For years, the cell-phone market followed a basic model. Customers signed a two-year contract, and in exchange for tying themselves to one carrier for that long they got a heavily subsidized phone.
A lower-end model or a refurbished handset might cost nothing in this arrangement, while a flagship phone such as an Apple (NASDAQ:AAPL) iPhone would require a $200 upfront payment. That's still well less than the full retail cost of the device, and this setup gave carriers some stability while spurring sales of top-tier phones.
There were variations between the major carriers -- some let you upgrade to a new phone earlier than the full two-year contract term as long as you signed a new deal -- but this subsidized system was the way the industry worked. Sign a contract, get a phone at a deal price, and pay a little more for service over the life of the deal.
The subsidy wasn't really like that. In most cases, it was more like a deferred payment plan, in which the cost of the phone was spread out over the life of the contract by charging more each month. Still, consumers felt they were getting a deal and were able to get the latest high-end handsets without shelling out their $500 to $700 retail price.
It was always a bit of a shell game, but it worked specifically to the advantage of the companies that make top-tier phones. In recent years, however, that model has begun to disappear, and that change has huge ramifications for customers, the wireless carriers, and the companies that manufacture smartphones.
The big four wireless companies are in different fashions all pushing away from the traditional two-year subsidy model. Here's a look at what each is doing instead:
- T-Mobile (NASDAQ:TMUS): CEO John Legere led his company to entirely drop the subsidy model in 2013. T-Mobile, as part of its Uncarrier efforts, got rid of contracts, and subsidies went with them. If you decide you want service from the company, you can either bring a phone with you or finance one and pay for it over time.
- Sprint (NYSE:S): The other discount carrier, Sprint, still offers two-year contracts and subsidies, but it's been pushing customers toward its cheaper lease plans -- specifically for iPhones. Leasing is the cheapest way to get the top-tier Apple phone, but at the end of the contract term, you don't own the phone.
- Verizon (NYSE:VZ): This company is perhaps the least aggressive about eliminating contracts, though it does offer them, along with its Edge financing plans.
- AT&T (NYSE:T): Finally, AT&T has begun phasing out subsidies and recently stopped offering them through third-party sellers. Two-thirds of the company's customers have been choosing its Next financing plans over a subsidized contract, according to CNN Money.
"I think it is one of those options that is going to go away slowly,"Ralph de la Vega, AT&T CEO of mobile and business solutions, told Re/code. The shift will happen, he said, "not because we insist on it but because customers will choose it less often."
How does this affect the industry?
For carriers, things won't change that much. By offering financed or even leased phones, the company still carries much -- if not all -- of the upfront cost of the handset. Financing requires a contract as well, so in reality, there's not a major change in the business model.
For the manufacturers, the potential problem arises when customers finance a phone and get a much truer picture of what it costs. The expense is no longer hidden in the monthly plan; it's expressly broken out. Companies can combat the sticker shock by getting creative and offering cheaper alternatives, such as leases, on the most expensive phones, but still poses a potential concern.
Thus, the wild card is the consumer. Dropping subsidies adds transparency, and it's possible that some former flagship-phone users will elect cheaper alternatives. Doing so becomes more and more viable as less expensive smartphones running Google's (NASDAQ:GOOG) (NASDAQ:GOOGL) Android or Microsoft's (NASDAQ:MSFT) Windows 10 continue to improve in quality.
It's easy to buy an iPhone when you don't feel like you're paying for it, but it might look less attractive when you see how much it costs upfront or broken down over a financing period. This way of doing business could be very good for some of the lesser players in the smartphone market moving forward -- Microsoft especially.
Subsidies won't go away
Although the day of the subsidy has mostly passed, the model may not entirely disappear. Since a certain segment of smartphone users is likely to continue to want the false savings of paying less upfront for a subsidized device, at least one of the big four is likely to continue the practice, even if it doesn't heavily push the option.
Daniel Kline owns shares of Apple and Microsoft. He has a subsidized iPhone and a non-subsidized Windows phone. The Motley Fool recommends Apple, Google (A shares), Google (C shares), and Verizon Communications. The Motley Fool owns shares of Apple, Google (A shares), and Google (C shares). 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.