Since mobile phones became a mass consumer product in the mid-to-late 1990s, wireless carriers used device subsidies to lure people into signing contracts. The customer would receive a phone for well less than its full retail value in exchange for committing to the carrier for a certain period of time (often two years).
Some, if not all, of the cost of the phone would be rolled into the monthly fees the customer paid, but he or she got a new device on the cheap and the company locked the user into a contract that would be expensive to break.
Now, however, the day of subsidies may be coming to an end, as all the major phone carriers are offering cheaper service plans for customers willing to finance their phone or pay for it outright up front.
Why are subsidies popular?
The subsidy system has worked for many years by giving customers access to better phones than they might be able to afford if forced to pay full price. In many cases, the companies make it possible to upgrade to a new phone, and commit to two more years, a few months before the first contract expires. That created a cycle in which people stayed with their carrier because it offered the fastest path to an inexpensive upgrade even if they were ultimately paying for that "deal" through higher rates over the life of the contract.
The problem with subsidies for the carriers is that in many cases the company must eat a portion of the cost of the device. That was fine when overage charges were a huge revenue driver. But now that unlimited talk and text are the norm and people are becoming more savvy about data charges, bribing a customer with a subsidized phone just to get a contract signed makes less sense. Two carriers -- Sprint (NYSE:S) and T-Mobile (NASDAQ:TMUS) -- are working aggressively toward eliminating subsidies; industry leaders AT&T (NYSE:T) and Verizon (NYSE:VZ) are being more subtle, but appear to be at least downplaying them, if not heading for a full phaseout.
Where do the four major carriers stand now?
T-Mobile no longer offers subsidized phones with any of its plans, though the company will finance a phone over a 24-month contract. Sprint has not been quite that bold, but its most heavily pushed new plans, the Sprint Family Share Pack and its unlimited data plan, do not include subsidized phones.
AT&T has straddled the line a little bit more, offering new plans without subsidies but still giving equal play to traditional subsidized plans. That does not mean the company is looking to maintain the status quo, as CEO Randall Stephenson suggested at a recent investor conference. CNET quoted him as saying:
When you're growing the business initially, you have to do aggressive device subsidies to get people on the network. But as you approach 90% penetration, you move into maintenance mode. That means more device upgrades. And the model has to change. You can't afford to subsidize devices like that.
Stephenson is clearly expressing where he believes things will go rather than where AT&T is now, since the company still aggressively pushes the subsidized model while also offering bring-your-own device plans.
Verizon has been perhaps the most subtle in its efforts to eliminate subsidies, as its signature "More Everything" plan lets customers pick subsidies, financing, or paying full price.
In many cases, if a customer upgrades his or her phone as often as the contract allows (usually once every 18-24 months depending upon the carrier), the provider recoups less money on the sale of the device than it would in an outright purchase or financing arrangement.
The 16GB iPhone 5s has a full retail price of $649.99. Sprint allows customers to purchase it in two different ways. They can get it subsidized for $149.99 by signing a two-year agreement, or for $0 down with 23 monthly payments of $27.09 and a 24th of $26.92 -- bringing the total cost to its full $649.99 retail value. The difference comes in the price for the service that goes with the phone. With the subsidized phone, the unlimited phone, text, and data user pays $80 a month. With a purchased or financed phone, that person pays $60 a month for the same service.
That extra $20 per month adds up to $480 over the two years of the contract, which, when you add the $149.99 up-front charge for the phone equals $629.99 -- a $20 loss for Sprint on the device. That's not a huge number, but multiply that by tens of millions of subscribers and you can see where leaving dimes on the table turns into millions of dollars.
The numbers vary depending upon phone and the various carriers, but, in many cases, it costs carriers money they never recoup to offer phone subsidies -- a loss that's even bigger if customers stop paying their bills before the two-year period ends.
Will they succeed?
T-Mobile has been successful in breaking the subsidy pattern. The company has been growing steadily, adding another 1.5 million subscribers in the last quarter to bring its total user base to over 50 million. Some of that total, though, has subsidized phones from before the company stopped the practice in March 2013. Dropping subsidies might be easier for T-Mobile, and perhaps Sprint, which are trying to disrupt the status quo in wireless, than it will be for AT&T and Verizon, which are the status quo.
Still, it seems a tide is shifting. With the carriers willing to offer lower rates and zero-cost financing to get people to pay full price for devices, it appears likely that will become the norm and that subsidies will lose popularity. It's unlikely that they will disappear, though, as AT&T and Verizon won't want to give their customers any more reason to defect to T-Mobile and Sprint than they already have.
Daniel Kline is long Apple. He has a subsidized iPhone 5s from Sprint and will likely upgrade to an iPhone 6 as soon as he can. 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.