The Last Hurrah of the Handset Subsidy

Tim Deluca-Smith, VP Marketing at WDS addresses how handset subsidies are impacting operator margins, yet many have been reluctant to remove them for fear of customer dissatisfaction. In trying to find the middle ground, several operators have looked to turn the traditional model on its head.

Guest author

August 5, 2013

5 Min Read
The Last Hurrah of the Handset Subsidy
Tim Deluca-Smith, VP Marketing at WDS

By the time most mobile subscribers are eligible for a device upgrade; their smartphone can already be two generations old. It’s little wonder then that device satisfaction starts to fall after just six months of ownership; but should the mobile industry be concerned?

An Upfront Commitment

Not many consumers would want to commit over £1,000 to use a product that will likely be superseded in just one year. However, the mobile industry has billions of customers doing just that.

That’s because today’s flagship smartphones are being updated and replaced at an increasingly rapid pace. Most are unlikely to remain at the top of the product portfolio for more than 12 months, meaning that even if purchased on launch day the device will be superceded just half way into the average 24 month mobile contract. Samsung’s Galaxy S3 was replaced by the Galaxy S4 in just 11 months. Meanwhile, Nokia’s Lumia 920 lasted just seven months before the arrival of the Lumia 925. Many other OEMs work to even shorter product lifecycles.

Of course, a short product lifecycle for a flagship smartphone is no bad thing; it’s simply the price we pay for innovation. The problem comes from the way these products are bundled with multi-year service contracts that tie the consumer to a device.

Mobile operators have long bundled products and services together as a means of lowering the cost of entry for consumers. Expensive smartphones can be heavily subsidised at the start of a contract, with the rest recouped as part of a monthly service payment. Today, anything up to 30 per cent of a customer’s monthly bill goes towards repaying the device. However, the practice has created a generation of consumers who have little appreciation for the true cost of their smartphone. Many of us have been conditioned into buying based on the upfront cost, rather than dissecting the total cost of a plan.

Hesitant to reverse what’s become a key tool in the battle to acquire customers, mobile operators have steadily increased their contract terms to provide enough time to recoup the cost of increasingly expensive smartphone products. Long gone are the days of the 12 month, even 18 month, contract. Now – two years has become the norm. In fact, Ofcom even had to step in to regulate the industry from increasing the contract term to 36 months.

For many consumers a lengthy contract is a perfectly acceptable trade-off in return for a smartphone with little up-front cost. However, buoyed by an industry intent on pushing the latest technology, we are now seeing an increase in ‘technology hostages’, customers that want the latest products but find that their contracts restrict them. It is these consumers that suffer from such a dramatic fall in device satisfaction in such a short space of time.

The truth is that for the mass populous, the mobile operator’s commercial necessity to recover a device subsidy is now completely misaligned with their OEM partner’s shrinking product lifecycles.

There is the danger that traditional bundling is creating more ‘technology hostages’. Just as the feeling of owning the latest device is pleasurable to the extent that it drives customer satisfaction; smartphones that are so quickly superceded can have the opposite effect. The issue is exacerbated by contemporary smartphones being unceremoniously exposed to price discounting to make way for a replacement, often within just a few months of launch.

Smartphone Satisfaction Erosion

WDS data supports this change in customer sentiment and has discovered that smartphone satisfaction declines surprisingly early in the customer lifecycle. In fact, it occurs almost immediately following the purchase of the device. The percentage of UK customers saying they are highly satisfied with their smartphone drops from 71 per cent in the first six months of ownership to 53 per cent by the end of the first year. In contrast, satisfaction with the network service actually increases by the end of the first year, growing from 60 per cent to 67 per cent. However, such is the importance of the device as part of the mobile experience that despite this increase in network satisfaction, the percentage of customers highly satisfied with the price they pay falls from 76 per cent (immediately after purchase) to 60 per cent by the end of the first year.

Network satisfaction, it seems, is simply not enough to compensate for the fall in device satisfaction. Indeed, customers’ overall ‘repurchase intent’ tracks device satisfaction remarkably closely; falling quickly in the second half of the first year with just 38 per cent guaranteeing that they would not switch at the end of their contract period.

This represents a concern on two counts. Firstly, a customer’s repurchase intent is being heavily influenced by device satisfaction. Network quality is too difficult to tangibly measure but a physical device elicits a far more powerful response. Secondly, because device satisfaction is such a powerful influencer, overall repurchase intent across a customer base is falling very early in the customer lifecycle. In a typical two year contract period, repurchase intent starts to fall to its lowest level just six months after the initial purchase. By the end of the second year, just 38 per cent of customers could guarantee that they would not switch at the end of their contract.

Changing the Model

Unbundling mobile subscriptions is not a new debate. But the mobile industry was built on subsidising hardware and change will not come easily. Most operators acknowledge that subsidies are impacting margins, but have been reluctant to remove them for fear of customer dissatisfaction. In trying to find the middle ground, several operators have looked to turn the traditional model on its head. T-Mobile US was followed by AT&T and Verizon in changing its plans, while O2 UK also launched a new plan this year designed to unbundle product and service. Such plans essentially amount to device financing schemes in which the customer’s subsidised device is covered by a separate bill over an agreed period of time. Not only does this deliver greater transparency, allowing the customer to gauge how much they are paying for their ‘free’ smartphone, but it also allows the payment plan to be settled outside of the contract, or extended over a new device.

Outside of rapid customer acquisition, legacy subsidy models today do little for the long-term health of the industry. It’s time to overhaul the traditional business model behind mobile subscriptions and create a generation of customers able to appreciate mobile operator value beyond price alone.

Tim Deluca-Smith, VP Marketing at WDS

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