US Carriers Disrupt the Subsidy Pattern

The Familiar Rhythm of the Two-Year Contract Is Breaking

Few consumer electronics segments enjoy the same reliable replacement cycle of the handset industry. The classic two-year contract period and device subsidy model has supported a reliable upgrade tempo, particularly in the US where subscribers have become accustomed to renewing their wireless contracts in exchange for a next-generation handset.

Perpetual device replacement has become a vital factor in the robust smartphone market. CCS Insight estimates that more than 1 billion smartphones bought during 2015 will be purchased as replacements, with device subsidies tied to contract renewals as a key supporting aspect.

However, there’s recently been a rush among US mobile carriers to deviate from the subsidy model to equipment instalment plans (EIPs), separating devices from subscriptions. T-Mobile’s Un-carrier strategy may have sparked this movement, but the reactionary response from other operators also recognized the advantages of shifting from the legacy model.

Subscribers have been quick to adapt to the benefits of contract-free post-paid services and EIPs. The resulting competitive service pricing and clarity of device costs are leading to a behavioural change among US customers, and subsidies are being replaced by EIPs at a rapid pace.

The switch to EIPs could be seen as more symbolic than structural at this early stage, with a limited effect on replacement cycles. The introduction of the new device financing plans and special promotions has actually led to an increase in upgrades. However, we believe this pace is unlikely to continue.

CCS Insight estimates that the average post-paid subscriber in the US upgrades their device every 20 months, but we believe that the swift shift away from subsidies will have a negative effect on smartphone sales, lengthening replacement cycles. The initial introduction of EIPs has accelerated device upgrades, but we believe that growing smartphone homogenization, marginal innovation and consumers’ need to spread their technology budget over a growing number of devices will lead to a slowdown in replacement. For many customers, free platform software upgrades will be “good enough”.

Recent subscriber subsidy statistics for the top-two US wireless carriers gives a clear indication of the trend. A growing number of customers at AT&T and Verizon are switching to available non-subsidy plans, even when subsidy offers exist. More than half of post-paid net additions choose non-subsidy plans by the end of the first half of 2015. This partly explains the phase of subsidy models: it isn’t just the result of competitive pressure from T-Mobile, but also changing consumer behaviour.

We so far haven’t seen operators in Western Europe follow their US counterparts in the adoption of installation plans, but would be surprised if there isn’t at least some experimentation soon. The initial success of EIPs in the US was supported by the iPhone’s dominance, but it’s unlikely that lower-end smartphones would benefit from the plans to the same degree.

CCS Insight expects smartphone replacement cycles to ultimately lengthen, with subscribers upgrading less frequently. We point to the longer replacement cycle in the developed markets of Asia–Pacific, where there is a lack of post-paid subsidies and device financing. Subscribers buy and bring their own devices, and this has driven replacement cycles to 42 months.

Consumer habits will be difficult to break, but the current shifts among subscriber trends and fast adoption raises uncertainty for handset makers. The subsidy model that has worked so well to drive upgrades can no longer be counted on.

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