Is It Time to End Cell-Phone Subsidies?

It might have sounded strange — counter-intuitive, perhaps — to attendees of a GeekWire panel in Seattle last week when USA T-Mobile’s chief marketing officer, Cole Brodman, said that if given the chance, he’d do away with cell-phone subsidies to equipment manufacturers. InvestorPlace looked at the issue last week, too.

Brodman said he’d end the discounts because they devalue the devices, which many consumers toss aside every 18 months for newer models. Also, he noted that subsidies create an “uneven playing field” for phone manufacturers, which have come to rely on subsidy pricing in the U.S. market and elsewhere, and carriers, which rely on service contracts to cover their subsidy outlays.

Subsidies in the U.S. are one of the key drivers behind the popularity of Apple’s (NASDAQ:AAPL) iPhone, which is offered by AT&T (NYSE:T), Verizon (NYSE:VZ), and Sprint (NYSE:S), but not by T-Mobile, a subsidiary of Deutsche Telekom (PINK:DTEGY).

Most wireless phone carriers discount their phones so customers will accept the companies’ two-year contracts. But the price breaks tend to be less generous than the discounts on smartphones like the iPhone, whose 4S model costs as much as $400 with a two-year service agreement.

T-Mobile’s refusal so far to join its U.S. rivals in paying the iPhone subsidy has cost the company. T-Mobile said 1.65 million customers canceled its service last year, including 802,000 net contract subscribers during the fourth quarter, because T-Mobile does not sell the iPhone. The exodus occurred even though T-Mobile has the U.S.’s largest 4G network — though no longer the fastest — and offers some of the lowest all-inclusive prices in the U.S. market.

T-Mobile’s customers went where they could get the iPhone, and that helped AT&T, along with Verizon and Sprint, which began selling the phone last year. But they also paid dearly for those customer gains. Each of the companies’ lost money in the fourth quarter, and each said the iPhone subsidy was one of the main reasons.

Keeping the subsidy debate going

So is Brodman just wishing out loud? Or is he saying aloud what other wireless carriers are secretly wishing for, if not actively planning?

Wireless cellphone service providers realize that the two-year-contract pricing model based on voice minutes and text messaging won’t continue to generate the profits it once did. That’s already happening in several European countries and in China and India, where customers buy smartphones running on Google’s (NASDAQ:GOOG) Android operating system for less than $200 without a contract. The iPhone’s retail cost without subsidies is the primary reason Android phones dominate iPhone sales in those regions.

With data now driving demand, wireless operators in the U.S. and abroad are moving toward new pricing models and installing hardware and software tools that will help them track how much data customers use so they can bill them accordingly. The pricing changes may make it less necessary for carriers to subsidize cellphones.

But doing away with cellphone subsidies, particularly the iPhone discounts, could be difficult in the U.S. because of the phone’s popularity. In February, the iPhone continued to be the top-selling smartphone here. Its continued adoption has also helped drive iPad sales, which in turn has boosted data-plan sales.

By continuing to subsidize cellphones, U.S. wireless operators may be digging themselves into a hole they can’t easily get out of. But don’t expect to see the companies pull back their iPhone subsidies until they’re assured that their new pricing strategies can deliver — or that other smartphone and tablet makers can attract customers the way the iPhone does.

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