The shift away from the traditional U.S. model of a subsidized smartphone in exchange for a two-year contract appears to be accelerating and is likely going to continue to do so for the next few quarters. However, the shift might not be in the best interests of carriers, handset makers or consumers in the long run.
Handset upgrade programs--including T-Mobile US' (NYSE:TMUS) Jump, AT&T Mobility's (NYSE: T) Next, Verizon Wireless' (NYSE: VZ) Edge and Sprint's (NYSE: S) Easy Pay--mostly benefit customers who really want to upgrade often to newer devices. However, they also benefit customers who want to keep their devices after two years, or customers who have paid off the full cost of their devices. That's because, in most cases, customers who stay on no-contract plans will see a permanent drop in their totally monthly service bill once their device has been fully paid off and they are no longer making monthly payments for their phones.
If a large number of customers wind up holding onto their devices longer, Recon Analytics analyst (and FierceWireless contributor) Roger Entner said that "the unintended, blatantly obvious consequence will be in all likelihood a slowdown of the (handset) replacement cycle." That means that handset makers likely will not see as many customers upgrading to newer models on a regular basis as they did under a two-year contract, which could lead to slower sales.
Additionally, people who hang on to their devices longer may not get newer devices with improved radios for different spectrum bands, which carriers are putting into use to augment capacity on their LTE networks and deliver faster service. That could lead to a degradation in the user experience on the network.
I don't want to be a doomsayer. I still think there are a lot of benefits for U.S. consumers, especially if they get a discount in monthly service pricing by going to a device financing model (Verizon finally got around to doing this earlier this month.)
And there are benefits in the shift to device financing for carriers and consumers. Carriers get to recognize more hardware revenue even if they see service revenue slipping. Importantly, they also remove the cost of subsidizing devices from their balance sheets. And consumers in most cases get lower service pricing for forgoing a subsidized phone. And companies that sell cheaper smartphones could enjoy a boost in sales when consumers realize that the cost of an Apple (NASDAQ: AAPL) iPhone is not $99 or $199 but more like $550 or $650. That's because removing the subsidy gives customers more price awareness and transparency.
So far device financing models seem to be picking up steam. T-Mobile last year moved exclusively to the model and has added 3.7 million net new subscribers in the past three quarters.
AT&T revealed in its first-quarter earnings that the adoption rate of Next was 35 percent in the period, when taking out about 1.1 million accelerated smartphone upgrades that occurred in the quarter. AT&T CFO John Stephens revealed that "more than a quarter of our postpaid smartphone base is on a Mobile Share Value non-subsidy pricing, and is no longer tied to the subsidy model."
At Verizon, Verizon Communications CFO Fran Shammo said that the adoption rate of Edge in the first quarter was less than 15 percent but that he expects that to "potentially double" into the second quarter with the launch of Edge in Verizon's indirect channel. Yet he cautioned it's too soon to know what the ultimate adoption rate will be.
Sprint hasn't revealed much about how its early upgrade program is doing, but I suspect the adoption rates are less than what AT&T has been seeing as Sprint has been much less aggressive in marketing its upgrade program.
Yet even with all of the momentum behind Next, AT&T is sounding cautious notes. When asked on the company's earnings conference call if AT&T expects the adoption rate on Next to grow to 50 or 60 percent in the quarters ahead, Stephens basically said, "not really." He noted that AT&T allowed customers in February to do early upgrades with Next, which really drove up adoption, and that 35 percent seems like a steady quarterly adoption rate going forward.
Even more importantly, Stephens was asked if AT&T wants to get rid of subsidies totally, as T-Mobile has. Stephens said a lot of customers still want a subsidized phone in exchange for a two-year contract. "I wouldn't suggest that it would be eliminated as long as there is a significant amount of customers who enjoy and prefer it," he said.
That's the key. The carriers don't yet know what all of the consequences of moving away from subsidies will be--not for their bottom lines, for consumers or for their handset partners. I suspect Verizon and Sprint will be similarly cautious. "Ultimately what they want to see is how the handset replacement cycle plays out," Entner said. T-Mobile had to do something radical because it was sinking. So far, it's worked out pretty well for T-Mobile.
There are pluses and minuses to embracing device financing. I think the benefits are becoming more apparent. But we shouldn't forget about potential negative consequences as well.--Phil