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Are Smartphone Subsidies A Thing of the Past?

By Daniel B. Kline – Aug 19, 2015 at 9:20AM

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Two major carriers have gotten rid of them and another is going to soon.

Verizon (VZ -2.55%) has eliminated subsidies on smartphones following T-Mobile (TMUS -0.30%), which got rid of them two years ago. Sprint (S) still has them, but plans to do away with them in the near future. That leaves only AT&T (T -1.84%) letting customers pay a heavily reduced price for a new phone in exchange for customers signing a two-year contract and paying a little more each month.

This marks a seismic shift in the U.S. wireless phone market and it's one the carriers have wanted for a long time. Abraham Seidmann, Xerox Professor of Computer and Information Systems and Operations Management from Simon Business School at the University of Rochester did an email interview with the Fool to examine exactly what the change means.

It's the beginning of the end of subsidies
Essentially, you can't put the genie back in the bottle, according to Seidmann, who actually thinks that lower-cost mobile virtual network operators are driving the change. Those companies offer very low-cost plans to customers who must buy their phones up front. He cited Google (GOOG 2.42%) (GOOGL 2.52%) as an MVNO, which could take share away from big carriers. 

Seidmann Source: University of Rochester

"For now, Verizon which is a top quality provider seems to be desperately trying to stem the tide before Fi, and others become even more popular," he wrote.

Seidmann also said that forcing people to pay for phones upfront (financing is also an option with Verizon) could have unintended consequences for the carriers. 

"In the long run, we do wonder though, since users will have to pay for their phone outright, will providers (Sprint, AT&T, or Verizon) be forced to stop locking their phones so users can move them to other carriers," he wrote. "It will be the next logical step after providing for phone numbers portability about 15 years ago."

No contracts and unlocked phones would be good for consumers, but it creates extreme volatility for the carriers. Customers would be able to switch on a whim between providers that their phone is compatible with and there would be nothing stopping them from jumping from deal to deal.

Why do carriers want this?
The above scenario and potential chaos of customer movement makes one wonder why carriers would want to end subsidies. Under the current system they do carry the up-front cost of the phone, but are essentially paid back (sometimes and then some) through higher monthly charges.

Subsidies are essentially financing under different verbiage and both are systems that lock people into their carrier for a set period of time. Seidmann believes that the carriers are not so much eager to drop subsidies under the current model, but they are preparing for a time when they cannot command monthly rates which are high enough to recoup the fees.

"In short, they have no choice." he wrote. "Recall that the rest of world's mobile prices are already a fraction of what we pay here in the U.S."

Seidmann also believes that Wi-Fi based MVNOs will create a climate which makes it much harder for the major carriers to compete.  

"With Wi-Fi rapidly being deployed, the added value of almost all conventional mobile phone companies goes down day-by-day," he wrote.

Get money where you can
The rise of MVNOs, and to a lesser extent T-Mobile and Sprint, are forcing lower monthly prices on an industry that has been able to avoid that for so long. As that is happening consumers are becoming used to the idea that those lower recurring fees come with a catch -- you must pay for your phone upfront.

Subsidies appear to be rapidly disappearing and there is no reason to believe that tide will reverse itself. AT&T may hold out for a while, but eventually the concept of paying $200 upfront for a top-tier phone on a two-year contract looks to soon be a thing of the past.

Daniel Kline has no position in any stocks mentioned. He has almost always bought subsidized phones. The Motley Fool recommends Google (A shares), Google (C shares), and Verizon Communications. The Motley Fool owns shares of Google (A shares) and Google (C shares). 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.

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