Could Verizon’s Move To Nix Subsidies Hurt Apple?

Verizon (NYSE:VZ) announced that it would be doing away with its mobile device subsidies for all new users beginning from August 13, marking the first time the largest U.S. carrier is making contract-free plans its primary offering. While we don’t see the move as having a significant impact on Verizon’s performance or outlook, it could potentially have an impact on high-end device manufacturers such as Apple (NASDAQ:AAPL), who have long benefited from carriers subsidizing the high sticker prices of smartphones in return for a two-year contract. For example, a new iPhone 6 buyer on Verizon would now have to pay $649 upfront (or in monthly installments) versus a subsidized price of $199. Considering that many high-end Android devices from the likes of Motorola and OnePlus now retail for roughly half the price of a flagship iPhone, Apple might seem vulnerable to subsidy cuts. So should this trend of subsidy-free plans be a cause for concern for Apple investors? We don’t think so. Below we discuss why.

Trefis has a $142 price estimate for Apple, which is about 25% ahead of the current market price. We are modelling iPhone shipments of about 237 million units for CY’15.

See our complete analysis for Apple here

Installment Plans And Subsidy Plans Cost About The Same Over Time

With subsidy-free plans, carriers basically lower the cost of monthly service fees and offer consumers the opportunity to pay for their handsets separately in installments (or buy them outright). Contract plans, on the other hand, are priced such that monthly service billings recover the cost of the initial hardware subsidy. In essence, contract free plans have just decoupled the cost of the phone from the monthly plan. Now, customers have grown used to paying a certain total fee for their wireless services (device + wireless fees) and it wouldn’t make much of a difference over two years if they were buying an iPhone in an installment plan or via a subsidy plan. For instance, AT&T – which has been adding most of its new users on contract-free plans – has seen monthly wireless postpaid phone billings (which includes service fees and monthly device billings) actually grow by about 6% year-over-year to $68 in Q2 2015. ^[1]

Smartphones Are Becoming The Most Important Connected Device

Smartphones are increasingly becoming the primary internet connected devices for many users. Accordingly, customers are likely to be more willing to pay a premium for the design and user experience that an iPhone offers, even if lower priced options are available to them. Moreover, the price differential becomes relatively insignificant when considered in the context of overall monthly billings. For instance, on Verizon’s new Medium data plans (3 GB of monthly data), a single line customer would pay roughly $84/month (excluding taxes) for a plan with a Motorola X device, versus about $92/month for the same plan with an iPhone 6. This translates to a premium of less than 10% per month. ^[2]

Apple Has Seen Solid Growth Even As Subsidy-Free Plans Have Proliferated

Mobile installment plans began gaining prominence in 2013, with T-Mobile launching its un-carrier initiative. Verizon and AT&T began similar offerings a few months later. Now, both T-Mobile and AT&T count these contract-free plans as their most popular offerings, while Verizon had also been seeing growing adoption through the last year. However, iPhone shipments actually rose by more than 25% last year, meaning that customers are still choosing the iPhone even though they have had the option of picking cheaper unlocked phones on contract free plans. Apple is unlikely to see a dip in demand from Verizon’s recent move, since the carrier’s higher quality subscriber base is unlikely to be swayed by the option of cheaper unlocked devices.

Early Upgrades Will Be Easier, Impact On Upgrade Cycle Unclear

The contract-subsidy model essentially meant that device upgrade cycles for Apple and other manufacturers stood at roughly two years. These plans often locked buyers into their devices, making early upgrades expensive. With the new plans, customers would have the freedom to upgrade every year if they wish, in line with Apple’s annual product life cycle, while taking advantage of increasingly attractive trade-in options. However, as smartphone innovation appears to be gradually leveling off, some mainstream customers could choose to hold on to their devices for longer after they pay off device installments, while continuing to enjoy the lower monthly plan rates.

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1. AT&T Q2 2015 Earnings Press Release [↩]
2. Simplified Data Choices Match Customer Lifestyles, Verizon, August 2015 [↩]