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Cellphone contracts suck, but pretty much everyone in the U.S. still has one. For the vast majority of people, signing a contract is the only way to get the phone they want for a price they can afford. But contracts present problems: They’re 24 months long, but phones typically have issues after the first 12 months (when manufacturer’s warranties have expired); if a phone is lost, the contract still stands, yet the consumer has no phone; and newer phones that are far more desirable are released yearly or more frequently, yet consumers are stuck with the same old phone. But carriers need contracts about as much as consumers disdain them. It’s the only way to ensure that consumers will be there month after month, allowing carriers to recoup the investment they make in phone purchases. (Your typical iPhone is sold at retail for $200 but actually cost carriers $600-$660, and this price is increasing.)
But what if all of this changed? What if consumers actually enjoyed signing contracts? What if carriers just gave away phones — all of them — for free?
What do consumers get?
Carriers need to rethink the current model of phone ownership. It’s not working for them or consumers. So let’s propose a new one: phone leasing. It would work like this. A consumer can get a free phone, any model they would like, and can keep it for 12 months. No charge aside from their monthly bill. If there are any issues with the phone, they would most likely still be covered by the manufacturer’s warranty. And any reasonable issues not covered by the manufacturer’s warranty would be covered by the carrier for free.
What’s the catch?
The carrier owns the phone, and it must be returned after the 12 months is up. Moreover, instead of signing a two-year contract, consumers would have to sign a four- to five-year one. But, and this is a big but, when a consumer gives that 12-month-old phone back to the carrier, they’ll get a brand-new one of their choice — every single year of the contract.
What do carriers get out of this model?
Three things: More phone “sales” — lowering the cost of phone acquisition will lead to more contracts; longer contract means more customer loyalty; and leasing instead of selling phones means the phones can be resold once the 12 months is up (a typical iPhone goes for $300-400 on Craigslist). So instead of a carrier purchasing a phone for, say, $650 from a manufacturer and only getting $200 at retail from a consumer, losing $450 in the process, they’ll be able to resell that phone after 12 months for $300-400. This process will be repeated until the contract ends.
But why would a carrier go this route when the churn rate (the percentage of consumers leaving) is so low? More profit. Smartphone adoption is growing, but it would be growing much faster if smartphones were free. Moreover, carriers are basically competing with the same phones (barring T-Mobile, which still doesn’t have the iPhone) and very similar monthly plans. Adding such a plan would be a game-changer that would provide a worthy competitive advantage. Lastly, churn may be low — Verizon, (s VZ) for instance, reported 1.1 percent among 88 million contract subscribers. That equates to 88,000 people, or nearly half the population of Richmond, Va., leaving every quarter. With each subscriber worth $54.89 of revenue, $4.8 million worth of churn walks away each quarter.
Why not prepaid instead?
Of course the prepaid phone market is an option, but for most consumers it is not a tantalizing one. Part of the reason could be due to the lack of cachet; the perception remains that prepaid users don’t have good enough credit to get a contract. But an even greater reason is the lack of cutting-edge phones the prepaid market offers. For instance, the iPhone (as well as many popular phones) isn’t available as a prepaid option. And for carriers, on average, prepaid has a higher churn rate and creates less revenue.
Carriers have little choice but to shake up the cellphone market. It’s ripe for a revolution.