Since the iPhone was first released seven years ago, the vast majority of American iPhone shoppers have purchased their device for around $200 with a two-year service contract. But this year, things could be much different.
By the time Apple (NASDAQ: AAPL) gets around to selling the iPhone 6 later this year, close to half of all Americans are expected to buy their smartphones through a handset financing program. So instead of paying $200 upfront and signing a two-year contract, around half of all iPhone buyers this year won't sign a contract and will instead pay for their phone through monthly installments.
And it's not at all clear what this trend means for Apple, iPhone 6, other smartphone vendors, third-party retailers and the wider wireless industry.
First, let's get to the numbers: The popularity of handset financing plans (also called equipment installation plans or early upgrade plans) has blown away most expectations. According to the NPD Group, enrollment in the programs has more than quadrupled since September 2013, going from 7 percent to 31 percent by the end of the first quarter. And earlier this month, analysts at Jefferies forecast that roughly 43 percent of all postpaid devices will be sold on equipment installment plans in 2014, "almost 50 percent more than we had previously expected."
T-Mobile US (NYSE:TMUS) is the main driver of this trend. The carrier ditched contracts last year in favor of financing plans, and in the subsequent months most other major carriers have introduced their own financing plans (though most also still offer two-year contracts alongside those financing plans). In the first quarter, T-Mobile reported more than 1.3 million net additions--exceeding AT&T Mobility (NYSE: T) and Verizon (NYSE: VZ) combined.
But it's also clear that T-Mobile customers aren't the only ones signing on to financing plans. For example, AT&T earlier this month said it expects to score around 3.2 million additions to its Next handset upgrade plan in the second quarter, up from 2.9 million in the first quarter. AT&T said around 50 percent of all of its sales in the second quarter will be through Next.
Under financing plans like Next, the cost of your phone is separated from the cost of your cellular service, and if your credit is good you can pay for your phone in interest-free monthly installments with no money down. Although the overall cost of the phone and service is roughly the same, or slightly more, in a financed plan as compared with the standard two-year contract plan, wireless users in financing plans in most cases can upgrade to a new phone sooner and are not required to sign a long-term contract.
According to NPD, the main factor driving interest in financing plans is the ability to upgrade your phone more frequently. The firm found that 39 percent of survey respondents named early upgrades as the factor that most attracted them to financing plans, followed by the ability to pay for their phone in monthly payments (17 percent) and the chance to get a discount on the cost of their cellular service (12 percent).
But what does this mean for the iPhone 6? If you're a glass-half-full person, you might think that these financing plans could help Apple ultimately sell more iPhones since they allow subscribers to upgrade to a new phone once a year or even more often, depending on the carrier. That could help Apple sell more phones. Or, if you're a glass-half-empty person, you might think that these plans will actually lead to fewer smartphone sales because wireless customers who pay off the full cost of their phones via handset financing plans will enjoy significantly less expensive monthly bills. That could prompt people to hang on to their phones longer than they would in the two-year contract scenario, thus leading to fewer iPhone sales.
At this point, there's not much data to indicate which way the industry will ultimately trend.
At least initially, financing plans could help Apple sell more expensive iPhones because there isn't much of an upfront payment. The 64 GB iPhone 5s costs $400 upfront with a two-year AT&T contract, but just $42.50 per month for 20 months with AT&T Next.
Recently, Consumer Intelligence Research Partners reported that the high-end iPhone 5s accounted for 73 percent of financed iPhone sales, compared to 61 percent of all iPhone sales overall. The report was based on the findings on a survey of 1,500 U.S. customers who activated a new or used phone in from July 2013 to March 2014.
However, on the downside, financing plans like AT&T's Next do provide more transparency on the actual cost of an iPhone or other smartphone. Before the advent of handset financing, most high-end smartphones cost $200 with a two-year contract--consumers were completely isolated from the actual cost of the phone. Now, though, AT&T customers can more easily see the difference in price between an HTC One M8 ($33.50 for 20 months, for a total of $670) and the Motorola Moto X ($20 for 20 months for a total of just $400), for example.
It remains to be seen how that kind of transparency will affect the iPhone 6, which reportedly could cost as much as $750 for the 5.5-inch "Pro" variant. According to IDC, the worldwide average selling price of an iPhone this year ($657) will be more than double the average selling price of an Android phone ($254) and a Windows Phone ($265).
Indeed, there is surprisingly little data on the types of phones that are being sold through handset financing programs. None of the wireless carriers I asked--T-Mobile, AT&T and Verizon--offered information on the topic. And analyst and investment banking firms including NPD, Jefferies and New Street Research also couldn't offer any hard data on whether the rise of handset financing will affect the kinds of smartphones people buy.
"We expect both Apple and the U.S. carriers to benefit from an iPhone 6 that is offered via a zero-down, no-subsidy model," Macquarie Capital analyst Kevin Smithen wrote in a recent note to investors, according to Investor's Business Daily. "We have recently spent time with carrier managements and we believe they are expecting strong pent-up demand for the large-screen iPhone."
But Smithen also noted that the no-subsidy model "could lengthen the (phone) upgrade cycle and/or drive more used phone sales."
Felix Wai, an analyst with New Street Research, said that it's unclear whether handset financing plans will change the types of phones Americans typically buy. He said that carriers used to break down their quarterly smartphone sales by iPhone and Android, but don't anymore. He also said that T-Mobile's smartphone sales jumped when the carrier stopped requiring an upfront payment on its handset financing plans.
"Installment plans in general make it more easily stomach-able for a consumer to buy a smartphone," he said.
As for whether the added pricing transparency in financing plans will change what types of phones people buy, Wai said: "Potentially. It depends on how the carriers push the device."
I doubt handset financing plans will significantly affect sales of the iPhone 6 or any other phone--at least initially. But the popularity of the plans could widen the gap in the smartphone market between the super high end (wherein customers will pay virtually anything for the latest and greatest) and the low end (wherein customers just want a device that can check email or offer navigation services). --Mike |+MikeDano | @mikeddano