Why Apple, Inc. Should Thank T-Mobile

Apple CEO Tim Cook is bullish on the installment plans and early upgrade programs that domestic carriers have adopted lately. Thanks, T-Mobile!

Jul 28, 2014 at 8:00AM

Hero

iPhone 5s. Source: Apple.

For the longest time, there was a justified perception that Apple (NASDAQ: AAPL) relied heavily on carrier subsidies. Anytime there was talk about subsidy reductions, Apple shares would suffer for it. That's largely because consumers have mostly been unwilling to pay full price for smartphones up until recently, and subsidies helped mask Apple's premium pricing. Sticker shock can be a powerful thing.

With T-Mobile (NYSE: TMUS) catalyzing a widespread shift away from subsidies, Apple actually stands to benefit. Wait, what?

Quitting is hard to do
The important thing is that carriers are not just taking away subsidies cold turkey. Like any addiction, calling it quits can be a hard thing to do without an alternative fix. Instead, T-Mobile was the first to introduce installment plans to replace subsidies. Every other major wireless carrier has since introduced similar programs. The net result to a consumer's total monthly bill was fairly minor, but now consumers have greater transparency into what they're paying for.

Unmasking retail prices theoretically risked making consumers more price sensitive. But in practice, consumers have become less price sensitive because installment plans allow consumers to spread out the cost differential over longer periods of time. Under the subsidy model where the carrier's outlay is fixed, upgrading to a pricier model results in higher upfront costs.

A JUMP of faith
On top of installment plans, the carriers now offer early upgrade programs that allow more flexibility. The industry is changing, and Tim Cook has take note:

In terms of the installment plans that you mentioned in the US relative to iPhone, there are a lot of different models that are being tried in the US, and throughout the world. And actually last quarter, as we estimated, and this is subject to the estimating error, but we're estimating that less in one out of four iPhones were sold on a traditional subsidy plan. And so that number is markedly different than it would've been two years ago.

The installment plans that you're speaking about which gives the customer the right to upgrade fast, or faster than a usual two-year cycle, we think that that plays to our customer base in a large way. So that makes us incredibly bullish that customers on those plans would be very likely to upgrade when we announce a new product.

Apple's data suggests that less than 25% of iPhones sold today are now using the subsidy model. That's a complete sea change in an industry that has used the subsidy model for more than a decade.

Of all smartphone vendors, Apple's customers are easily the most loyal and most anxious to buy the Mac maker's latest and greatest. It's true that many of the early upgrade programs aren't financially advantageous to consumers, which is partially why carriers offer them in the first place.

For instance, T-Mobile JUMP requires a $10 per month subscription fee (JUMP includes device insurance). JUMP initially required a 6-month waiting period before upgrade eligibility, but eliminated that requirement earlier this year. The new catch is that T-Mobile will only forgive half of the device's cost when you trade the device in.

Just bought a $600 phone and want to upgrade 3 months later? T-Mobile is effectively buying that phone off you for $300, and will likely resell it for a profit. You're on the hook for whatever difference you owe, but then you're free to upgrade to a new phone. Remember, you're also paying T-Mobile $10 per month for this privilege. Realistically, T-Mobile expects people to upgrade once per year.

But what these programs may lack in financial pragmatism, they make up for in convenience. Consumers have a long history of placing high value on convenience. These programs do make it much easier to upgrade annually, even if there is a cost differential relative to having to sell your phone on eBay yourself to squeeze out an extra $50.

If Tim Cook is bullish that the net result is faster iPhone upgrade cycles, then I believe him.

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Evan Niu, CFA owns shares of Apple. The Motley Fool recommends Apple and eBay. The Motley Fool owns shares of Apple and eBay. 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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