By Andrea Chang
4:54 PM PST, December 24, 2013
It's a perk wireless customers have come to expect: Sign up for a two-year service contract, and get a new smartphone at a deeply discounted price or sometimes even free.
But the reign of cellphone subsidies could be ending as customers demand more flexible mobile plans, forcing wireless carriers to look for alternatives to the long-standing practice.
AT&T Inc. hinted this month that it was considering doing away with phone subsidies. Chief Executive Randall Stephenson said subsidizing a smartphone every two years was an expensive undertaking that he didn't think the company could afford.
Subsidies were originally intended to lure people onto a company's wireless network with the promise of a cheap phone. With so many customers owning smartphones nowadays, Stephenson said, such incentives may no longer be necessary.
Some customers have balked at the notion of paying for a phone's full retail cost, which is often hundreds of dollars more than the subsidized price.
But analysts said cellphone subsidies were a myth and that without them, consumers could end up saving money.
That's because wireless carriers that offer subsidized phones embed extra fees into monthly service bills to make up for the expense of partially covering the cost of the phone.
After two years, subscribers keep paying that higher monthly service fee even though the phone has been paid off — a practice that many consumer advocates have called a scam by the wireless industry.
If a customer buys a phone at full retail cost, carriers are expected to lower the monthly service bill, typically by about $15 a month.
T-Mobile USA Inc. became the first of the four major U.S. carriers to embrace a non-subsidy business model when it scrapped annual service contracts and phone subsidies in March.
"The mobile industry has lots of lame rules. They say that's just the way it is. We say not cool," the No. 4 carrier says on its website.
Instead, T-Mobile rolled out a value plan called Simple Choice that gives customers lower rates for their cellular service by separating it from the cost of a full retail price phone.
"The idea of a 'subsidy' is a misnomer," spokeswoman Paula Gottlob said. "With the device cost separate from the monthly service plan, T-Mobile customers don't continue paying for the device each month after it's been paid off, unlike our competitors."
Under the plan, customers can bring their own devices, pay full retail price for a phone upfront or pay a low down payment for a phone followed by no interest monthly installments of around $15 to $29 for two years.
And under T-Mobile's Jump program, customers can upgrade their phones as often as two times a year, as soon as six months after enrollment.
Part of the impetus for the latest trend stems from efforts of smaller rivals to compete against the four behemoths, which control most of the wireless market.
Companies such as Metro PCS Wireless Inc. and Leap Wireless International Inc. in San Diego helped pioneer flat rates for voice, text and data and sold plans that didn't require contracts or hefty cancellation fees. T-Mobile and MetroPCS merged May 1.
The lower cost and the focus on no contracts helped push the number of prepaid plans 12% for the year ended June 30, 2012, over the previous year, while typical post-paid plans that the major brands offered were flat.
T-Mobile's decision to scrap subsidies and two-year contracts, analysts said, was a game changer for the wireless industry, causing the other major carriers to reevaluate their own offerings.
"It took off like wildfire. T-Mobile started taking market share and everyone else was put back on their heels," said Craig Moffett, senior analyst and founder of research firm MoffettNathanson.
"Now Verizon, AT&T and Sprint are in the position of having to respond, and the urgency is the greatest for AT&T," whose customers T-Mobile has been aggressively targeting, he said.
T-Mobile's overhaul has worked so far. The carrier added 648,000 post-paid customers in the third quarter and 688,000 post-paid customers in the second quarter — big gains after years of subscriber declines.
Rivals have quickly launched a flurry of new service and device upgrade plans that move away from two-year service contracts and subsidized phones, although those conventional plans remain as options.
AT&T this year announced Next, a program that lets users upgrade their devices more frequently while paying a separate monthly payment for the device. The plan comes with no down payment and no interest charges.
After critics noted that AT&T didn't lower the price of its monthly service fees under the Next plan, the carrier this month announced that users who buy their phone outright, bring their own device, use a device for more than two years or get a device using AT&T Next can save about $15 per month for their service plan.
Meanwhile, Verizon Wireless introduced Edge, an installment plan that allows customers to upgrade their phones every year with no upgrade fees and no long-term service contract. Sprint Corp., too, embraced the monthly-installment-early-upgrade trend with its One Up program launched in September.
The latest carrier price war is seen as a boon for consumers and signals that the conventional subsidized wireless plan "is certainly on its last legs," Moffett said.
"You're looking at what is likely to be a lower price, less profitable wireless industry in the future as a result," he said. "Service and device are being unbundled, and the consumer gains transparency in the process."
Yet with so many options being introduced, analysts said consumers need to take the time to read the fine print and carefully compare before settling on a new plan.
"It's super-complex, and if you don't appreciate and understand all these different nuances, you could find yourself in a plan that is not really for you," said Colby Synesael, managing director at Cowen and Co.
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