Analysis: Pain, promise seen in T-Mobile's subsidy elimination
By Sinead Carew | December 12, 2012 8:28 AM EST
T-Mobile USA's bold move to stop offering handset discounts to consumers has the potential to disrupt pricing in the U.S. wireless services market, but it will not bring the struggling unit of Deutsche Telekom AG
At least for the short term, larger competitors Verizon Wireless Inc
Subsidies are payments carriers make to cellphone makers so they can sell the device at a discount to consumers in exchange for binding them to two-year service contracts. Carriers gradually recoup the costs by charging higher monthly service fees over the course of the contract.
As phones have become more pricey, it is tougher for operators to pay subsidies and maintain profitability, particularly in the same quarter when Apple Inc launched its much-anticipated iPhone 5. Carriers have been paying subsidies of roughly $400 for iPhones, roughly 60 percent above other devices, according to analysts.
This level of subsidy is particularly tough for smaller operators such as T-Mobile USA, the No. 4 provider, which announced the move to eliminate subsidies along with a deal to sell the iPhone last week.
"For the economically weaker providers the (subsidy) model is starting to fall apart," Recon Analytics analyst Roger Entner said.
T-Mobile USA needed to take drastic action to revive its business after AT&T's $39 billion takeover bid collapsed late last year. It is banking on the move attracting customers who do not mind paying a higher upfront fee for their phone in return for cheaper service plans.
This may win over some customers. T-Mobile USA says there is already a big consumer appetite for lower service plans. Some 80 percent of its current device activations are for customers who agreed to forego the device subsidy in favor of cheaper service fees under its "value" branded plans, it said.
While this shows some demand for no-subsidy plans, Piper Jaffray analyst Christopher Larsen said it was not clear why T-Mobile USA needed to give up its other options.
He worries that the company could risk losing out on potential growth by getting rid of a business model that, at present, appears to please 20 percent of its customers.
"At the end of the day, Americans would much rather pay you Tuesday for a hamburger today," Larsen said, referencing Wimpy's famous line in the "Popeye" comic strip.
So, too, would many Europeans.
Operators in Europe have also tried to forego subsidies, with mixed results. Those who have succeeded are smaller operators looking to distinguish themselves from larger, costlier rivals.
In Spain, for instance, market leader Telefonica and No. 2 mobile operator Vodafone Group Plc
But in Deutsche Telekom's home market the smallest mobile operator, O2 Germany, a unit of Telefonica SA
"In the U.S. the shoe is on the other foot. This time Deutsche Telekom gets to play the disrupter," said Bernstein analyst Craig Moffett.
RISKS TO T-MOBILE USA
Playing the upstart in this way is a big risk for T-Mobile USA, however. Analysts think that as a result of eliminating subsidies, T-Mobile USA customers could be poached by Verizon Wireless and AT&T, the two most dominant U.S. mobile providers.
Subsidies are too important for customer growth at AT&T and Verizon Wireless for those companies to change, Entner said.
Roe Equity Research analyst Kevin Roe described T-Mobile USA's move away from the subsidy as an acknowledgement that it cannot compete head-on with Verizon Wireless and AT&T for the highest-spending U.S. wireless consumers.
"They're throwing in the towel," Roe said.
For customers who object to paying hundreds of dollars upfront for a new cellphone, T-Mobile USA is offering a plan that allows subscribers to pay for their device in $20 installments. Since the payments would come on top of their monthly service fees, this too may be off-putting to some customers as it would increase their monthly bill.
The no-subsidy plans represent the most attractive deal for customers who have an older phone they can use on T-Mobile USA's network, according to analysts. These customers can take advantage of T-Mobile USA's lower service fees without having to spend hundreds of dollars up-front for a device or pay for it in installments.
Some analysts said T-Mobile USA's move may be its only hope of attracting consumer attention because it distinguishes the company's marketing from that of bigger rivals.
And with quarterly customer losses averaging in the hundreds of thousands - T-Mobile USA reported 492,000 subscriber losses in the third quarter - it could benefit from even tepid adoption of these plans.
But T-Mobile USA's most important effort to retain customers will most likely come down to the decision by John Legere, the new chief executive, to sell iPhones next year, analysts said.
Regardless of how the elimination of subsidies works out, analysts expect T-Mobile USA to slow customer losses in 2013 thanks to the addition of the iPhone.
Though he doubts the wisdom of the subsidy elimination, Piper Jaffray's Larsen, who estimates T-Mobile USA will lose 2 million net subscribers this year, said that thanks to the iPhone he will be "surprised if T-Mobile USA loses 2 million customers again in 2013."
In Japan, operators including Softbank Corp <9984.T>, which is buying a 70 percent stake in No. 3 U.S. mobile operator Sprint Nextel, make customers pay for phones in installments.
Analysts expect Softbank to bring some of the aggressive pricing tactics it uses in Japan to the U.S. market after the Sprint deal closes in mid-2013. But Softbank will not be the only thorn in the side of AT&T and Verizon Wireless, Bernstein's Moffett said.
"T-Mobile could end up being just as disruptive and even more so," he said.
(Editing by Peter Lauria and Matthew Lewis)