Verizon (NYSE:VZ) is done with two-year contracts.
Well, sort of.
Last month, Verizon made a big change to its smartphone plans. New customers looking to join Big Red can no longer take advantage of subsidized devices. Instead, they must purchase their phone outright, use a phone they already own, or pay for their handset in monthly installments.
Existing customers, however, can continue to take advantage of subsidized phones if they wish. In a subsequent blog post, Verizon clarified its plans, noting that it would continue to offer contracts and subsidies to existing subscribers.
Verizon's announcement is less of a death knell to contracts than it originally seemed, but regardless, the move away from two-year contracts remains in full force.
Contracts remain -- for now
"You can renew your current contract once that cool new handset launches -- and take advantage of subsidized contract pricing," Verizon writes, but only if you're a current subscriber with a two-year agreement. (Verizon also suggests that contract-pricing may be limited to select devices, but offers no further clarification.)
New customers, and existing subscribers without contracts, won't have the option. Subscribers under contract can also move to one of Verizon's new plans, but if they do, they'll forever lose the ability to sign a two-year agreement.
Verizon's new plans offer many advantages over its standard two-year contracts. Customers who pay for their phones in installments do not have to make large, upfront down payments, and they may save money on their monthly data allotment. Their bill becomes more transparent, and they can upgrade more often if they're willing to pay off their current handset.
Many of Verizon's customers had already opted for its non-contract plans prior to its August announcement. In May, at JP Morgan's Global Technology, Media and Telecom Conference, Verizon CFO Fran Shammo said that only about 60% of Verizon's recent phone activations were on contract.
Verizon's new plans are simpler and more enticing, and while some customers may hold out, in time it seems likely that the bulk of Verizon's customer base will be without a contract.
With more Verizon subscribers moving to installment plans, it could put pressure on Verizon's free cash flow. These plans are generally accretive to margins, but require Verizon to spend more upfront on hardware without taking in large down payments.
Still, Verizon's management believes the shift is necessary for competitive reasons. During Verizon's second quarter earnings call, Shammo explained that, while the move away from contracts occurred more rapidly than Verizon had anticipated, the industry at large was clearly headed in that direction. "That's where the market has gone, so that's where we need to compete," he said.
A market without contracts
T-Mobile was the first to ditch contracts entirely, and like Verizon, Sprint also plans to phase them out. When that happens, AT&T will remain the sole provider of contracts to new wireless customers (though probably not for long).
The loss of the two-year contract model was once viewed as a major threat to the carriers, as it could effectively render them interchangeable utilities -- "dumb pipes" prone to brutal price competition.
Yet consumers have been too receptive to these plans for carriers to ignore. It will take some time, but the two-year contract appears destined for extinction.
Sam Mattera 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.