Subsidy vs. Installment Models-Wireless Phones

Part
01
of two
Part
01

Subsidy vs. Installment Models-Economic Impacts

The key difference between wireless subsidized and financing/installment models is that a sizable portion of the phone price is carried by the carrier in the subsidized model. In the installment model, the full price is split monthly in equal installments over the full period of the plan with no subsidization. With the installment plan model, the wireless courier makes a marginally higher incremental margin. In both Canada and the United States, major wireless carriers no longer offer subsidized contracts. In addition, the cost of wireless phones is rising, resulting in a decline in subscriber growth. Below, we discuss this topic in more detail.

Overview

Subsidized Model

  • A wireless subsidized model or contract bears a sizable portion of the cost of the phone paid by the carrier up front. The result is a smaller contract price for the consumer.
  • To protect the initial cost of acquisition (COA) by the courier, the consumer must sign a contract for a period of months. This is typically 24 months in both Canada and the United States.
  • The subsidized price is recovered over the length of the contract.

Installment Model

  • In the installment model, the full retail price (FRP) is shown up front to the consumer.
  • The FRP price is divided over the term of the plan into monthly repayments. Most plans are 24 months.
  • In Canada, the installment plan can include a payment up front. If there is payment up front, it will reduce monthly repayments.
  • Interest is not charged over the repayment period of the wireless phone.
  • The phone belongs to the consumer at the end of the plan.

Economics

Model Cost Comparison

  • When comparing the purchase of a wireless device of around $600 in value between a subsidy and outright payment contract model, the following applies:
  • The following items are charged for in the subsidized model, a monthly service charge, activation and retention ETF/EU waiver.
  • Total monthly cost of the $600 phone is $46.33.
  • The following items are charged for in the outright payment model, a monthly service charge, activation, retention and the outright cost of the wireless phone.
  • The total monthly cost of the phone on the installment plan is $69.99.
  • From this exercise completed by NPI, the cost of an outright payment contract model is more expensive than a subsidized contract model. This is primarily because a subsidized phone contract has a reduced cost on the phone model bought.
  • The idea of a subsidized model is about retention, keeping the consumer in the carriers stable for as long as possible, increasing your profit per client over time.
  • In an installment model, there is a general incremental profit over subsidized contracts.
  • Wireless carriers raise the finance for the phones through bank loans and public security.

Profits

  • Because the cost of an ever-improving wireless phone is increasing constantly, the risks to profit margins are high for the carriers and have dropped the subsidized model.
  • All the leading carriers in Canada and the United States only offer the installment model now. AT&T stopped using the subsidized contract model in 2016.
  • The 24-months installment contract is the normal contract length, but longer installment contracts are now being explored by carrier companies. This will keep the consumer locked in for longer with increased profit margins.
  • According to Verizon, their previous consumer subscribers are not replacing their phones. This indicates both the subscriber and profit margins are down.
  • An article by the New York Intelligencer supports Verizon’s findings and that a smartphone plateau has been reached. United States wireless sales are in a decline across the board. This is expected to continue into 2022.
Part
02
of two
Part
02

Subsidy vs. Installment Models-Companies

The wireless phone companies that use a subsidy model for selling phones are Rogers, Telus, Bell, and Freedom. On the other hand, the wireless phone companies that use a finance/installment model are AT&T and Verizon.

WIRELESS PHONE COMPANIES IN CANADA that use a subsidy model

ROGERS

  • Rogers uses the subsidy model for selling phones.
  • This involves partial payment of the phone upfront with the remaining portion collected in service fees monthly.
  • It is believed that this model gives customers the most options and the highest value in making purchases according to Sarah Schmidt, the spokesperson for Rogers.
  • In 2017, they made a slight adjustment ("one price for the service") to their subsidy model to cater to high-end users which makes it a little similar to an installment plan.
  • Adam Ilkowitz, a Citigroup analyst said, the new adjustment may result in lower cost for customers.
  • However, the company does not plan to change to an installment model because the company doesn't see the real benefits of installment model.

TELUS

  • Telus uses the subsidy model for selling phones.
  • The company has recently launched an initiative to help young adults who are leaving the foster care system to have a smartphone with a plan (TELUS Mobility plan) that is fully subsidized.
  • Telus reported that the company had high expenses to acquire and retain customers because of the subsidies for smartphones, especially during major promotions.
  • Telus does not plan to switch to installment plans because the company is satisfied with the results of the subsidy model.

FREEDOM

  • Freedom uses the subsidy model for selling phones.
  • In 2017, the company offered device subsidies ranging from $120 to $1,200.
  • If customers pay more money upfront then their monthly payment would be less over 24 months.
  • To compete with the wireless phone company leaders in Canada (Rogers, Telus, Bell), Freedom offered maximum subsidy of $0 down payment using its MyTab Boost.

BELL

  • Bell uses the subsidy model for selling phones.
  • Upon expiration of the customer's 2 year-contract, they can get another subsidized device and plan or continue with the same one.
  • Bell does not plan to switch to installment plans.
  • A new program under this model that was recently launched is called "Pay Less Upfront" which allows customers to keep or return their device at the end of the two-year agreement.

WIRELESS PHONE COMPANIES IN THE U.S. that use finance/installment model

AT&T INC.

  • AT&T uses the installment model which can be paid off between 24 and 30 months.
  • Once an agreement is made with the company and customers for a device, the customer is solely responsible for it once on their possession but there is an insurance for mobile devices that can be bought to help with the protection of the device.
  • This company offered the subsidy model in the past but stopped offering this option on January 8, 2016.
  • Subsidies were too expensive for both the company and its customers. It was also considered as not transparent and payment was long-term. But the installment plan is cheaper and has more benefits like an early upgrade of the device for customers.

VERIZON COMMUNICATIONS INC.

  • Verizon uses the installment model with a 24-month agreement.
  • There is an additional fee to add a line or to change/upgrade one's phone and the only limit in having several devices on the plan is one's financing limit.
  • Verizon stopped offering the subsidy model on August 2015 for new customers but continued to offer the service to old customers up until January 2017.
  • This helped the company to cut back on expenses and create cheaper plans for customers.
  • There has been an increase in the cost of device upgrade for customers, which enables the company to offer a 4G LTE network.

Research Strategy:

In our research, we found that AT&T Inc. and Verizon Communications Inc. are industry leaders as wireless phone companies in the U.S. The installment model seems to be the main model used by wireless phone companies in the U.S. We provided information for AT&T Inc. and Verizon as wireless companies that use a finance/installment model.

Freedom does not seem to have made any switch from the subsidy model to the installment model. Initially, we searched the company's website for this information but we did not find any dates or announcements. We then looked for news sources or press releases for this information but did not find an announcement of a change or plan to change. Finally, we expanded the scope to include information as far as 2010 but did not find any announcements of a switch from subsidy model to installment or any plans to do so. Therefore, we assumed the company has no intention to switch any time soon.
Sources
Sources

From Part 01
Quotes
  • "This is part of what is known as COA, or Cost Of Acquisition. This is part of the cost to get a new customer, which includes a number of factors, including the phone cost (or subsidy), dealer compensation, marketing, etc. What this means for you is that the wireless carrier actually may have paid $700 for a phone that they then sell to you for $200. That difference of $500 is called the handset or phone subsidy and actually represents an initial loss. "
Quotes
  • "Your payments for the cell phone are shown as the full FRP (full retail price) of the phone, divided by equal payments over an agreed period (usually 24 months). The payments are interest-free, and customers with a good credit history will pay $0 down when signing on to these plans. "
Quotes
  • "In this example, we are comparing apples-to-apples using the same $600 cost for an older version smartphone. The two-year cost under the un-subsidized model is more expensive and represents an incremental margin to the carrier."
Quotes
  • "T-Mobile (NASDAQ:TMUS) is now exploring longer installment plans, according to TmoNews. Most installment plans tend to last two years (the same duration as service contracts under the subsidy model), but the Un-carrier is now testing out three-year installment plans in an effort to further spread out the cost of those expensive phones and make them more affordable."
Quotes
  • "AT&T Wireless announced that the 2 Year Contract is ending January 8, 2016. New and Existing Customers will only be able to buy phones using the Next Installment Plan after this time. The move from the long time 2 year phone contract that included hardware and the plan, to separate the plan from the phone started in 2016."
Quotes
  • "We compare the monthly payments (and real prices) on the most popular $0 down deals from all major carriers inc. Rogers, Bell, Telus, Sasktel and more. "
Quotes
  • "The trend started nearly five years ago, when carriers pinched by costly promotions stopped offering deeply discounted phones in exchange for two-year service plans. Instead, they marketed installment payment plans for new phones priced at up to $1,000."
Quotes
  • "Not because sales are picking up again, but because we’re heading toward the downslope. “I think we’re well over the plateau,” says Ben Stanton, senior analyst at Canalys. “We’ll see little pockets of growth in the global market, but on the whole it’s a declining picture.”"
  • "More worrying for smartphone manufacturers is that desire for new technology doesn’t really spur consumers to buy new phones. “The number-one purchase trigger is ‘My last device was broken,’ and this has increased year on year,” says Chan. “Triggers like ‘I just wanted a newer model’ and ‘I had the option to upgrade early’ have declined or remained flat.”"
Quotes
  • "Wireless companies have handled these installment “loans” in different ways. Verizon was the last carrier to adopt these plans, but it was the only U.S. company so far to package them as public security, meaning bundles of cellphone loans have been sold on Wall Street as asset-backed securities. Other carriers also securitized but have used bank lending to cover the receivables, and the accounting treatment is more favorable, said McCormack."
Quotes
  • "Over the course of two years, that brings you to $2,304 — about $30 more than if you were on a contract. The real kicker with this plan, however, is that the program allows you to trade in your phone early for a new one without putting down another $199 upfront for the device."
From Part 02
Quotes
  • " Customer acquisition and retention costs remained elevated and continued to pressure earnings due to both the prevalence of heavily discounted smartphones during key promotional periods and the ongoing market adoption of more expensive smartphones. "