Could Apple Benefit From the End of iPhone Subsidies?

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Apple's current flagship phone, the iPhone 5s. Source: Mashable.

Ask anyone in the market about Apple , and you're likely to get two distinct responses. The first is almost sycophantic; the other is very bearish. The latter's most-developed argument involves the supposed end of cell phone subsidies from the major wireless carriers. However, it is entirely possible that Apple bears are reading this incorrectly. Apple could actually benefit from the end of subsidies.

The bear argument makes sense -- sort of
On the surface, the bear argument makes sense. The cell phone market is heavily subsidized: Apple's current flagship iteration -- the iPhone 5s -- costs $649 unlocked. However, you can purchase the unit for $199 with a two-year contract from the three major carriers: AT&T , Sprint , and Verizon . The carriers value the relationship with Apple so much that the price of the phone is effectively lowered by $450. Free money for buyers, right? Not so fast.

To understand this relationship in more detail, it helps to look deeper into the subsidy. Going back to the first rule of economics -- there's no such thing as a free lunch -- the carrier isn't paying the subsidy, you are. The carriers are simply paying up front to lock you into a contract; they price the monthly plans accordingly to reap the costs of the initial hardware subsidy.

The downside of the traditional two-year contract
However, what Apple bears aren't considering is the downside of subsidies for Apple and other hardware manufacturers. A two-year contract essentially guarantees a two-year refresh cycle for its customers. The early termination fee -- which is as high as $350 at some carriers -- essentially locks the buyer into the phone as well as the contract.

To that end, Apple fans who want the latest and greatest iteration of the iPhone are stuck with rather onerous hurdles to jump: They are forced to pay the full cost of the phone out of pocket and to remain with their carrier, or to jump to a new carrier and get the subsidized phone price while paying a termination fee upward of $350 -- rinse, lather, and repeat each year. The end result is that many would-be serial upgraders tough it out and wait for their contract to expire.

Economics of the end of subsidies
The question on subsidies for Apple then becomes whether the serial upgraders and new converts outweigh those who will trade down to lower-cost models and those who will actually slow their upgrade cycle. Personally, I feel the serial upgraders will win out here.

First, it's important to look at how carriers are ending these subsidies. T-Mobile has been at the forefront with its "Un-carrier" initiative. For all intents and purposes, this plan is similar to the standard two-year contract. T-Mobile basically lowered the cost of its monthly plans and offered consumers the opportunityto pay for the phone in installments. And although the company decoupled the cost of the phone from the monthly plan, you pay for both in one bill -- the end result is a bill much like what one paid originally.

It's not just T-Mobile, The recently announced AT&T Next plan spaces payments for Apple's 5s unit over 20 months at $32.45 -- with 0% interest -- with the ability to trade it in after 12 months. This plan appears to be discounted by $15 per month, but when one considers that buyers don't have to pay $200 up front for the phone, or the nearly $40 activation fee, and can upgrade every year, it seems like a good deal for serial upgraders.

Final thoughts
Here, as in many cases, the common consensus is wrong. If  subsidies end, it could put in wrinkle in Apple's iPhone plans. That's a strong bearish argument on the stock, because Apple's iPhone line provides over 50% of its revenue haul. However, the new archetype appears to be similar to the current two-year contract model in both form and substance.

The end result from AT&T's Next plan appears to be a modest price increase for the ability to upgrade every year instead of every two. When reading the tea leaves, Apple seems likely to actually benefit from the end of hardware subsidies by a shorter upgrade cycle.

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The article Could Apple Benefit From the End of iPhone Subsidies? originally appeared on Fool.com.

Jamal Carnette owns shares of Verizon Communications. The Motley Fool recommends Apple. The Motley Fool owns shares of Apple. Try any of our Foolish newsletter services free for 30 days . We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy .

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , Stocks

Referenced Stocks: AAPL , S , T , TMUS , VZ

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