Apple Will Be Crushed if Smartphone Subsidies Go Away

Smartphone subsidies could be coming to an end. While prepaid providers have long refused to pay for their subscribers' phones, the practice has begun to spread to the major carriers, with T-Mobile (NYSE: TMUS  ) abandoning subsidies and AT&T (NYSE: T  ) hinting that it will do the same.

Apple's (NASDAQ: AAPL  ) dependency on carrier subsidies is fairly well established -- in markets where they're available, the iPhone does extremely well; where there are no subsidies, cheaper phones running Google's (NASDAQ: GOOGL  ) Android dominate. If subsidies go away in the US, demand for iPhones could likewise plummet.

The iPhone doesn't sell like a premium product
As a company, Apple positions itself to sell premium products at premium prices, pocketing a healthy margin in the process. The iPhone is no exception -- at $649, it's an expensive smartphone, and it earns Apple billions (by some estimates, about two-thirds of Apple's profits).

But the iPhone is special: It doesn't sell like Apple's other products. Apple's expensive Macs compose just a fraction of the larger PC market, while its iPad sales have stagnated in the wake of cheaper competition. But not the iPhone -- despite carrying a premium price tag, Apple's smartphone has been able to absolutely dominate some markets, including the US and Japan.

These markets are special in that they are heavily distorted by carrier subsidies. Very few US consumers pay $649 for an iPhone -- instead, they get Apple's best model for just $199 (or free if they're Japanese). This makes the choice very simple -- why accept an inferior phone running Google's Android when you can have Apple's superior iPhone for a hundred dollars more? Since you've signed a contract, and will stuck with the phone for two years, going with Apple's better phone is a no-brainer.

Not the same old Android
But it wouldn't be such a no-brainer if consumers had to pay for the phone themselves. Apple's iPhone may be better than a cheaper Android handset, but is it really $300 better?

Google's own Nexus 5 costs only $350 off-contract, and has received rave reviews. Compared to the Android phones of old, it sports a fast, responsive interface and has access to nearly all of the same apps as Apple's iPhone.

Years ago, subsidizing the iPhone was an easy choice for the carriers: It was the best phone on the market, and nothing else even came close. While it still might be the best phone out there, Google's Android has rapidly closed the gap. Initiatives like Project Butter baked into new versions of Android have made it nearly as fast and responsive as Apple's phones. A few years ago, Apple's iPhone was the better phone and it wasn't even a debate; now it comes down to personal preference.

Carriers are starting to move away from subsidies
T-Mobile was the first of the major smartphone carriers to abandon subsidies, dropping them this year in favor of full retail prices. Consumers can pay for their phone upfront, or pay for it in monthly installments, but either way, they're paying the full price.

This has actually turned out stunningly well for T-Mobile -- the carrier has grown rapidly, far outpacing its rivals. Notably, however, it hasn't sold many iPhones: in its recent quarter, just 21% of the smartphones it sold were made by Apple.

Historically, about 80% of AT&T's smartphone sales are Apple-made handsets, though this could change in the wake of the company's new policy. The recently launched "Mobile Share Value Plan" allows AT&T subscribers to reduce their monthly bill if they use a paid-for handset.

For now, AT&T still offers subsidies, but that could change. The company's CEO said earlier this week that the subsidy model cannot continue -- carriers cannot afford to keep paying for their subscribers' handsets.

iPhone sales could plummet if subsidies go away
If that happens, then it stands to reason that iPhone sales would plummet. Of course, Apple isn't the only handset maker that would suffer -- sales of Samsung's high-end, high-margin Galaxies would also take a hit.

But cheaper handsets powered by Google's Android should flourish. Though they might not be as good as Apple's iPhone, advancements in Android may have made them "good enough."

Most people choose a cheaper Windows PC over a better Mac; they're starting to choose cheaper Android tablets over a better iPad; and if subsidies vanish, they'll choose a cheaper handset over a better iPhone.

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Read/Post Comments (26) | Recommend This Article (6)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On December 14, 2013, at 9:59 AM, ConstableOdo wrote:

    Apple could well afford to subsidize their own iPhones. Just because AT&T doesn't want to do subsidies anymore that doesn't mean every other carrier will follow suit. All that could happen to AT&T is that they would lose customers as consumers started to switch to other carriers who do have subsidies if it's possible for them to do so. Also, Apple could simply let people pay for their iPhones over a period of time just like they do on the online Apple store. Apple should become a loan company with as much reserve cash as they have.

    The iPhone empire can't last forever and Apple will just have to find new ways to make money. They have an ample cash reserve to do whatever is necessary to survive.

  • Report this Comment On December 14, 2013, at 11:26 AM, longdoc wrote:

    I'm typing this on my new iPad Air. It's so nice. Love it....... You might want to reconsider your characterization of iPads as "stagnating". Apple has every price point covered minus absolute junk.

    Apple will just offer financing for its phones. But perhaps you should look at T-Mobile. No subsidy on its phones, lower pricing. Number one phone sold? iPhone. Aren't the free software upgrades so easy?

    Have you read about Apple's move into the auto sector? While Google is playing with self driving cars Apple is taking over the cars interface. Just more ieverything........

    Is cheaper always going to win?

  • Report this Comment On December 14, 2013, at 12:00 PM, larryw101 wrote:

    Sam Mattera, the author of this article, is an absolute fool.

    I am convinced more than ever that he intentionally bashes Apple for his own personal attention. He has no credentials whatsoever and has nothing listed in his profile. Where did Motley find this nobody at?

    I swear he is obsessed with bashing Apple and all I can say is Shame on Motley for continuing to publish his garbage articles.

    To Mr. Mattera: Do you realize how much of a fool you make of yourself each and every time you write? Or, is it that you enjoy the recognition of being thought of as a fool? Maybe you do.

    Motley has lost ALL credibility. This is not just my opinion. It is shared by many who have posted on various message boards on how Motley has sunk to new lows.

    Mr. Mattera: Get a real job. The pennies a click you get from Motley for this garbage journalism will hardly make you living in life.

  • Report this Comment On December 14, 2013, at 12:29 PM, jabstrat wrote:

    I was going to lambast this "article" based solely on it's premise, but "DanManners" user above basically said it all for me.

    So, there you have it.

    hint: i might help to expand your perspective beyond trying to take the contrarian position, and reflect on the level of idiocy of a premise BEFORE you actually write.

  • Report this Comment On December 14, 2013, at 1:18 PM, slapppy wrote:

    I completely agree with "DanManners" and others in agreement. This article from this writer is ridiculous.

  • Report this Comment On December 14, 2013, at 1:29 PM, GaryDMN wrote:

    Apple appears to be uncrushable, by the media. I just can't figure out why the press continues to attack Apple, while trying to make Korean and Chinese products appear to be more appealing than the actually are. Samsung does spend 5-10 times as much on advertising, so it is possible that the advertising dupes the press, but more likely they are somehow compensated financially for their support. Samsung has been fined in Taiwan for paying bloggers to promote their products, are they doing the same in the USA? Do they pay well?

  • Report this Comment On December 14, 2013, at 1:31 PM, macktv wrote:

    I think Mr. Mattera actually gets off on everyone berating him, otherwise why would he keep on writing all these senseless articles about Apple.

    I know it's hard not to respond, but If everyone ignored him, maybe he would just give up and go away to that place wherever washed up Apple bashing writers go. 😄

  • Report this Comment On December 14, 2013, at 1:40 PM, canerom wrote:

    Sam you sound like an angry bitter little man you need to get over your hatred of Apple

  • Report this Comment On December 14, 2013, at 3:58 PM, larryw101 wrote:

    Click on Mr. Mattera's profile at the top of the this article …….. there is nothing listed. I rest my case.

    He is a know nothing novice trader who gets his kicks continually writing negative articles on Apple.

    He has pumped out over 50 negative articles in the past year alone here on Motley.

    BTW, i chuckled when i read one of his current positions: Blackberry

    Need I say more ?

  • Report this Comment On December 14, 2013, at 4:40 PM, vernr75 wrote:

    I'm in total agreement with the author, because I independently arrived at this rather obvious fact months ago. The iPhone got its market share from being a $0-$200 phone. If you want to know what happens when you eliminate subsidies and expose its high prices to consumers, just look at all those other markets where the iPhone is approaching single digit share. The subsidy system was never meant to support the number of users of extremely overpriced smartphones that it is supporting at present. That's a reality that the major carriers will be forced to address in the near future, whether Apple and Samsung like it or not.

    Right now the single largest and growing complaint from the average US mobile data consumer using a major carrier is about the high cost of monthly data. Under the subsidy system, the monthly data cost isn't just a monthly data cost. You have to pay hidden monthly payments on the handset's true cost. But that's not all. The data cost is adjusted way upward to give the carriers the portion of revenue that is then used to fund the massive upfront cost of purchase of the premium phones. US consumers may be paying $0-$200 upfront for high priced 16GB handsets, but carriers are paying manufacturers like Apple up to $650 upfront for them on a constant basis and that money has to come from somewhere...somewhere other than their profits. Buying just one million 16GB iPhones from Apple to supply a mere one million mobile users cost carriers over a billion dollars. America is a market where 91% of adults are on cellular phones and over 62% are now using smartphones. That's over 140 million smartphone owners and growing!

    The real reason why 'premium' phones still cost $600+ (like they did back in 2007) and not $350+ (as a result of the massive fall in component costs that have been occurring yearly since 2007) is because of the US subsidy system itself. Every high end phone including Apple's $850 64GB iPhone are all made from around $200 in parts. These phones, high end or low end, are not expensive to make; the high prices are completely artificial and have nothing to do with quality. Take a look at the manufacturing cost of the iPhone vs the iPad. The iPhone and iPad are actually made using most of the very same components and circuitry. The iPad costs substantially more to make than the iPhone because it uses a much larger, and therefore more costly display and battery. But look at the final price. The full size iPad costs $150 less than the tiny iPhone with the same memory size despite costing more to make. The only reason the iPhone costs more is because Apple is simply pricing the iPhone to abuse the subsidy system...and Samsung has followed in their footsteps with their high end phones. What consumers don't grasp yet is that all abuses of the subsidy system eventually come out of their own pockets because carriers passing those costs down as hidden fees rather than absorb them. America ends up with ridiculously high data costs while in other markets that don't subsidize phones, data costs are already falling as carriers are financially free to actually compete on data price. In order to do the same in the US, carriers are going to have to do what T-Mobile and now AT&T are doing - create mobile plans that separate phone costs from data costs so that consumers can pick phones that they can actually afford rather than pick phones that are artificially made affordable.

    So, there you have it. Subsidies, the very thing that was meant to make acquiring smartphone hardware more affordable, is now the thing that is keeping the price paid for high end hardware ultra expensive despite the progressive fall in component prices. And it's also the very thing keeping the cost of monthly data far higher than it should be. Carriers are now increasingly sensitive to this reality, because the remaining US mobile users who have not yet switched away from feature phones are the very folks who are extremely price sensitive when it comes to both phone costs and monthly fees. That's why T-Mobile started gaining more monthly subscribers than AT&T and taking AT&T customers, and that's why AT&T, the big iPhone seller, had no choice but to respond.

  • Report this Comment On December 14, 2013, at 7:40 PM, larryw101 wrote:

    To Vernr75:

    It is quite obvious why you agree with this author. Based on you other postings it is very clear that you are very anti Apple regardless of writes the story. You criticize authors who boast Apple and defend those whose bash it.

    However, it seems you have completely missed my point which is that this author is consumed in writing article after article week after week just to bash Apple. He is an attention seeker.

    The author has no market experience nor has he ever been right yet on any of his predictions.

    Botton line: Motley Fool + good journalism is an oxymoron.

  • Report this Comment On December 14, 2013, at 11:20 PM, Davewrite wrote:

    I predict Apple will suffer when Aliens mistake the new 'Space ship' Apple campus for a real space ship and nuke Cupertino from Alpha Centauri.

    My predictions probably make more sense then those in this article.

  • Report this Comment On December 14, 2013, at 11:49 PM, BigApple wrote:

    "why accept an inferior phone running Google's Android when you can have Apple's superior iPhone for a hundred dollars more?" That is a matter of opinion. An opinion that is not supported by the facts. Android has the dominant market share of smartphones in the US and worldwide, generally twice the market share of the iPhone. I have access to both an iphone and android, as well as mac and pc. Their is really nothing I prefer to do on mac/iphone that I can't do faster on a pc/android. And I'm not locked into the ridiculously clunky itunes eco-system.

  • Report this Comment On December 15, 2013, at 1:31 AM, ddcmall wrote:

    Why focus only on the iPhone? Samsung's Android products are just as popular and just as expensive to the consumer as Apple's products off contract. Wouldn't the Galaxy line suffer just as badly? What would more like happen is this. If consumers could only afford crap - smart phones would likely go the way of pc's as consumers loose interest and begin spending money on food or heaven forbid - education.

  • Report this Comment On December 15, 2013, at 5:49 AM, iSheep101 wrote:

    All I can sat to this is GREAT!!! Now let's see how loyal iSheep and wannabe's will be when they realize they are really getting soaked on the highest margins around. Then it won't be so easy to pretend to be cool and have a false sense of being richer or better than others who are smarter and know android phones are actually better than iPhones.

  • Report this Comment On December 15, 2013, at 5:55 AM, CPA01 wrote:

    It's funny how the author's detractors can't actually give a reason why he's wrong. They just rely on personal attacks. The one g who did venture some rational reason failed to notice how iPhones made up a staggerly SMALL portion of phones sold compared to carriers who do subsidze. The author is right and the peanut gallery can't sand it

  • Report this Comment On December 15, 2013, at 8:19 AM, Jaccus58 wrote:

    I love it when someone says it only cost x amount to make this phone. They obviously have never run a business, did you factor in the hundreds of millions of dollars that it cost for all the R&D the cost of the building, heating ,insurance ,electricity cost of all the buildings that are used to support all the Apple products the ongoing employee cost health insurance retirement etc. When people state facts of the cost of a phone to make they only consider how much each part cost and not the entire process. Shipping cost, return RMA cost refurbishing a phone for resale, environmental cost that are paid to the country where the parts are manufactured, help desk etc etc etc I could go on and on but it is a waste of time because all these people see is what some idiot blogger said was the iPhone cost $200 to make the blogger is a fool much like the writer of this article who just puts out a few of the facts and not the whole story. The writers of today don't actually do any investigating they just post half truths and lies they don't do any investigating to find the entire story.

  • Report this Comment On December 15, 2013, at 9:14 AM, GabrielleGar123 wrote:

    I used to be a hardcore pc user, but once I switched to Apple products, I actually saved money, time and frustration re: virus protection software (ripped off on "driver" programs, etc) and find that my iPhone is so easy to use re: syncing with my car and my other devices. While there are issues with iTunes and Apple's customer service, at times, particularly in the stores, and the products are very expensive, but there is no other system on the market that offers such a high degree of user compatibility among devices. Google has a history of spying on customers and is not as trustworthy as Apple. One reviewer commented that the iTunes system is "clunky." I'm not sure what iTunes he is using, but mine is streamline and efficient and available to me on every device, including my automobile's blue tooth system (which is iPhone compatible). My audiobook picks up right where I left off free of plugs or cords once I start driving. My husband has a Ford which is Android compatible, but he has tons of problems with that system. If Android can offer a virtually glitch free system that is not at risk for continual viruses (my friend's Android phone has had viruses twice!) and syncs up with high quality tablets (my iPad is terrific), then I might consider it given the cost. To date, there is no other system that can do all that Apple does. Further, I have a significant amount of content on my Apple products, so price isn't much incentive to switch to a less organized operating system given how much I'd lose.

  • Report this Comment On December 15, 2013, at 3:04 PM, aeosfool wrote:

    Duh, have to agree with most comments here. The iphone is #1 on T-Mobile because they do the same thing as subsidize them. They finance them for $20 a month. What the difference between subsidizing them and $20 less per month for service and charging $20 for the phone payment? Answer: Nothing.

    If anything, the disconnect between subsidized phones and monthly service will result in more iphones sold, not less. Up to this point, you had to wait 2 years to get a new phone...until the contract renews...from now on you will not be restricted by this if you want to buy one every year.

  • Report this Comment On December 15, 2013, at 3:30 PM, CPA01 wrote:

    @aeostool, that's quite wrong.

    There is a key difference in how people see it. People associate the $20 on service with service even though it's actually for the phone. Second, it's more than $20. AT&T/Verizon and Sprint are charging way more than $20 on device fee. Verizon is more like $40. Meaning that iPhone is closer to $1,000 after two years. How many people are going to pay that much?

    When you break out your device fee, you can compare that to compeitors as well as service fee and make an informed decision. T-Mobile has given the market a huge dosage of transparency and that is a big problem for Verizon and AT&T.

    iPhones account for something like 80% of AT&T's phones, but account for about 20% of T-Mobile phones sold. Moving more towards T-Mobile's financing where the carrier flat up tells you how much you're going to pay is going to cause iPhones (and $649 Samsungs) to see their sales plummet. Most people don't realize what their phone is actually costing them. Many ignorant consumers think that down payment is everything. Strip that illusion from them and they're going to change their behaviors like consumers who live in countries where subsidization isn't happening. Spain doesn't subside and iPhone market share is under 5% there. Yes, 5%.

    Most people aren't going to drop $649 on a phone every year.

  • Report this Comment On December 15, 2013, at 5:44 PM, larryw101 wrote:

    @CPA01:

    You obviously didn't take time the read the comments. So, I will be happy to point them out again.

    1) the author has no credentials. None !

    2) the author has never been correct yet on any of his predictions. Yet, he continually writes one bashing article after another week after after week.

    In his mind Apple can't do anything right. Even the most staunch bears will give Apple credit when due.

    This author has written of 45 negative articles on Apple this year alone. His has no credibility.

    3) the author appears to be an attention seeker. He has no financial background whatsoever. Yet, he continues to write article after article based on his personal feelings.

    Defend him if you will. But realize you make a fool of yourself doing so.

  • Report this Comment On December 16, 2013, at 1:13 AM, JackBaker1 wrote:

    For the love of God, MF, would you please shut this feckless shill Sam Mattera down. He has no credibility and he does nothing but continue to erode what little credibility MF has left -- which is not much.

  • Report this Comment On December 16, 2013, at 3:21 AM, MrRuprect wrote:

    I will approach this article from the other side. Take the largest carrier in Japan. Docomo, what happened when they didn't offer the iPhone or subs. the iPhone. Simple, they lost market share to the other carriers. Now that they are offering the iPhone you can guess which phone is the most popular and at 61% of their smartphone sales as well. The same thing began happening at China Mobile. So no the telecoms don't have to subsidize the iPhone, but to do so would be at their own peril.

    So go ahead ATnT, stop subsidizing the iPhone, you would lose my business, along with the large data fees you charge your most valuable clients. IPhone users, are more educated, surf the web more, and spend more online and those are the clients you want to loose. So go ahead Randall Stephenson stop subsidizing the iPhone so I can short your stock and laugh a year later when the board fires you for being so shortsighted.

  • Report this Comment On December 16, 2013, at 7:35 AM, jdmeck wrote:

    Sam - Do you ever do a non negative Apple story?

  • Report this Comment On December 16, 2013, at 1:50 PM, johnestromjr wrote:

    Mattera, it's not a subsidy but a financing scheme for the AT&T's to get subscribers. The subscriber STILL pays for the iPhone but in monthly payments. The same is true with Verizon and probably T Mobile. And the "subsidy" is also used to sell Android devices. But they're NOT subsidies even if you media geniuses continue to call them that.

    Were those "subsidies" to end then new/different financing mechanisms would be created by the market to get as many sales as they can whether the manufacturers provided the financing or the carriers or some third party.

    That "subsidy" you talk about is no different that a dealer selling you a new car and providing financing. You STILL pay for the entire car, including the finance costs, but the dealer or a bank owns the vehicle until you have paid it off. Again it's NOT a subsidy and never has been one. As usual you are oblivious to financing methods and how they've been created to allow people to buy what they can't afford to pay cash for. Not a very impressive article, sorry to say.

  • Report this Comment On December 21, 2013, at 8:53 PM, CPA01 wrote:

    @ larryw101

    It clearly doesn't bother you that nothing you said provides a shred of evidence as to why anything the author wrote is wrong.

    If the lunatic said the sky is blue, does that automatically make it wrong?

    Point out what he said is wrong. All you are doing is throwing ad homeni attacks in the hopes people don't realize you don't have any rebuttal to him.

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