Carriers whine, but handset subsidies aren’t going away

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U.S. mobile network operators are increasingly clamoring to minimize the cost of the handset subsidies they’ve long used to lock customers into lengthy service contracts. AT&T CEO Ralph de la Vega was the latest to bemoan pricey subsidies, saying the carrier “will lower (subsidies) in every case that we can.” That echoes the claim from outgoing T-Mobile USA executive Cole Brodman that he’d prefer to simply abolish subsidies because they have created a consumer mindset that hardware “has become kind of throw-away.”

But subsidies aren’t going away soon. And I’m not sure I believe that many carriers really want them gone at all.

A steep price, but a hefty payoff

Don’t get me wrong: There’s no question that network operators pay a steep price to get some phones into the hands of consumers. Moody’s warned last summer that margins in the telecoms industry are being threatened by subsidies that have increased an estimated 78 percent over the three previous years to $139 per unit. Which explains why carriers have taken a page from the airline industry and adopted a nickel-and-dime approach to offset those costs with tactics like doubling fees to upgrade handsets, or forcing users to pay full price for upgrades if they want to keep their grandfathered data plans.

But as All Things D explained earlier this week, carriers still have very little leverage when it comes to negotiating subsidy terms with Apple. No single handset has emerged as a threat to the iconic iPhone, which apparently outsold all Android handsets combined in the U.S. during the last quarter of 2011, according to ComTech. Which means Apple can continue to charge carriers $450 or so for the iPhone with little fear of a drop in orders. Carriers can take a harder line on subsidies with, say, HTC, but Apple continues to make the sole must-have smartphone in the world. So network operators (aside from poor T-Mobile USA and some others) must pony up for it.

Controlling the retail end

While subsidies are expensive, though, they pay off in spades for network operators. They serve as a tool for enticing users to sign two-year data contracts, of course, resulting in recurring revenue that eventually outweighs the upfront cost of the subsidy. But as my GigaOM Pro colleague and fellow analyst Derek Kerton reminded me last week, subsidies also let carriers handle the retail end by selling to consumers directly and removing manufacturers from the loop. Reselling handsets allows them to put their brand on the handsets as well as bloatware – applications such as Verizon Navigator that are packaged with the phone and often can’t be uninstalled, providing additional revenue streams. It also enables them to block services that might compete with their own offerings (such as broadcast TV or third-party digital music services), and limit or even prohibit technologies that could be used to circumvent wireless networks.

Finally, eliminating subsidies would require changing the mindset of U.S. consumers, who have consistently demonstrated a willingness to accept service contracts in exchange for cheap (or free) smartphones. Unsubsidized devices like Google’s Nexus line have gained a bit of traction among tech-savvy types who truly understand the economics of phone contracts, but the vast majority of smartphone users are OK with walking into a retail store for a new phone and walking out with a long-term contract.

Mobile network operators will continue to whine about the high price of subsidized handsets until a real threat to the iPhone emerges to give carriers better leverage against Apple. Meanwhile, operators will continue to try to find ways to minimize the cost of those subsidies by jacking up upgrade fees and other charges, and by offering competitive smartphones at minimal cost. But they’ll continue to pay the subsidies that give them so much control as retailer and distributor of smartphones.

Question of the week

Do you think carriers are truly eager to stop paying subsidies in exchange for ceding control of selling and distributing their smartphones?

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