Apple’s iPhone Could Get a Boost From the Death of Smartphone Subsidies

T-Mobile is killing U.S. wireless subsidies, and that could be great for Apple.

Aug 14, 2014 at 4:45PM

The U.S. wireless industry is in the midst of a tectonic shift: Brought on by T-Mobile's (NASDAQ:TMUS) aggressive "Un-carrier" strategy, smartphone subsidies are on the decline, and the once-dominant two-year contract model appears to be falling by the wayside.

Although this dramatic change could weigh on Apple's (NASDAQ:AAPL) iPhone, it also presents a tremendous opportunity and could ultimately give the business a boost.

T-Mobile shatters an industry standard
Originally, T-Mobile's decision to do away with smartphone subsidies was not well received: Analysts were skeptical and rival carriers doubted customers would be interested.

But T-Mobile proved its critics wrong when, late last year, the company emerged as the nation's fastest-growing wireless carrier. Perhaps it was better marketing or the addition of Apple's iPhone to its smartphone lineup, but the end of subsidies coincided with a massive influx of new T-Mobile subscribers. Although T-Mobile's customers don't receive smartphone subsidies, they get more freedom to end their service or upgrade to a new handset whenever they please.

Other carriers have now rolled out similar initiatives. T-Mobile's rivals have not completely done away with two-year contracts, but all of them now offer alternatives to those standard agreements.The various programs are increasingly popular with U.S. wireless subscribers: According to a report from Consumer Intelligence Research Partners, about 25% of smartphones sold in the first quarter were purchased using these no-contract plans; Macquarie expects that figure to approach 43% by the end of the year.

Many of those phones were iPhones.

The end of subsidies could mean fewer iPhones sold
During Apple's last conference call, CEO Tim Cook estimated that fewer than 25% of the iPhones Apple sold last quarter were subsidized. At first glance, this figure could be a bit deceiving, as subsidies are not common in other countries (with the exception of Japan). However, the United States is the iPhone's single largest market -- according to research firm NPD Group, the U.S. accounted for more than one-third of the 150 million iPhones Apple sold last year. Clearly, a shake-up in the way Americans purchase their iPhones could have a dramatic effect on its business.

That impact could be negative if existing smartphone owners keep their handsets for an extended period of time. Traditional subsidy models create regular upgrade cycles, in which existing iPhone owners are incentivized to buy a new model every two years. Changes to upgrade policies -- extending the length of time customers must wait to get a new phone -- have weighed on Apple's U.S. business in prior quarters.

But it could also give Apple a boost
Apple could also benefit since customers who previously would have been required to wait can (if they're on a contract-free plan) upgrade more quickly. Cook said this change will benefit Apple's business, stating the company believes it "plays to our customer base in a large way ... makes us incredibly bullish that customers on those plans would be very likely to upgrade when we announce a new product."

It may be too early to say how this shakes out. Subsidy-free plans may be taking over, but they haven't been around long enough to determine the effects on consumer behavior. This fall could prove a worthy test: If Apple's upcoming iPhone 6 smashes existing sales records, it would suggest that current iPhone 5s holders are taking advantage of their ability to upgrade more frequently.

Still, it shifts the onus back to Apple: Without two-year agreements, Apple will have to convince U.S. wireless customers that its newest iPhone is worth the upgrade.

Leaked: Apple's next smart device (warning, it may shock you)
Apple recently recruited a secret-development "dream team" to guarantee its newest smart device was kept hidden from the public for as long as possible. But the secret is out, and some early viewers are claiming its everyday impact could trump the iPod, iPhone, and the iPad. In fact, ABI Research predicts 485 million of this type of device will be sold per year. But one small company makes Apple's gadget possible. And its stock price has nearly unlimited room to run for early in-the-know investors. To be one of them, and see Apple's newest smart gizmo, just click here!

Sam Mattera has no position in any stocks mentioned. The Motley Fool recommends Apple. The Motley Fool owns shares of Apple. 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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