Verizon (NYSE:VZ) has found a sneaky way to make it harder for customers to drop it for a rival while making it harder on those rivals if they do.
The company has changed language in its contract -- fine print few people are likely to read -- to delay monthly reductions in the early termination fees (ETF) customers have to pay in order to end their relationship with the carrier before the two-year period passes. In Verizon's defense, it does bold the financial terms of the ETF in the agreement, which makes them stand out a little in the 5,400-word document. The problem is that it does not point out that in the current contract the terms have changed in a way that does not favor the customer.
What did Verizon do?
Before the contract change Verizon customers who signed a two-year contract on a top-tier smartphone saw their ETF, which starts at $350, drop by $10 each month starting the first month. Now, the reductions don't kick in until eight months. That means that in a worst-case-scenario a subscriber who seeks to leave after seven months will now still owe $350 rather than the previous $280. Under the new contracts, ETFs decline "$10 per month in months 8-18, $20 per month in months 19-23, and $60 in the final month of your contract term."
The company made a similar change to its contract for basic phones and tablets. Those customers start with a $175 ETF which under the old deal dropped by $5 from the first month. Now the $175 penalty will drop "$5 per month in months 8–18, $10 per month in months 19–23, and $30 in the final month of your contract term."
Why is this bad?
The purpose of an ETF is to protect the company, which essentially fronts a portion of the cost of the phone for the customer. Generally the wireless carrier makes up the lost money by charging more for service each month. If a customer stays for two years then the deal has worked. He or she got a phone without paying full price up front and the company makes up more than it put out by collecting the extra monthly charges.
When a customer breaks that deal the ETF allows the company to recoup its loss. Under Verizon's new terms it gets to collect seven months of increased monthly fees before it lowers the ETF. On a two-year contract for an iPhone 6 the company recommends a 2 GB data plan that costs $75 a month. If you finance the same phone (or buy it outright upfront) Verizon offers a $15-a-month discount on plans of 500 MB-8 GB of data. The savings climb to $25 a month on bigger data plans.
So customers on a plan that's 8 GB or smaller will spend $15 a month for seven months, or $105 more than their counterparts who chose to finance or purchase their phone. Even though that money has partially paid off their phone, Verizon won't be crediting them on their ETF.
Why is this bad for T-Mobile and Sprint?
Sprint and T-Mobile are both offering to pay up to $350 per line in ETF fees in order to win customers from their rivals. Because of the sliding scale previously offered, the companies only had to pay that much to Verizon customers if they switched immediately after signing up. The change means that T-Mobile and Sprint will have to pay more if customers decide to leave earlier in the terms of their contract. That's not going to keep the customers on board as long as Sprint and T-Mobile offer to pay the ETF, but it could increase the costs for the two companies and may lead to them rethinking this deal.
T-Mobile introduced its ETF payment plan in January and Sprint followed in April. Those actions likely put millions of previously trapped smartphone customers into play because they could now move without penalty. Before the plans, however, only about 1% of Verizon and AT&T customers moved each month, The Wall Street Journal reported in July 2013.
Neither T-Mobile nor Sprint reports how much it spends paying ETF fees in its quarterly reports, but T-Mobile did just post its biggest customer gain ever for a quarter -- 2.3 million in the third quarter -- which suggests that people are talking advantage of these offers. Some are likely at the end of contracts, but not having to pay an ETF makes it possible for any customer to move at any time in their contract and some certainly will.
Verizon is being smart
Verizon has been clever in two ways. First, it makes it less likely that a customer will choose to pay his own ETF in order to switch to an ultra low-cost carrier. Second, it essentially places a tax on its two upstart rivals that will increase the cost of offering to pay ETFs as a way to entice customers to switch.
The company has also done something that makes its overall contract worse, which very few people will notice until it's too late to do anything about it. And, of course, the people getting angry at Verizon are customers who plan to leave. This change may keep them around for a few months longer or it will send them to Sprint or T-Mobile with Verizon having pocketed some extra money along the way.
It's not a good deal, but it's also subtle enough that it's unlikely to cause very many people to not sign a Verizon contract in the first place.
Daniel Kline has no position in any stocks mentioned. He is a Sprint customer. The Motley Fool has no position in any of the stocks mentioned. 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.