Microsoft (NASDAQ:MSFT) recently announced its Surface line of tablets that will ship in two flavors – one running the stripped down Windows RT version and the other running the complete Windows 8 OS. Though the tablet has a broad set of features, a striking omission has been that of a cellular modem to access wireless networks on the go. Instead, Microsoft chose to go with Wi-Fi alone as an option to connect to the Internet. Microsoft is not alone in this, however. Both Google’s (NASDAQ:GOOG) Nexus 7 and Amazon‘s (NASDAQ:AMZN) Kindle Fire also lack cellular capabilities.

Whether the decision not to have cellular connectivity was made to keep costs down or to avoid dealing with the design issues of integrating a cellular radio is up for debate, but what is clear is that it poses an interesting dilemma for the wireless carriers who are looking to increase the number of mobile devices they offer with shared data plans.^[1] Should the carriers continue to subsidize tablets that have cellular capabilities or stop it for the time being and hope to cash in on the demand for these data-only devices through shared data plans alone? Verizon, for one, has already chosen the latter.^[2] It will be interesting to see how the other carriers react.

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Shared data plans may provide the solution

The push from wireless carriers to derive more value from the surge in data demand is well known. Both Verizon and AT&T stopped offering unlimited plans to new subscribers a year ago and now Verizon has prohibited its grandfathered-in unlimited users from availing handset subsidies if they choose to keep their plans. (see Verizon’s Share Everything Plans Could Kill The Last Unlimited Plans) It is likely that AT&T, having made its displeasure with unlimited plans clear on many occasions, will also come up with similar ways of discouraging usage of unlimited plans. (see AT&T Looks To Reduce Subsidy Pressures While Boosting Revenues Through Shared Data Plans) Instead, the carriers are looking to monetize every byte of data that is transferred on their networks by getting users to connect more of their devices to their 3G/4G wireless networks and promoting tiered data plans that can be shared across multiple devices.

However, the higher price of devices that come with an in-built cellular modem has caused users to refrain from purchasing these devices. For example, an iPad with cellular connectivity costs $130 more than a similar one with only Wi-Fi connectivity. A recent report from ABI Research put the number of 3G/4G enabled tablets sold in 2011 at 17.6 million, which is less than a third of all tablets sold worldwide last year.^[3]

Furthermore, those who purchased tablets with 3G/4G access haven’t necessarily activated a cellular data plan to access the Internet due to the costs involved with purchasing a data plan. According to Chetan Sharma, only about 10% of tablet owners in the U.S. activated a cellular data plan at the end of 2011.^[4] Moreover, with the advent of faster 4G networks, the danger of exceeding one’s monthly quota in tiered data plans is even higher. While offering data plans that can bundle multiple devices under a common data pool could alleviate these issues, the fact that some of biggest technology firms have decided to go without cellular support in their tablets makes it tougher for the carriers to benefit from the rising number of mobile devices.

Tablet subsidies are Plan B if shared data plans don’t catch on

We do believe that offering a common data pool makes it easier for customers to add more devices to their cellular network and may gradually cause those that were initially reluctant to add a separate data plan for their tablets to see the benefits of a shared data plan. As customers increasingly warm up to the idea, they could move into higher data tiers and add more devices to their data pool, thereby decreasing the average cost per device. As the usage of 3G/4G on tablets grow, we could see Microsoft and others add cellular capabilities in the future iterations of their mobile devices. It may therefore be too soon to say that subsidies on tablets with 3G/4G will make a comeback at Verizon considering that shared data plans haven’t been launched in a major way.

On the other hand, if customer adoption of the shared data plans remains sticky and if Verizon sees fewer new subscribers joining, the situation could become rather unpleasant. AT&T and other carriers may then roll back their plans to introduce shared data plans, possibly forcing Verizon to do so as well. Such a situation could lead to diminishing growth opportunities for carriers outside of smartphones, which is something we believe the carriers would want to avoid.

Will Verizon then contemplate subsidizing these data-only wireless devices once again to incentivize the manufacturers to add cellular radios as well as to spur consumer demand? Considering the short-term margin impact that subsidizing smartphones has had on the carriers, this is definitely not Plan A as Verizon has amply demonstrated by stopping tablet subsidies. But, in case the plan to increase the demand for these devices by promoting shared data plans fails, Verizon may ponder re-offering subsidies on these data-only devices as well, albeit to a smaller degree. AT&T and others may want to see how this plays out before deciding on the future of their tablet subsides.

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