The way consumers purchase smartphones is changing as traditional two-year contracts slowly give way to installment plans. If you're a new customer, Verizon (NYSE:VZ) won't let you sign a contract even if you want to.
These new plans separate the cost of the smartphone from the cost of the service. And while they make it easier for customers to upgrade more often, they also give consumers the option of saving money if they're willing to to hold onto their existing hardware. During the recent Bank of America Media, Communications & Entertainment Conference, Verizon's management addressed the transition, arguing that while there's potential for a change in smartphone upgrade cycles, it wasn't anticipating a major shift.
Were a major change to occur, it would likely have a significant affect on Apple's (NASDAQ:AAPL) business.
Saving money, or having the latest and greatest?
Two-year agreements carry fixed monthly payments that do not vary based on a customer's device. Whether they're using a handset that's brand new or five years old, a customer on a two-year agreement receives the same bill each and every month. Even when the contract expires, the monthly bill remains unchanged. Wireless carriers encourage customers to sign new contracts by offering subsidized handsets; customers who do not take them up on this offer are leaving free money on the table.
With contracts, consumers are locked into their current handsets for roughly two years -- upgrading in the middle of a contract is prohibitively expensive. At the same time, they are heavily incentivized to purchase new phones every two years, as using an older phone on a contract plan offers no monetary benefit.
Installment plans, however, change both dynamics. Now customers can upgrade far more often. Some programs, like T-Mobile's JUMP! On Demand, AT&T's Next, and Sprint's iPhone Forever, give smartphone owners the ability to trade in their existing device for a new one at least once per year (JUMP! On Demand is up to three times per year).
But if customers hold on to their handset for more than two years, they can save quite a bit of money. A single-line smartphone plan with 3GB of data and a brand new iPhone 6s will cost a Verizon customer around $92 per month. After that iPhone is paid off, the bill drops to just $65 -- a decline of almost 30%. By holding onto their iPhone for four years, a Verizon customer could save $650.
These potential cost savings could lengthen smartphone upgrade cycles, weighing on Apple's iPhone business. A customer who once purchased an iPhone every two years could hold off, perhaps buying one every three years or every four years instead. Alternatively, they might decide to purchase a new iPhone every single year, boosting iPhone sales.
Around 30 months
Nevertheless, Verizon isn't anticipating a major shakeup. During the conference, Verizon Wireless's CEO, John Stratton, admitted that there could be a shift in purchasing behavior, but explained that Verizon thought upgrades would continue to conform to historical norms -- about every 2.5 years on average.
"When we look back historically at our upgrade cycles -- 30 months, 31 months -- typically, we have a sense that from a standpoint of the core technologies, the features, the benefits, the capabilities of the device, that's still probably a pretty natural time for a customer to choose to do an upgrade."
30 months ago, Apple's top-of-the-line smartphone was the iPhone 5. Its screen is significantly smaller than the iPhone 6s', and its processor far slower. It lacks Touch ID, Apple Pay, and 3D Touch. From a technological standpoint, it's woefully outdated, and an upgrade would bring immediate and significant benefits. The same could be true 30 months from now -- significant progress could make the prospect of holding onto an old iPhone for an extended period of time too unappealing regardless of the monthly savings.
But what about more rapid upgrades? Unlike its rivals, Verizon doesn't offer its customers a way to upgrade more often -- at least not easily. It has no JUMP! On Demand, no iPhone for Life. Verizon used to offer early upgrades through its Edge program, but has fazed that out. Verizon customers who purchase a phone on an installment plan can pay it off early and begin a new one, but that may entail spending several hundred dollars at once. Verizon does allow its customers to bring their own devices. Those that want to upgrade more frequently could take advantage of Apple's new iPhone Upgrade Program, which gives iPhone owners the ability to upgrade annually by trading their device in.
Given that the iPhone generates about two-thirds of Apple's revenue, and iPhone sales seem to drive Apple's performance, the shortening or lengthening of upgrade cycles -- were it to occur -- would directly affect Apple's share price.
Sam Mattera has no position in any stocks mentioned. The Motley Fool owns and recommends Apple. The Motley Fool recommends Bank of America and 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.