Verizon Introduces Smartphone Upgrade Fee; Looking For iPhone Subsidy Relief

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Verizon (NYSE:VZ) has finally given in. After rival AT&T (NYSE:T) hiked its activation fee on phone upgrades from $18 to $36 recently, it seems Verizon has followed suit with a $30 fee for all phone upgrades starting April 22nd. With this announcement, Verizon joins the rest of the top U.S. national carriers in charging upgrade fees of one kind or the other to soften the impact of smartphone subsidies. Smartphones have turned into a double-edged sword for the U.S. wireless industry, with the top 3, Verizon, AT&T and  Sprint (NYSE:S) seeing their margins contract heavily as the smartphone boom takes over.

See our complete analysis for Verizon stock here


Smartphone subsidies forcing Verizon’s hand

Saturation in the voice industry and the the rise of data services have caused smartphones to increasingly figure into wireless carriers’ plans. The lure of the high data ARPU generating smartphone customer has also led the wireless industry to heavily subsidize these smartphones in order to drive their sales. For example, a basic iPhone 4S model costs around $650 for the carriers who then subsidize it heavily to sell for $199.

Although this strategy holds promise over the longer term, their margins are under pressure in the near-term.Verizon’s gross margins fell by almost 500 basis points over the previous quarter while AT&T’s wireless operating margins fell by almost a half sequentially as iPhone sales touched all-time highs. Sprint’s OIBDA margin was also down to under 11 percent, compared to 18.2 percent in the third quarter.

Verizon’s latest move shows that the company is starting to feel the heat of its huge subsidies. This is an attempt to increase the upgrade cycle of smartphones so as to lessen the impact of subsidies, and is quite a departure from a year or so ago when the company used to offer a $30 discount to customers who had completed a certain portion of their contractual obligations. Also, the fact that users are also increasingly using cheaper Internet messaging options such as BBM as well as iMessage and moving away from the traditional high-margin SMSes could have played its part in the trend being set. (see Smartphone Boom Means Data Will Get More Expensive as SMS Use Declines)

The fee hike will help Verizon cover a portion of the upfront subsidies it offers, as most of the smartphone sales are to existing customers who just upgrade their smartphone. Verizon sold 7.7 million smartphones last quarter, however it added only 1.2 million net postpaid subscribers during the period.

Verizon’s upgrade fee hike follows AT&T’s hike in February and Sprint’s in September last year. The cheapest of the lot is T-Mobile, which still charges $18 for the same. While carriers are afraid to lower the subsidies on offer since that may have an adverse impact on their smartphone sales, it seems that they see it more prudent to increase the prices of the fringe services that they offer instead. How long that is going to last is anybody’s guess. But looking at the trend, it does seem that the industry is heading towards lower subsidies eventually. Is Apple listening?

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