Apple, Inc.'s iPhone Business Won't Be Devastated by the End of Subsidies

The end of subsidies could give Google the advantage over Apple.

Apr 23, 2014 at 9:35AM

The end of smartphone subsidies poses a threat to Apple's (NASDAQ:AAPL) iPhone business, according to an article published by The Wall Street Journal on Tuesday. Major U.S. wireless carriers are quickly moving their subscribers to non-subsidized plans, threatening Apple's core business in the process.

By just about any measure, Apple's flagship iPhone 5s is expensive. Google's (NASDAQ:GOOG) Nexus 5, despite offering a larger screen and comparable hardware, retails for only about half as much. In the past, carriers had borne the burden, paying for their subscribers' handsets -- in the process, obscuring the relative costs of various models.

If subsidies go away, consumers could opt for cheaper phones -- like the Nexus 5 -- in place of more expensive ones from Apple. A recent survey, however, suggests that won't be the case.

The end of subsidies
The Wall Street Journal's argument is hardly new -- in fact, since last November, I had been warning that the loss of subsidies could disrupt Apple's business. At the time, the argument appeared convincing -- if consumers were rational, they'd buy a cheaper, "good enough" device in place of a more expensive handset from Apple.

If a consumer, opting for one of the new, unsubsidized plans, purchased a Nexus 5 up front (rather than an iPhone 5s), they could save themselves a great deal of money, cutting the cost of his monthly wireless bill by as much as 50%. In contrast, under the old, subsidized model, the cost savings would be minimal -- Google's phone would have little advantage over Apple's flagship.

Consumers choose more expensive phones
But the data doesn't support such notions. According to a recent survey by Consumer Intelligence Research Partners, smartphone buyers on unsubsidized plans actually choose more costly rather than less expensive handsets. How can this be? Shouldn't they be looking to save money? Perhaps the best explanation is one that considers cash flow.

Plans that use subsidies often require up-front payments of several hundred dollars -- getting Apple's flagship on a subsidized plan usually entails coughing up $199 at the time of purchase. In contrast, unsubsidized plans often (though not always) allow subscribers to get the same phones for no money down -- instead, the cost is spread out over monthly installments.

Purchasing a more expensive phone results in higher monthly payments, which makes it a less than prudent financial decision. But given that some three-quarters of Americans are living paycheck to paycheck and about a quarter of the country has no savings whatsoever, any plan that gets rid of large, up-front payments is obviously appealing. In that context, Google's cheaper phone (which requires a one-time payment of $350) is less affordable.

The risks to Apple remain
Of course, the trend away from subsidies is not without its risks: Under a subsidized plan, the monthly cost stays the same even after the two-year contract expires. This makes regular, biennial smartphone upgrades the norm -- your bill isn't dropping anyway, so why not upgrade your phone?

In contrast, unsubsidized plans become less costly after the handset itself is paid off -- getting a new phone requires a conscious decision to raise one's monthly bill, perhaps by a substantial amount. As unsubsidized plans become the norm, investors in Apple should be prepared for longer upgrade cycles, though, to be fair, that too is unclear. Unsubsidized plans allow subscribers to trade in their handsets after a year or less -- extending their monthly payments but allowing them to get the latest and greatest phone.

Overall, while there are risks, it doesn't appear that the move away from subsidies will devastate Apple's iPhone business.

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Sam Mattera has no position in any stocks mentioned. The Motley Fool recommends and owns shares of Apple and Google (C shares). Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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