Friends, Americans, countrymen, lend me your ears; I am here to bury device subsidy, not to praise it!
Alright, burying is probably a little premature, but, clearly, device subsidy (in the form of 2-year contracts) is on its death bed. Ever since T-Mobile pioneered equipment installment plans in the US in 2013, Americans started going the way of the rest of the world. Today, equipment installment plans are the norm for the majority of customers upgrading their phones. So, how does it change the mobile industry landscape and who does it benefit most?
What Was Good about Device Subsidy?
Before we jump to how the landscape has changed, I want to give a little thought to what was good about device subsidy. (Even though it's not dead, I will stick to the principle of not speaking ill of the dead. ;) )
If you agree that supplier competition is good for the consumer, then, more choice in original equipment manufacturers (OEMs such as Samsung, Apple, LG, Motorola etc) and more operating systems (OS) is better for the consumer. Device subsidy allowed the operators to level the playing field somewhat for the smaller OEMs and less adopted OSs by offering more subsidy to the devices offered by the weaker players. Why would operators be interested in doing this? Higher diversity in OEMs and OSs increases operators' leverage and helps them differentiate themselves from others. So, the interests of the consumer and the operators are well aligned in this case.
Obviously, life wasn't perfect even with this benefit of device subsidy. Operators vied with each other to carry the most popular phone brand, ever since it was first released in 2007. Operators were willing to provide more subsidy for devices from Apple that was able to bring in higher value customers. This clearly tilted the playing field against some of the same weaker players that the device subsidy should have helped.
The other benefit of device subsidy was that it sped up the technology adoption cycle for the mobile industry. With subsidy, most customers upgraded like clock work every two years. So, OEMs and other players could plan for the demand for new technology based on this upgrade cycle. This was also good for mobile operators in managing their networks since transition between technologies (2G to 3G to 4G) could be managed smoothly with device technology transition via the upgrade cycle. Unfortunately, this resulted in higher costs for the consumers because the costs of upgrades were ultimately borne by them.
So, How Might Future be Different?
I see three main ways in which future could be different from today - likely lengthening of phone upgrade cycle, a focus on long term value of device and potential play by OEMs to get closer to the customer with their own equipment installment plans.
Lengthening of Upgrade Cycle, Especially in the Premium Segment
With the consumers directly responsible and cognizant of phone pricing, some have theorized and I tend to agree that the consumers are likely to upgrade less frequently. The evidence for this theory till now has been scant. Driven by their sudden ability to upgrade on a whim, consumers have actually pushed up the upgrade rates at most operators since the introduction of the equipment installment plans. But, I would hypothesize that the consumers who want to upgrade more frequently (than every two years) are a small fraction of the total consumers.
With AT&T's completion of two years of its launch of Next (equipment financing plan) program and high installed base of iPhones, a large majority of its customer base will be off their 2-year contracts. If the hypothesis is correct, I would expect to start seeing a slow down in upgrade rate in AT&T's Q2 results.
One possibility is that the upgrade cycle will be different between the premium segment of phones such as iPhone 6 or Samsung Galaxy S6 and lower segment phones driven by the difference in the monthly cost of ownership between the two tiers. At higher monthly costs, consumers might be more sensitive to upgrades than otherwise. This would be contrary to the past where the premium segment upgraded much more frequently.
Focus on the Long Term Value of Device to the Consumer
Reduction in upgrade rates will spur some of the OEMs to provide a device with a better long term value for the money. But, unfortunately, not all OEMs will be able to play this game. Apple, with its tight coupling of software and hardware, is much better placed in this aspect. We can already see this in Apple's plans for iOS 9 which will be compatible all the way back to iPhone 4S. At the time of the likely official release of iOS 9, iPhone 4S will be four years old. Assuming that Apple would want the device to work for at least another year, the life of iPhone 4S will be almost five years.
Now, one might wonder if this would be a good strategy, even for Apple! With a saturating smartphone market, a longer upgrade cycle will decrease the volumes even further. Apple is already preparing for this eventuality by pushing harder into services such as music and news. Even though the customer might keep the device longer, app and subscription sales will provide a steady stream of revenue that, hopefully, will compensate for revenue lost due to lower device sales.
Another way OEMs are likely to demonstrate long term value of the device is by supporting the prices in the secondary markets. We have seen this in the automotive industry for a number of years whereby some of the premium car manufacturers have participated in the secondary market by acquiring customers' vehicles and offering used certified vehicles. Apple, again, has shown early signs of intervening in the secondary markets and we should expect much more of this behavior in the future.
Equipment Installment Plan as a Means to Enhance Customer Relationship
One another advantage due of the proliferation of equipment installment plans and the gradual death of device subsidy is the ability of customers to bring their own devices. Clearly, consumers have been taking advantage of this - AT&T announced in its Q1 results that 313,000 of its gross adds were bring-your-own-devices. This provides an avenue for anyone that desires a closer relationship with the mobile customer to realize it through their own equipment installment plan.
Traditionally, Android OEMs, despite their best attempts, have had tenuous relationship with their customers because the customers identified themselves first and foremost to the App Store with their google ID. Reasons for signing up for an account with the OEMs weren't very strong. Equipment installment plans, if offered by OEMs, might now provide a stronger reason to be truly contract free. Motorola has already gone down this path. Using this financing relationship, OEMs could potentially understand their customer needs better and drive better customer retention. Again, Apple is ahead of its competition, even without offering equipment installment plans of its own because of its App Store and OS relationship with the customer.
So, What Does This All Mean?
Despite potentially being at a higher risk due to lengthening of upgrade cycle, Apple is likely the best prepared and positioned to take advantage of the future with equipment installment plans. While other OEMs might be able to replicate some aspects of Apple's strategy, they would do so without the cushion of services revenues (that Google is likely to claim in the Android ecosystem) and the strong customer relationship Apple has enjoyed. The net result is likely a continued race to the bottom in the Android ecosystem while Apple continues its domination of the higher end. Apple will continue to expand the reach of the higher end by selling its older generation devices to those that can't afford the latest devices and by improving the long term value of the devices with OS support and secondary market intervention. Equipment installment plans are likely to strengthen status quo in favor of Apple!
