Two months ago, during the 2012 Mobile World Congress in Barcelona, Movistar Spain (Telefonica) announced that they would stop subsidizing devices, effective March 1st. According to Telefonica, the current subsidy model was “too costly” for the operator. That piece of news, perhaps unintentionally, became one of the highlights of the congress. Only a few weeks later, Vodafone in Spain followed suit and announced that they were stopping their subsidization scheme as well.
The era of “free handsets for everyone” seems to be coming to an end, but how did we come to this point? What are the drivers compelling more and more operators around the globe to curb handset subsidies? If you abstract from the wireless industry for a moment and imagine the following situations, the answers to the above questions might start becoming clearer:
- Imagine a Canal+, DSTV, Orbit, etc. sales rep, knocking on your door and telling you: “Dear customer, we see that your 46’’ 3D HDTV set is already 1 year old. Don’t you think it is time to change it? We will be happy to give you a brand new one for free, but please, stay with us and watch Canal+ for 18 months, ok?”
- Or we can fantasize about this other one: Imagine Exxon, BP, Repsol, etc. advertising on highways that they will give you a new car every year as long as you commit to filling the tank exclusively at their gas stations. I’ll admit this one is a bit far-fetched, but you get my point
Looking at it from this perspective it seems obvious that operators should have never gone that far down the road of handset subsidization. After all, is it fair for consumers to expect or even demand the latest cutting-edge equipment for (almost) free, especially when they enjoy and use them for things that operators often neither control or benefit from (e.g. taking pictures, listening to music, playing games)? Looking back at the early days of mobile will help us understand how the now much-criticized handset subsidy model unfolded.
How did this phenomenon start?
It all started in the 90’s, when mobile operators around the world, riding a healthy growth wave, started applying moderate subsidies on their basic phone portfolio. With the objective of decreasing the cost of entry and continue increasing mobile penetration rates (by enabling less affluent consumers to adopt mobile), operators offered discounts on many mid and low-end SKU’s to subscribers that acquired a line (even a prepaid one in the beginning). And on the basis of boosting mobile penetration, it is undeniable that handset subsidies were a successful strategy.
As the mobile industry evolved, basic phones paved the way for feature phones, and later on smartphones. The latter (especially the iPhone) changed the rules of the game drastically, but operators did not immediately realize the damage of continued handset subsidies. As smartphones became more and more popular, operators rushed to partner with leading OEM’s, trying to link their service with fancy phones and piggy back on the ascending brand image of the likes of Blackberry (we are still talking about a few years back), Apple, and the like.
Perhaps inadvertently, operators buried themselves in a bigger hole than they anticipated. Price wars were fought on two fronts: in addition to increasingly lower mobile tariffs (price per minute of voice and price per MB of data), operators were also competing to see who could offer the most advanced handset at the lowest price (or even for free). The phones themselves (and more recently even the OS’s) became one of the main hooks of the value proposition. With the push of ULPH (ultra low price handsets, not to be confused with ultra low cost handsets or ULCH), customers stopped paying attention to the operators’ prices and promotions to only focus on how cheap the upcoming iPhone 4S would be. Unlike TV sets and cars, however, mobile operators managed to change consumers’ purchase behaviour by fostering a culture of “free handsets for everyone”. Putting it is simple: operators ended up becoming prisoners of OEMs.
This situation would not have been all bad if operators had been able to sustain or grow EBITDA margins and profits. But this has not been the case. Many mobile operators around the globe are seeing their profits and margins plunge, and some have openly stated that handset subsidies have been one of the main causes for this. For example, China Unicom’s profits decreased 60% in 2010, from 9.56 Bln Yuan to 3.85 Bln Yuan, and handset subsidies accounted for 3.17 Bln Yuan. The operator has admitted that the profit decrease was mainly caused by “rising costs for 3G handset subsidies and high depreciation and amortization fees”.
Coming back to reality
The handset subsidies conundrum has been on the spotlight since the appearance of smartphones. While many operators have alerted of the risks of excessive handset subsidization, few have taken actions to curb these risks. Most operators keep suffering its harmful effects in silence, promoting handsets that are harming their profitability.
Things may be changing, though. Some operators have started being more vocal about the need to change the model and rid themselves of the handset subsidy shackles. Cole Broadman, T-Mobile USA’s CMO, said in a recent panel chat: “if I was the king for 1 day in the USA market, I would stop handset subsidies”, to which the moderator told him that he was actually 1 out of the 4 kings of the market, and that he could do it. But generally, operators have been afraid to be the first to stop subsidies, lest the others not follow on their path and take their customers away.
But this apparent prisoner’s dilemma might not be such after all. While a first mover would probably see its market share eroding in the short term, player(s) maintaining handset subsidies would see their subsidy cost increasing (as customer acquisition rises), worsening overall margins even more. So a lose-lose situation could occur if only one player stopped handset subsidies in a given market (instead of a lose-win). The only way to win might be for all operators to stop subsidies.
My take on the future of subsidies
I foresee strong incumbents in advanced markets (with high subsidy levels) taking the lead and reducing subsidization costs in the short term (1-2 years). Smaller operators and challengers might be tempted to stay put and assess the impact on the market, but I believe they will also end up adjusting their handset subsidy models in the short to mid term.
The end of handset subsidies does not necessarily mean that operators will start charging the full price of handsets. Most likely, operators will look for alternative methods for subscribers to have access to smartphones and other devices with a reduced upfront payment, without compromising operators’ profitability, such as:
- Payments in installments, in partnership with local financial institutions, with low or no interest (e.g. Telefonica + Finconsum)
- Reverse subsidies: under this model, operators will not provide large upfront handset discounts, but instead offer in-kind services over a period of time to entice acquisitions or renewals. For example, offering a bulk of free minutes or SMS every month for a period of time with every new purchase
- Handset replacement schemes: allowing customers to return their old phones and get a discount on their new one (e.g. Telefonica is promoting this scheme in its new model, and it plans to refurbish and re-sell used handsets to lower income customers in its home market or ship them to Latin America or Africa)
In those cases where handset subsidies remain, these will probably be targeted as a retention strategy (i.e. for the purposes of customer renewal), rather than for new acquisitions. And more importantly, operators are likely to offset subsidy cuts with more attractive data prices in the mid term (a more natural basis of competition for operators after all).
Subsidies on low-rotating equipment (e.g. dongles) will be maintained, as penetration still needs to be pushed in most markets and consumers’ appetite to upgrade this type of equipment is limited.
Actually reverse subsidies have been used in emerging markets for a long time already (in India for instance by most of the operators) and most operators in emerging markets never really subsidized handsets due to the lack of proper banking system. Nothing new in the “future of subsidies”…
I guess “reverse subsidy” might be a “reverse innovation”….
I’m not going go into whether 2gb is egounh space or not, the point here is that Google still hasn’t figured out yet a way of having one file system for everything which makes like just easier and shows maturity of the OS. And NO you can’t move apps to sd, you can only move parts of it which makes things even worse, it means you apps are scattered on two different file systems and slows it down.
Are you advocating a new business model?
Operators everywhere (from countries that did not traditionally offer handset discounts like Malaysia, to those on the opposite end of the spectrum, like the UK) have essentially built a model, where a smartphones are sold with a varying amount of discount (I wouldn’t use the word subsidy), depending on the package/contract chosen.
How do you see your new model effected? By passing the smartphone cost to the customer, say, spread over 24 months? Isn’t this done now, with the discount amortised over the duration of the contract under the guise of “subsidy”? What do you think will happen to churn? Do you think, like imposed reduction in mobile termination rates, operators will be forced to ditch fixed-duration contracts?