Killing subsidies and raising fees a double-edged sword for Verizon

Verizon confirmed last week that it will kill subsidies and raise activation and upgrade fees.

Verizon’s move to kill smartphone subsidies and raise activation and upgrade fees will increase profit margins, according to analysts, but it risks losing customers and lowering ARPU.

The nation’s largest mobile network operator confirmed last week that it will kill subsidies and two-year service contracts to new and existing customers, and instead will require all customers to sign up for its equipment installment plan. Verizon also raised its activation and upgrade fees from $20 to $30.

Wave7 Research was the first to report on the changes, which went into effect Jan. 5.

Handset subsidies from carriers have plummeted precipitously in recent years as operators have moved away from contracts in favor of installment plans and leasing models for phones. Subsidies represented roughly 30% of phone sales last year, according to UBS, down from 46% in 2015 and 82% in 2014.

“With this move, we estimate just 10% to 15% of sales (representing business subs) will be subsidized going forward,” UBS Analyst John Hodulik wrote in a research note to investors Wednesday. “Verizon also increased its activation/upgrade fee to $30 from $20. We believe these moves will allow Verizon to maintain 2017 margins at similar levels to 2016 vs. our prior expectations for a decline. However, it will likely pressure subscriber trends as churn increases, aiding T-Mobile and Sprint efforts to take share.”

Walter Piecyk of BTIG Research echoed Hodulik’s sentiments, saying the changes “increased our reported EBITDA estimate by $1.7 billion primarily due to the favorable accounting impact of a higher mix of phones” sold through installment plans. BTIG lowered its cash EBITDA estimate, however, because the move will result in rate plans that generate lower ARPU.

“When a customer converts to a phone payment plan, their rate plan is reduced, which has a negative impact on ARPU,” Piecyk wrote. “The popular shared data plans charge $40/month for access to subsidized phone customers, but only $20/month for BYOD and phone payment plan customers. We estimate that 41% of Verizon’s postpaid subscriber base are on phone payment plans, so there are still a substantial amount of customers that can be re-rated down to these new plans. This compares to 70% and 60% on payment plans for T-Mobile and Sprint, respectively.”