at their expense and could be a step toward Apple cutting out carriers entirely.

Under Apple's iPhone Upgrade Program, which starts at $32 per month and allows users to upgrade their iPhone every year, customers get an unlocked iPhone 6s or iPhone 6s Plus with the Tier 1 carrier of their choice, and Apple's AppleCare+ warranty service.

Apple makes explicit that carriers are not exactly the most important aspect when customers are buying new iPhones. "Because the iPhone Upgrade Program isn't tied to a single carrier, you don't need a multiyear service contract," Apple states on its website. "If you don't have any carrier commitments, you're free to select a new carrier or stick with the one you have." 

As U.S. carriers have shifted away from subsidized smartphones and two-year contracts and in favor of EIP programs and leasing, a move like this from Apple almost seems inevitable in hindsight. The cost of a new iPhone has never been more transparent, which I think is an unqualified good for the industry. However, Apple wants to sell iPhones, and instead of the sticker shock of a $650, $750 or $850 (or more) iPhone, it is working from the same playbook carriers have been, offering phones for a low monthly cost -- except without the carriers' involvement.

Apple's program supports service from the big four nationwide wireless carriers: Verizon Wireless (NYSE: VZ), AT&T Mobility (NYSE: T) T-Mobile US (NYSE:TMUS) and Sprint (NYSE: S). Users can purchase one new iPhone every year. Prices for the service start at $32 per month for the 16 GB iPhone 6s and increase to $45 per month for the 128 GB iPhone 6s Plus. The program is financed through Citizens One Personal Loans.

While I think the move is a pretty good one for consumers, there are many downsides to this situation for carriers. Since customers can easily switch between carriers if they do not have any commitments to them, customer loyalty is to Apple first and the carrier second. "Historically the device relationship has been a key anchor for carriers, and by financing a device through Apple, consumers will have greater flexibility to switch carriers, shifting the battle to own the customer relationship closer to Apple over the long term," Jefferies analysts Mike McCormack, Scott Goldman and Tudor Mustata said in a research note. "This could also limit the number of customer interactions, reducing carriers' opportunity to upsell customers to higher buckets."

The iPhone upgrade program will also likely increase volatility and churn at carriers. "If Apple is successful with its own lease offering, it could make it easier for carriers to switch networks," Macquarie Capital analysts Kevin Smithen, Ben Schachter, Will Clayton and John Merrick said in a research note. "This could benefit the challengers at the expense of the incumbents in our view, but churn may increase for everyone."

That may explain why T-Mobile seems so enthusiastic about the Apple program. "We love this. Anything that gives customers total choice is a win for them and it is a win for T-Mobile," T-Mobile COO Mike Sievert said in a statement.  "Unlocked phones give consumers the freedom to try out any carrier. That is a fantastic thing for T-Mobile too."  More customers who can more easily switch between carriers could be great for T-Mobile, the fastest-growing carrier in the industry.

Yet for most carriers, losing EIP revenue on iPhones, which have typically commanded the highest device payments, could also hurt their financials and standing with investors. In the shift to EIP and leasing, carriers have also emphasized a new metric for investors to look at -- average monthly billings per user, which takes into account service revenue and what the carriers receive in monthly device billings. Without the device billings from iPhones, those figures will start to drop.

"It's classic disintermediation. But we shouldn't expect anything else from Apple," said Recon Analytics analyst (and FierceWireless contributor) Roger Entner. "Apple has tried to marginalize the carriers since Day1. This is the just the last chapter that started with the App Store, where Apple went around the carrier app stores."

Interestingly, the Jefferies analysts also added that "it is also possible that Apple could lever the program to test a future MVNO offer." I consider that much less likely, but the program is certainly a step in that direction.

"The writing is on the wall, about how Apple is very methodically turning the carriers into dumb pipes," Entner said.

There are a few upsides for carriers. They will save time and money procuring iPhones, and will move bad debt and other expenditures for iPhones off their books, and won't need to worry as much about phone inventory. The upgrade program could help reduce carriers' balance sheet exposure to consumer credit, benefiting cash flow, the Jefferies analysts noted, adding that AppleCare+ does not cover device losses and theft, while carrier options do.

Apple's program could also spur more competition on monthly EIP or leasing pricing, which is already happening. Sprint said that through Dec. 31, customers on any other carrier or existing Sprint customers who are upgrade-eligible and who turn in any smartphone will get a promotional monthly leasing rate of just $15 per month on a new iPhone (when customers next upgrade after that, the leasing price will return to $22 per month). T-Mobile said it will offer the iPhone 6s for $20 per month on its "Jump! On Demand" leasing program. That kind of competition is great for consumers.

Yet the carriers now have a major league rival in device sales that they did not have before. Customers will certainly keep financing phones through carriers, which have even more incentive to compete with Apple and each other. New Street Research analysts Jonathan Chaplin, Spencer Kurn and Zach Monsma said in a research note that "if churn does start to creep up, the incumbents may respond by lowering the costs of their lease plan, effectively reintroducing subsidies."

The Apple program may not spell doom for carriers, but it is just one more headache for them they did not have before, the New Street analysts said: "Apple's financing plans may not have a major impact on the incumbents and the impact may not be instantaneously noticeable; however, it adds to the long list of pressures that the incumbents are already dealing with." --Phil