During the third quarter of 2018, Verizon (NYSE:VZ) showed another big year-over-year increase in equipment sales. That provides evidence that rising smartphone prices could lift handset manufacturers like Apple (NASDAQ:AAPL) again, as they have all year. However, Verizon and Alphabet's (NASDAQ:GOOGL)(NASDAQ:GOOG) Google are using the rising prices to get aggressive with promotions. The strategy could be a boon for both companies.
Expensive smartphones and earning a slice of the pie
Verizon's wireless segment equipment sales were up 23% during the third quarter and are now up 24.4% year to date when compared with 2017. Much of that is due to higher smartphone pricing, led by Apple's iPhone X. This year's models bring another round of price hikes with them, setting up the possibility of another year of advancing equipment revenue, if consumers remain willing to spring for high-end devices.
In case swallowing high prices is unpalatable, though, Verizon is running a buy-one-get-one-free promotion on Google, Samsung, and Apple phones. The deal works for new and existing customers -- though existing customers have to open a new line with the purchase to qualify. The phones also need to be purchased via an installment plan. Verizon will credit back the monthly payment on statements, which should help the company spread out its cost on the free phone over time.
Of the three BOGO offers, Google's is the most aggressive. Going with Apple means a free iPhone XR -- its cheapest new model -- or a $750 credit toward another Apple phone. The Samsung deal is on the Galaxy Note 9, which starts at $999, and comes with a $999 credit toward a second Note 9.
As for the Google Pixel 3 and 3 XL, it's also a buy-one-get-one at equal or lesser value. Google's new devices already undercut the competition, though, starting at $799 for the Pixel 3 and $929 for the 3 XL. Plus, along with the second free phone, Verizon is also throwing in a free Pixel Stand with each phone -- a wireless charging dock powered by Google Assistant that basically turns the phone into a smart-home hub. A Pixel Stand retails for $79 right now, so that's another $158 value that Google is tossing into Verizon shopping carts.
More subscribers, for mobile and software
The big jump in equipment sales this year has been nice for Verizon shareholders, but equipment sales are a less profitable business than wireless subscriptions. Plus, 70% of Verizon's wireless segment revenue comes from service fees. Offering free phones is a great way to move the needle there.
Changes in service revenue are driven by new customer acquisitions, fluctuations in average revenue per user, as well as "churn" -- the rate at which customers leave for greener pastures. Though the company has had to get aggressive with its promotions because of stiff competition from other telecoms, Verizon has managed decent growth in net subscriber additions this year. There were 515,000 net wireless additions during the third quarter.
As for Google, the BOGO promotion could be good for its business as well. The Pixel family of phones is an underdog, as the smartphone market is currently dominated by Apple and Samsung. Google is a newcomer, having just brought the design process in-house in early 2018.
However, while selling hardware would help diversify Google's advertising-dominated moneymaking model, software is the bigger opportunity in the long term. At the recent Pixel event that officially introduced the Pixel 3, the hardware releases took the backseat as Google showed off its software and services prowess using the phones and a new Home Hub as a canvas.
Using a free Pixel (and free Pixel Stands) as a carrot could help introduce consumers to Google Assistant's artificial intelligence and all the related capabilities that come with the Pixel family. The internet search giant thinks its platform will simplify daily tasks and improve the quality of life of its users. If it can convince them of that, the hardware shipments could become a meaningful part of Alphabet's empire, but ad-based revenue would surely increase, too.
This BOGO offer is thus a win-win, especially for Verizon's arrangement with Google. With the all-important holiday shopping season drawing near, expect others to get aggressive with deals as well, to prevent a Pixel upset of the hardware industry.
Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Nicholas Rossolillo owns shares of Alphabet (C shares), Apple, and Verizon Communications. The Motley Fool owns shares of and recommends Alphabet (A shares), Alphabet (C shares), and Apple and is long January 2020 $150 calls on Apple and short January 2020 $155 calls on Apple. The Motley Fool recommends Verizon Communications. The Motley Fool has a disclosure policy.