Subsidized Phones Never Were Free, And Soon Won’t Even Seem That Way

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I don’t generally use personal anecdotes in posts because it seems a bit narcissistic. Categorically refusing to do so, however, in a way is just as narcissistic.

In any case, this is a brief story: A couple of months ago, I upgraded to a Samsung Stratosphere II (which I like). The upgrade was free. I went home and did some checking and found that the phone has a list price of more than $500.

While I was waiting on hold to sign up for the device loss insurance I had waved off at the store, I wondered how sustainable a business model is in which carriers hand out sophisticated and pricey computer gear for little or no cash, at least up front. Granted, the carrier is locking in the consumer for a couple of years and finds sneaky ways to recoup the investment. It still feels a bit unbalanced, however.

Apparently, others are thinking about the same issue. Last week, ABI Research Senior Practice Director Nick Spenser suggested that the carriers’ system is a bit creaky. A press release containing his quotes suggested that over-the-top (OTT) alternatives to the incumbents are a main reason. This competition is squeezing operator margins and increasing stress on the subsidized device approach.

ABI added that 68 percent of the cost of carrying a subscriber for two years is related to device subsidies. A follow-on problem is that subscribers no longer want to use the same phone for two years. Shorter terms are more expensive for the operator, however, and exacerbate the problem.

Tim Deluca-Smith, VP of Marketing at WDS, a wireless management company associated with Xerox, expands on many of the same points. Competitive pressures tend to force carriers to maintain the subsidy system, however. Ending the subsidies may make sense, and may in actuality be less expensive for the subscriber. But they look terrible.

Change may be coming, however. Deluca-Smith writes that new approaches will separate the devices from the service. He mentions T-Mobile US, AT&T and Verizon in the United States and O2 and EE in the UK as carriers seeking new paths:

Such plans essentially amount to device financing schemes in which the customer’s subsidised device is covered by a separate bill over an agreed period of time. Not only does this deliver greater transparency, allowing the customer to gauge how much they are paying for their ‘free’ smartphone, but it also allows the payment plan to be settled outside of the contract, or extended over a new device. This is crucial in changing the consumer mindset towards smartphones to try and emulate the same value they place on tablets.

The T-Mobile example mentioned by Deluca-Smith illustrates how carriers are attempting to break out of this mold. The carrier announced in March said that it was ending its traditional service plans. Customers can pay up front for devices, pay in installments, or bring their own devices and pay only for service. In the process, at least according to CNET’s Roger Cheng, many hidden charges that more than pay for the device are eliminated. He explained the logic:

T-Mobile is attempting to bring some visibility in the process by separating the phone and service costs into two different fees. Yes, consumers have to pay the entire price of the phone through an upfront fee and monthly installments. But the fees are more distinctly laid out relative to the bundled fee from a rival carrier, and are ultimately lower.

Regardless of whether it makes sense to end subsidies, it will be a hard sell. A person buying a device may intellectually understand that he or she is getting a better deal by paying full freight. Paying nothing at the point of purchase, however, feels terrific. For that reason, it will be a difficult habit to break.