The recent trend among U.S. wireless carriers has been to offer customers the option to buy a phone using an installment plan and upgrade the phone earlier than the typical two-year cycle. T-Mobile (NASDAQ:TMUS) started the trend with its Un-carrier initiative. The company won't offer a subsidy on its phones anymore. AT&T (NYSE:T), Verizon (NYSE:VZ), and Sprint (NYSE:S) followed suit with similar plans in the following months.
While carriers say they're only trying to give consumers what they want, who really benefits from these early upgrade programs?
Why you shouldn't upgrade your phone early
Phones are depreciating assets, but if you buy the right one -- like an iPhone -- they depreciate much more slowly than things like a new car, which loses value as soon as you drive it off the lot.
When you go to upgrade your phone early you have to trade in your old phone. Often times, the carrier simply forgives your existing balance on the phone in exchange for upgrading early. That's why carriers require you to have paid off a certain amount on your phone (usually 50% or more) before you can upgrade.
The carrier, essentially, is buying the phone back from you well below market value. It can then turnaround and sell it to a third-party, used-phone vendor and turn a profit. You'd be better off paying off the existing debt yourself by selling the phone on Craigslist, eBay, or any one of the specialized used-phone purchasers online.
How to take advantage of early upgrade plans
The nice part of early upgrade plans is they allow subscribers to separate service costs from hardware costs. That means carriers charge less for service since the phone subsidy isn't hidden in your monthly bill. Those subsidies kept almost every subscriber in an endless upgrade cycle every two years.
There's an easy way to take advantage of the separation of hardware and service billing: Don't upgrade every two years.
Early upgrade plans are designed so that you are able to upgrade your phone more often, and that's exactly what carriers want you to do. But if you forego the upgrade, your monthly bill will decline by $20 to $30 every month once you own the phone outright. Eventually, you'll be compelled to upgrade, but that old phone may still be worth $50 to $200 by the time your look to sell it. (16GB iPhone 4s still sell for over $100 on eBay.)
The benefits for carriers and investors
Besides the ability to easily take advantage of customers always looking for the newest phone, carriers benefit in a couple other ways.
First, carriers don't have to pay a subsidy on smartphones. A new iPhone typically carries a $450 subsidy if a consumer buys it with a two-year contract. That $450 comes out of the carrier's profits.
Now, carriers are able to account for a large percentage of revenue upfront on phone sales, making their income statements look nice and profitable. It's worth noting, however, that cash flow typically lags behind those revenues.
That's why the carriers are now securitizing those debts and selling them to banks. It allows carriers to recoup the majority of the cost of the phone relatively quickly, and make up the difference when customers come into upgrade.
Who's taking the most advantage of its customers?
Early upgrade plans are a double-edged sword for carriers, but most often they take a slice out of customers' wallets instead of the carriers. T-Mobile, as mentioned, has 100% of its customers on nonsubsidized smartphones. But it has a separate upgrade plan, called JUMP, that allows customers to upgrade every six months. It says "the vast majority" of customers with equipment installment plans also have JUMP.
Meanwhile, AT&T says that 65% of customers bought phones using its Next plans in the first quarter of the year. Verizon, comparatively, activated just 39% of its new customers in the first quarter using its Edge installment plan. Sprint financed 53% of new customers in the first quarter of the year, including 37% of customers who took the carrier up on its offer to lease a phone for two years.
It looks like T-Mobile and AT&T are taking full advantage of the trend, but Verizon is catching up quickly. In the near future, carriers may completely do away with subsidies and only offer early upgrade plans.
Adam Levy has no position in any stocks mentioned. The Motley Fool recommends Verizon Communications. 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.