You won't be getting a subsidy on your new smartphone in 2016.
AT&T (NYSE: T) and Sprint (NYSE:S) are the last two of the four major wireless carriers to do away with the two-year phone contract and subsidy model. Now, any new contract requires customers to pay for their new smartphone upfront or in installments separate from their service bill.
Verizon (NYSE: VZ) killed off smartphone subsidies in August, and T-Mobile (NASDAQ:TMUS) is now three years removed from its Uncarrier initiative that kicked off this whole trend. Ultimately, wireless carriers could be better off for it, and big phone companies like Apple (NASDAQ: AAPL) and Samsung (NASDAQOTH:SSNLF) have plans to take advantage of the change as well.
How the wireless carriers benefit from no contracts
Two-year contracts have practically been dead for some time now since competing carriers have offered to pay early termination fees for customers willing to switch to their networks. Therefore, the negative impact from customers being able to switch carriers more easily should be minimal.
At least with the new system of installment and early upgrade plans, carriers can benefit from customers when they decide they want to upgrade equipment before their two-year contracts would be up.
Early upgrade plans have proven surprisingly popular. T-Mobile says "the vast majority" of customers with equipment installment plans also pay for its early upgrade program called JUMP. The other carriers include upgrade options within their regular installment plans, allowing customers to trade in their existing phones for a new contract after a certain number of payments.
Early upgrade plans provide some stability in the competitive wireless environment. Additionally, they allow wireless carriers to profit off the sale of smartphones, whereas smartphone sales were previously a burden. With the subsidy model, wireless carriers paid up to $450 to acquire a new customer, leading to wild cash flow variances when a new smartphone from Apple or Samsung came out.
Now, they can securitize these contracts and sell them to institutional investors (typically by way of an investment bank), getting the balance off their books quickly. Carriers just bundle all their equipment loans into one product, which is then marketed to pension funds, university endowments, sovereign wealth funds, and other income-seeking investors.
Opening the doors for Apple and Samsung
With customers now forced to pay full price for their phones (either upfront or over time), there's less incentive for customers to buy phones directly from their wireless carrier. Instead, they might opt to buy their phone from an electronics retailer or directly from the manufacturer itself.
To that end, Apple introduced the iPhone Upgrade Program with the introduction of the iPhone 6s last Fall. It includes Apple's insurance plan, AppleCare, and allows customers to upgrade their phones every 12 months, in line with Apple's upgrade cycle. Samsung is reportedly considering a similar upgrade plan.
The reason these manufacturer-sponsored upgrade plans are detrimental to carriers is because they make customers loyal to the manufacturer, not the carrier. When a customer wants to upgrade his phone, he contacts Apple or Samsung. That phone can be transferred to any carrier without having to deal with terminating the smartphone contract.
After Apple's announcement, Verizon changed the terms for iPhone customers on its Edge installment plan program. They can upgrade their phones every 12 months just like Apple's plan. Everyone else must wait 18 months to upgrade early. Sprint and T-Mobile offered discounts to iPhone customers for a limited time to ensure they would stick with their upgrade programs instead of going to Apple's.
The death of the two-year contract marks the acceptance of the new competitive environment for wireless carriers in the U.S. Not only are they competing with other carriers for phone customers, they're now competing with manufacturers and retailers for loyalty as well.
Adam Levy owns shares of Apple. The Motley Fool owns shares of and recommends Apple. 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.