Daily: T-mobile and the end of wireless carrier subsidies

The big new yesterday in the TMT world was T-Mobile’s plans for 2013 which centered around a significant network upgrade, the end of subsidized handsets and the addition of Apple mobile products into the T-Mobile line-up. T-Mobile’s dropping of the subsidy was the biggest piece of the news for me as it could be the move that gets all US carriers to shift to an unsubsidized handset model. And given the importance of the US market to the profits of Apple and other handset manufacturers, this is a big piece of news.

Let me start with the T-Mobile specific news and move to what the handset subsidies mean afterwards. T-Mobile USA, a subsidiary of the German legacy national telecommuications giant Deutsche Telekom, is the smallest of the big four US carriers and one of only two US telecoms that use GSM, the global standard, for telephony. Because of T-Mobile USA’s small size, it has felt at a disadvantage in the US market and has suffered slow subscriber additions or subscriber losses over the past couple of years. In 2011, the other GSM telecom AT&T announced it had ended plans to merge with T-Mobile after the US Justice Department and state attorneys general blocked the deal on anti-competitve grounds.

While T-Mobile received $4 billion in cash and wireless spectrum in the (important for iPhone)1900 Mhz channel as a break-up fee when the AT&T deal fell through, T-Mobile USA is still at a competitive disadvantage vis-a-vis competitors like Verizon, AT&T and Sprint. Verizon Wireless, a joint venture between Verizon and UK Wireless Giant Vodafone, was always America’s largest provider. And AT&T and Sprint both engaged in a number of mergers in order to compete with Verizon which had significant economies of scale that had allowed it to build the top-class wireless network. T-Mobile USA will merge with MetroPCS, a smaller carrier to compete but this merger is sub-optimal given the lack of GSM at MetroPCS and T-Mobile USA will still be undersized. The plan now, therefore, is to merge the legacy networks that operate on the CDMA and GSM standards into a true high-tech 4G HSPA+/LTE network that can carry high bandwidth mobile traffic by 2015. T-Mobile’s German parent is spending $4.7 billion to modernize the network in 2013 and another $3 billion in capex in 2014 and 2015 respectively. The goal is to stabilise T-Mobile USA’s revenue stream by making the network competitive.

Part of the competitiveness involves being accessible to Apple mobile products (iPhone, iPad and iPod). T-Mobile has been an Android-only smartphone carrier because its network was not ready for the iPhone. However, Apple has confirmed that it has reached an agreement with T-Mobile USA to sell the iPhone at T-Mobile starting in 2013. Here’s where the key part of the T-Mobile announcement comes into play. T-Mobile USA will no longer subsidize mobile handsets as all US carriers do. The way it works now is you and I get a really expensive phone that retails for $600 for $200 if we purchase a two-year contract that locks us into a rate $25 or $30 more expensive than an equivalent “value plan”. The $400 upfront savings is therefore eaten up within little more than one year. And we end up paying more due to the contract. Meanwhile, carriers entice users to and from their networks with these teaser phone rates, causing significant customer churn and incurring handset subsidy costs as well as increasing customer acquisition and marketing costs. T-Mobile is saying that it is doing away with that model and offering the handsets at cost, with customers either paying upfront or on layaway. Note: last quarter, 80% of T-Mobile’s customers opted for value plans. And this is why the company is making the shift.

Apple should look to gain from the fact that it now has a whole new customer base to sell product to. And even though they will buy an unsubsidized phone, the fact that T-Mobile will offer the layaway purchase plan will get as many as 4.8 million of T-Mobile’s 33 million customers over to an iPhone, according to RBC Capital Markets. The problem here is the upgrade cycle. Carriers really want to stop subsidizing handsets and there has been a lot of speculation about when this shift would occur. T-Mobile’s move to an unsubsidized model could spur the other major carriers into doing the same, And to the degree the unsubsidized model takes hold, it will definitely slow handset upgrades, the bread and butter of mobile handset maker revenue, now that adoption rates in the US are slowing. To me, this slightly favours Android because all of the premium users that would pay for a lot for a handset are already mobile users and their upgrade propensity would slow. New users, upgrading from feature phones are more likely to go with Android because of cost.

“T-Mobile will be receiving a hefty sum of $4.7 billion from parent company Deutsche Telekom ($3 billion is also promised in both 2014 and 2015). This will help with the rollout of their upcoming LTE network, and in the refarming of their existing 2G network to 3G/4G. Speaking of refarming, Seattle, Minneapolis, and Atlanta are the latest cities to receive some of T-Mo’s network modernizing, bringing the official grand total to 18 markets in the US that have been upgraded.”

“The move by T-Mobile to wrap the iPhone into its new pricing model comes as other wireless carriers around the world begin to shift away from the long-held practice of subsidizing devices. “

“T-Mobile also plans to make major changes in its pricing structure in 2013, eliminating the subsidy model long used in the cellular industry. So instead of getting a $400 price cut on your handset when buying the phone, T-Mobile asks that you pay the full price. That’s not exactly cheap — often upwards of $400 to $600 for high-end devices — but it’s cheaper than the current industry standard, which lets you buy the subsidized phone up front, but locks you into a contract with higher monthly rates.
Legere didn’t get into the nitty-gritty on how the company would get around offering unsubsidized phones come 2013, a challenge considering customers often don’t recognize the value in paying more money up front for cheaper rates over the long term.
But he did drop a few hints. “You may pay $99 for the most iconic device in the world,” Legere said, likely alluding to Apple’s iPhone, “and then you may [pay] $15 to $20 a month” thereafter with your monthly bill. So in essence, it’s a sort of layaway program, eventually paying the full cost of the hardware but over time rather than all at once.”

“Amit Daryanani with RBC Capital Markets said in a note to investors on Thursday that with about 33 million subscribers on T-Mobile, Apple could sell about 4.8 million iPhones in the first year.

He noted that Sprint, which is the third-largest carrier in America, sold 6.3 million iPhones in the first year of availability. That represented about 20 percent of the total number of postpaid subscribers at Sprint.

Of T-Mobile’s 33 million subscribers, about 70 percent of those are postpaid. That means there are about 24 million postpaid subscribers that Apple could target.”

“T-Mobile will shift entirely to its unsubsidized Value Plans, which offer customers far cheaper rates for voice and particular data. Traditionally carriers factor subsidies into their normal contracts rates – basically you’re paying a mortgage on your phone. With the Value program, T-Mobile is keeping the contract, but passing what it saves on subsidies back to consumer.

According to T-Mobile, 80 percent of its activations in the last quarter were for value plans, which leads it to believe there’s a huge demand for this kind of a model. The question is whether the iPhone breaks the model. The unlocked, unsubsidized price of the iPhone 5 is steep, between $650 to $850 depending on the model. One of the reasons the iPhone is so popular is because the operators offer big subsidies for the devices, driving the out-of-pocket costs to as low as $200.”

“Will T-Mobile change up its device strategy and put all of its eggs in the iPhone basket?

Since T-Mobile was unable to convince Apple that it deserved to carry the extremely popular iPhone after the OEM’s exclusive AT&T contract was up, the carrier took a different approach to the snub. T-Mobile actually embraced it, and launched a few different advertising campaigns promoting its Android line of products more than anything.”

“Though the iPhone is not officially available through T-Mobile, the carrier is said to have more than 1.5 million active unlocked handsets on its network. Many of those handsets operate at wireless data speeds slower than 3G because of technical limitations with T-Mobile’s network.

To address that issue, T-Mobile has begun widening its 4G HSPA+ network in major metropolitan areas across the U.S., offering users of unlocked iPhones the ability to access high-speed data on its network.

The main reason T-Mobile has not offered the iPhone is because its network’s frequency band is incompatible with current versions of the iPhone. While the iPhone can place calls on T-Mobile’s network, it cannot connect to the carrier’s unique high-speed 3G frequency.

That’s begun to change as the carrier has transitioned its service to the 1900 MHz GSM band. That’s the same frequency used by AT&T, and is compatible with existing iPhone models.”

““T-Mobile USA has entered into an agreement with Apple to bring products to market together next year,” Deutsche Telekom said in a press statement. An Apple spokeswoman confirmed the deal but declined to offer further details.”

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