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Farewell, subsidized tablets. We hardly knew thee.
AT&T (NYSE: T ) has just decided to discontinue subsidizing tablet sales, following in the footsteps of big red rival Verizon (NYSE: VZ ) , which made a similar move just last month. There are several reasons axing these subsidies makes sense, starting with the fact that the subsidies never made sense in the first place.
Dollars and sense
The discounts that consumers saw were much smaller than those for smartphones, making it an unattractive proposition to save maybe $100 initially in exchange for a lengthy contract. In addition, consumers sometimes generally and incorrectly perceive tablets to be worth more than smartphones since they're larger devices, adding to the willingness to pay full price. The vast majority of tablets sold nowadays are also only Wi-Fi-capable, since tablets are more frequently used within range of Wi-Fi networks, reducing the desire for constant cellular data connectivity.
It's worth mentioning that these subsidies had applied only to Google (Nasdaq: GOOG ) Android tablets, and not Apple's (Nasdaq: AAPL ) iPad. Therefore, the handouts, or now lack thereof, shouldn't be greatly affecting the market, which continues to be dominated by the iPad.
Instead, the carriers are now using tablets to try to gently push customers to their freshly unveiled shared mobile data plans, which force subscribers to overpay for things like unlimited voice and text, which are seeing usage declines in favor of pure data.
A tale of two mobile device categories
Despite the obvious similarities, smartphones and tablets are very different beasts, and their respective markets are panning out very differently. Subsidized markets skew the perception of a product's true cost to consumers.
Most smartphone buyers are now generally only willing to pay between $200 and $400 for a new device on contract, when they actually retail for typically $600 to $800. Entry-level tablet prices are usually around $400 but can go for more than $800 for an iPad with all the bells and whistles. The majority of people simply aren't willing to pay that much for a smartphone, even though smartphones should cost more.
An important distinction is that Apple is doing in the tablet market what it couldn't do in the smartphone market: pricing the device closer to actual retail prices without subsidies. It tried to do this with the original iPhone, originally pricing the device at $500 / $600 for 4 GB / 8 GB models at a time when the subsidy model had long been in place in the smartphone market.
Within just over two months, Apple quickly dropped these price points by $200, presumably because consumer adoption was tepid at unsubsidized prices. The iPhone maker adopted the industry standard subsidy model with the second generation, the iPhone 3G, and saw unit sales explode.
Source: SEC filings.
Source: SEC filings.
Source: SEC filings.
In smartphones, Apple failed at combating carriers and subsidies and had to go with the status quo to be competitive.
Tablets, however, are an entirely different and new market -- one that was only recently created (not including the Windows PC tablets a decade ago) and one where Apple is succeeding in shedding the legacy of the subsidy model. Device makers are unsurprisingly sick of carriers' stifling ways and are looking to reduce their role in the value chain wherever possible.
This is why Google's Nexus 7, Amazon.com's Kindle Fire, and probably Microsoft's (Nasdaq: MSFT ) Surface are all Wi-Fi-only devices. By limiting the role of carriers, device makers improve their go-to-market strategy by eliminating device exclusivity, reduce costs, and sell directly to consumers, all of which are more conducive to innovation. Carriers will be rightly commoditized, since their service inherently is a commodity, and data plan pricing should decrease.
Without subsidies, consumer perception of a tablet's value will be more in line with their actual costs, which means they'll be willing to pay unsubsidized retail prices, and innovation can flourish.
Pick your poison
Ma Bell's and Big Red's moves are an admission that subsidized tablets don't make sense, but you can be sure they won't accept service commoditization willingly and will continue to do everything in their power to keep prices high, starting by pushing overpriced shared data plans.
Apple's continued and overwhelming domination of the tablet market is why Apple's run isn't over yet. Sign up for The Motley Fool's brand-new research service all about Apple, and you'll also get regular updates on new developments as we monitor Apple so you don't have to. Sign up today.