The elimination of carrier subsidies on smartphones in the U.S. has been done in a strategic way that shifts costs, but adds very enticing benefits that very well could accelerate device sales with more frequent upgrades.

The move to eliminate subsidies for smartphones in the U.S. has been done in a way that disguises the cost shift from the wireless carrier to the consumer.  In a society that evaluates cost based on the 'here-and-now' (the what do I have to pay to leave with this phone right now mentality) rather than the long-term, the way in which installment plans have been implemented will not stunt growth of device sales, rather, they may actually accelerate it, with the attractive annual upgrade options embedded in the value proposition.

Unsubsidized Installment Plans:

The unsubsidized installment plans are the newest trend that U.S. carriers are offering, which effectively eliminate the subsidies and allow the carriers to collect the full device cost rather than just the $199.99 that is collected upfront for the latest-and-greatest smartphone.  A subsidized contract provides the customer the opportunity to purchase an entry-level flagship smartphone for $199.99, as opposed to $649.99 (the unsubsidized price of a 16GB iPhone 5S).  These new installment plans allow a customer to pay $0 upfront, but then divides the full price of the device $649.99 into either 20 or 24 installment payments.  So for a 16GB iPhone 5S, an additional $32.50 monthly charge is added for the 20-month installment plan, or $27.08 for the 24-month installment plan.  Note that these installment payments are in addition to voice and data plans.  

But $0 down is just one of the appetizing incentives presented to customers contemplating an installment plan; the other incentive is just as powerful - upgrade rights. The key hook of the installment plan purchase is that customers on the plans have the right to trade in their smartphones after a certain number of monthly installment payments have been made (12 in the case of the 20-month installment plan, 18 in the case of the 24-month installment plan) and upgrade to a new device at no cost. Since OEMs are releasing new flagships annually now and everybody wants "the latest", there is a large incentive to go with an installment plan that allows for the annual upgrade.

When carriers sell phones using traditional subsidies, they collect the $199.99 upfront, but that's all they collect as far as the device cost goes, and the gap of $450 ($649.99 - $199.99) is the effective subsidy. Under this scenario, they rely heavily on the 24-months of contractual service (voice & data) revenue to more than offset the subsidy.  With the installment plans, the carrier is now collecting the full $649.99, but over the span of 20 or 24 months. So even if a subscriber chooses the 20-month installment plan and elects to upgrade at no cost after 12 installment payments have been made, the carrier has received the following:

  • The device - as it has to be traded-in, which can be refurbished and sold
  • $390 of device-related payments ($32.50 x 12 installment payments), which far exceeds the $199.99 that a customer would pay upfront on a traditional subsidized plan
  • Monthly service revenue, which would run at least $60 per month for the lowest data plan

Your typical customer does not understand the elimination of the subsidy.  In fact, they see these installment plans as a great deal as they can walk into a wireless store, pay at-most a $35 activation fee, and walk out with a brand new phone.  What they don't understand is that even after 12 installment payments, they have paid 95% more ($390 vs. $199) just for the hardware than they would have under a subsidized program, while still paying the same service revenue that they would have incurred under a subsidized purchase.

It Gets Better:

Installment plans and elimination of subsidies sound like it would eliminate being tied to a contract as well, which is another way that these plans are being pitched - ummm, not so much.  The fine print on these installment plans requires that if at any point you decide to cutoff service, you owe the remaining balance of the device.  So in the example of an iPhone 5S, if you decide to cutoff service after 10 months, you owe the carrier $325.00 ($649.99 less 10 installment payments of $32.50).  So while the carriers are touting these new plans as contract-free, it's merely semantics.  In all reality, the $325.00 balance due after 10 months of service is effectively a contract termination fee.

The Alternative:

When the move away from subsidies started coming up, one likely thought of a scenario that had the customer paying the full price of the phone upfront at the time of purchase, which would be $649.99 for a 16GB iPhone 5S.  However, when given more thought, that wouldn't work for the carriers for a number of reasons, including:

  • It would cause people to keep using the same device forever and thus, wouldn't allow for new activations and would put the carriers on the hook for unsold units that they have been contractually obligated to purchase under MOQ clauses with OEMs
  • It would not tie the customer to the profitable side of the business - monthly data and device access fees. After all, after you have paid for a device in-full, there is no contractual obligation - you become a month-to-month subscriber

Conclusion:

The elimination of subsidies in the U.S. has been given much attention and has largely been viewed as a very negative trend for the OEMs (AAPL, Samsung, HTC, etc.).  However, the negative attention has largely been overstated and perhaps isn't even a negative at all.  With the old subsidized contract, a customer could only upgrade after two-years.  The new installment plans are being sold to customers as a $0 down and upgrade every year type of deal, which are both very enticing to your average person not doing the math or not understanding how subsidies work.

It should be noted that the international markets are an entirely different animal, in the sense that in most countries where credit quality is weak or non-existent, phones do require payment in-full upfront.  The carriers in these countries are much more concerned with recouping device costs than their domestic counterparts, who are looking much more at metrics like ARPU and churn.  As emerging markets establish better credit systems, the installment plans that have led the subsidy elimination in the U.S. will likely become a similar way to disguise who is paying what, and the shift in focus will move to ARPU and other usage metrics.