Will Verizon Cut Its iPhone Subsidy?

by Brad Moon | May 11, 2012 11:57 am

Will Verizon Cut Its iPhone Subsidy?

Apple’s (NASDAQ:AAPL[1]) retail price for an unlocked iPhone 4S ranges from $649 to $849. U.S. wireless carriers provide them to their customers for $200 or less on a contract, a subsidy they’re showing some reluctance to continue.

Competing Android smartphones are priced similarly to iPhones, but Time points out that they tend to carry a lower subsidy from carriers[2].

For example, Verizon (NYSE:VZ[3]) offers the $649 iPhone 4S for $199 on a two-year contract, but the $649 Galaxy Nexus from Samsung (PINK:SSNLF[4]) is priced at $299 with a two-year contract. Digital Trends broke down the numbers on iPhone contracts offered through AT&T (NYSE:T[5]), Verizon and Sprint (NYSE:S[6]) and discovered that after accounting for the current subsidy, carriers are still collecting anywhere from $1,000 to $3,600 per customer over the life of a two-year contract[7].

Why are carriers offering a bigger subsidy on iPhones when they are already in such high demand? Samsung doesn’t seem to be having trouble moving smartphones despite customers effectively paying more for many of its models.

Would customers accept a model that removed or lowered the iPhone subsidy and instead offered a lower monthly service charge? In other words, would they pay $649 or $400 upfront in return for shaving the $18 or so per month it costs the carrier to subsidize the handset?

What about a monthly installment plan instead?

Two telcos in Spain have already adopted this model. Telefónica (NYSE:TEF[8]) eliminated subsidies and is offering customers the option of paying an extra $45 monthly to pay for an iPhone.

Unfortunately, the math gets fuzzy. What happens if not everyone is onboard? If some customers balk, the number of contract subscribers slows and operational costs are spread over fewer customers, making it more expensive per customer to run the business. That would raise rates, wiping out at least some of the monthly savings for wireless service.

In the case of Vodafone (NASDAQ:VOD[9]), which cut iPhone subsidies, customers are facing this fuzzy math if they want a new iPhone.

Old Model: 24-month contract at $77 per month (U.S. dollars); iPhone 4S costs $258 at signup; total cost to user is $2,123 over life of contract.

New Model: 24-month contract at $77 per month (U.S. dollars); iPhone 4S costs $776 at signup (with the option of amortizing the cost interest-free and adding that to monthly plan); total cost to user is $2,642 over life of contract.

Vodafone is offering a slightly more generous text, data and voice plan for that $77, but the net result is that customers pay $519 more under the new plan than the old. According to The Wall Street Journal, Verizon CEO Lowell McAdam has said that his company may follow Telefónica’s lead[10].

Among the many questions about subsidies, one stands out: If consumers were forced to pay significantly more for an iPhone, would they continue to buy Apple’s smartphones at the same pace? Or would they hold on to an iPhone for four years instead of upgrading every two years, or perhaps even decide the premium isn’t worth it and look into cheaper alternatives from the Android, Windows or even BlackBerry  camps?

At least one analysts is worried that this is a possibility. Forbes notes that Walter Piecyk of NBTIG cut his rating on Apple from buy to neutral[11] based on the likelihood that elimination or reduction of subsidies by carriers will result in slowing iPhone sales.

Consider other consumer technology in the same price range as the iPhone. A laptop is a reasonable example. A poll on SmartBrief asked users how frequently they bought a new laptop. Under 10% buy one every one to two years, while the vast majority (47%) answered that they only replace it only when they really need to[12].

That sounds about right to me. However, if ISPs subsidized a new laptop — specifically a hot seller such as Apple’s MacBook Air — so it cost  only$199 to upgrade to a new one every two years, you can bet there would be a lot more people walking around with new MacBook Airs.

Keeping an iPhone for four years doesn’t mean you have an obsolete device. The iPhone 3GS, which Apple still sells and carriers still offer, was launched three years ago. This three-year-old smartphone still commands a $375 price tag — $100 more than the Motorola Triumph, a decently rated Android smartphone released just eight months ago and competitive with the BlackBerry Bold 9790, a six-month-old model from Research in Motion (NASDAQ:RIMM[13]).

If  consumers are forced to choose, will they pony up an extra $200 to $400 of their own cash every two years to stay with the latest and greatest when their existing iPhone is perfectly good?

The only way we’ll find out is if all U.S. carriers pull back on iPhone subsidies. If Verizon acts unilaterally, it will pay the price as consumers with iPhone lust flock to wherever the subsidy remains. It’s a game of chicken in a way, and I don’t think Apple is too worried at this point.

Endnotes:
  1. AAPL: http://studio-5.financialcontent.com/investplace/quote?Symbol=AAPL
  2. they tend to carry a lower subsidy from carriers: http://www.digitaltrends.com/mobile/are-iphone-subsidies-destroying-carriers/
  3. VZ: http://studio-5.financialcontent.com/investplace/quote?Symbol=VZ
  4. SSNLF: http://studio-5.financialcontent.com/investplace/quote?Symbol=SSNLF
  5. T: http://studio-5.financialcontent.com/investplace/quote?Symbol=T
  6. S: http://studio-5.financialcontent.com/investplace/quote?Symbol=S
  7. $1,000 to $3,600 per customer over the life of a two-year contract: http://www.digitaltrends.com/mobile/are-iphone-subsidies-destroying-carriers/
  8. TEF: http://studio-5.financialcontent.com/investplace/quote?Symbol=TEF
  9. VOD: http://studio-5.financialcontent.com/investplace/quote?Symbol=VOD
  10. his company may follow Telefónica’s lead: http://online.wsj.com/article/SB10001424052702304020104577384562576617618.html
  11. cut his rating on Apple from buy to neutral: http://www.forbes.com/sites/ericsavitz/2012/04/09/apple-whoa-btig-analyst-cuts-rating-to-neutral-from-buy/
  12. replace it only when they really need to: http://www.smartbrief.com/news/smallbusiness/poll_result.jsp?pollName=FC49475B-1A7E-4987-AFAD-79F93893CB1C&issueid=3D4A6C19-5537-441B-B88C-BE4163B1A25B
  13. RIMM: http://studio-5.financialcontent.com/investplace/quote?Symbol=RIMM

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