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Summary

In August 2015, Verizon decided to eliminate two-year contracts and device subsidies. From now on, new users must bring their own device, pay for a device upfront in full, or finance a device through Verizon’s equipment-installment plan (EIP), formerly called Edge but now just referred to as “monthly device payment.” In doing so, Verizon follows T-Mobile, which eliminated two-year contracts in 2013. The move marks a significant shift in Verizon’s attitude toward EIPs and essentially solidifies the end of the traditional subsidy model in the US.

Verizon changes attitude towards EIPs

Verizon’s change in strategy to eliminate two-year contracts and subsidized devices is significant because when all major US operators introduced EIPs with early upgrade options in 2013, Verizon was vocally bearish about it, saying that EIPs were not likely to be popular among its customers. Verizon offered an EIP option anyway, saying it wanted to give customers the choice.

Over the past several quarters, Verizon’s EIP really started to gain traction. As this was happening, Verizon was changing the terms of its program to reduce some of the advantages to consumers. It began dialing back the benefits little by little over the past year, and in June it made a significant change, eliminating the early device upgrade benefit, effectively transforming what had started as an upgrade program into a pure device-financing program. Ovum viewed this as a way for Verizon to rein in the popularity of its EIP and steer customers back to the traditional two-year contract.

However, Verizon proved that even the leader in the US wireless market is not immune to competition and prevailing consumer preferences. In August, Verizon decided to stop offering two-year traditional contracts with subsidized devices and offer only devices that can be purchased in full or financed via EIP.

T-Mobile was the first major US operator to eliminate traditional two-year contracts with subsidized devices, in 2013, and Verizon is the first to officially follow in T-Mobile’s footsteps. However, although AT&T and Sprint still offer two-year service contracts with subsidized devices, both have been heavily pushing other device-acquisition options. AT&T has been pushing its Next EIP with its Mobile Share Value Plans, with 68% of all postpaid smartphone gross adds and upgrades in 2Q15 using Next. Sprint offers an EIP option as well, but it has been heavily pushing device leasing, especially through its new All-In wireless plans, with 51% of customers who took a new device in 2Q15 doing so on the leasing model.

It is clear that the US wireless market is moving away from subsidies, and quickly. Verizon’s decision essentially puts the last nail in the coffin of the traditional subsidy model in the US wireless market. Since Verizon’s announcement that it was ending contracts, Sprint’s CEO has said that his firm will do away with contracts by the end of the year as well. Sprint is favoring the leasing model over the EIP model, however, with the CEO stating that the carrier will transition to a leasing model exclusively. AT&T has also said in the past that it plans to eliminate contracts at some point – and already its third party retailers can sell devices only on EIPs or paid for fully upfront.

How will the death of subsidies change consumer behavior?

In terms of customer commitments and churn, not a lot is set to change under the new models. Right now, the majority of customers who do not get a subsidized device finance it through EIP rather than pay for a device upfront. This means that the customer is locked into a contract for the device, rather than a contract for the service. The customer can’t leave the operator (and therefore its service agreement) until the phone is paid for in full. If a customer takes a $649 device on EIP and decides to switch to another operator while bearing a balance of $400, that $400 is due in full before they can leave. This figure is higher than typical ETFs levied by US operators with two-year service contracts, effectively shifting contracts from services to devices rather than eliminating them. However, bring-your-own-device options are growing in popularity, and that model does not lock customers into any type of contract.

One of the most significant changes EIP provides is transparency. Consumers are now clearly made aware of the actual retail cost of the device. But that transparency does not appear to have had a big impact on consumer behavior. The prices have probably shocked many users, but with the costs spread over time via no-interest installment payments, coupled with lowered service-plan fees and ongoing competition that pushes down service prices, the resulting monthly bill still appears to be acceptable.

The shift to EIP does open up an opportunity for device manufacturers that produce lower-priced devices to gain traction in the market. Price sensitivity will always exist for some, and the transparency regarding device costs shows consumers that there is a wide range of price points.

Although the traditional subsidy model is disappearing from the US, the move might not spell the end of subsidies forever. Over the next few years, it’s possible that we could see operators begin to reintroduce subsidies as a competitive tool to attract customers. But for the moment, the focus is on EIPs.

Appendix

Further reading

“Verizon steers customers away from Edge with new upgrade policy,” TE0001-000973 (July 2015)

Verizon Consumer Update, June 2015, TE0001-000969 (July 2015)

Author

Kristin Paulin, Senior Analyst, North & South America

kristin.paulin@ovum.com

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