Last week AT&T announced another pricing change, their second in two months, when they reported they will begin to allow wireless customers to avoid 2-year contracts. (Read the article: http://tinyurl.com/o2vktlh). Later this month, subscribers will be able to skip the 2-year deal if they buy their phones outright or finance them for one year. This follows a recent similar move by T-Mobile to allow customers more frequent upgrades by either bringing their own phone or paying full price for a new one. I imagine that in both AT&T and T-Mobile, there were constituents arguing 1) “our industry does not work that way, so customers won’t pay full price for their phones” and 2) “our cost to acquire customers will increase if they can leave in less than 2 years”. In my opinion this move is a good way to offer customers another alternative, and I doubt the customer defection rate will change much.
The pace of change in mobile phone technology has been brisk during the past two decades. It seems like shortly after someone gets a new phone, a newer, better model is introduced. However, most of us have been locked in 2-year cycles. Historically we would pay $49 or $99 for a new phone, but we would simultaneously agree to a 2-year service agreement. We could cancel the agreement before 2 years were up, but we would have to pay a termination fee. Over time the phones have gotten more powerful with more features, and for some phones the price is now $149 or $199 up-front plus a 2-year contract. In my case, I bought a new phone in April and renewed my contract, and if I want to get a new phone before the 2 years is up, I will have to pay a $350 termination fee. That termination fee exists primarily because the phones cost more than the prices we are paying for them, but wireless carriers are subsidizing our purchases with large payments to the manufacturers. The 2-year agreement enables the carriers to recover their subsidy payments.
T-Mobile and AT&T have correctly recognized that there is a segment of the population that would like to get new phones more frequently and will pay something for that privilege. For example, my neighbor really loves gadgets. He is a true early adopter and he has purchased every version of the iPhone and every version of the iPad since they were introduced. He has also had a couple Android phones along the way. He has paid a bunch in termination fees, and he is ok with that. I personally prefer not to spend so much on telephones, but there are others like my neighbor who want the latest phones and are willing to pay for the right to switch phones more often. Customers in this segment who are currently not at AT&T or T-Mobile may decide they want to try the new option, even though the rest of the industry does not work this way.
The second argument revolves around the cost of obtaining customers in the first place and the value of hanging on to them over time. Wireless carriers, like all businesses, spend money on sales and marketing to get their messages out and explain their value to potential customers. The cost of that sales and marketing is more easily recovered when customers stay for longer periods. Similarly, each time a customer makes a choice about where to buy, he or she makes a decision about the price/ value relationship among competitors. If the customer is locked in for 2 years, their carrier does not have to worry about them leaving for a competitor’s artificially low prices during that period. This is a valid argument, but we need to remember that for most customers there is value in staying where they are. It is a hassle for customers to switch providers, and if they are happy with their current provider there is value in not switching. On the other hand, if customers are unhappy they will be inclined to try a different carrier.
Although I like AT&T’s new offering because it offers customer a choice and may attract more early adopters, I don’t think it will be a huge game changer. Economically, it does not seem appreciably different than our current deals. Today if you want to get a new phone more frequently than every 2 years, you pay the termination fee. Tomorrow you will pay an extra $300 – $400 either up front or in a monthly finance charge in order to obtain this flexibility. The total values will be similar, but customers will be able to do that math and determine which structure they want. I also doubt that the customer retention rates at AT&T or T-Mobile will decline. Only those customers willing to pay the extra $300 or $400 will have the flexibility to switch in less than 2 years, and even then they will have to consider whether it is worth the hassle to switch carriers. Anyone willing to do both of those things is probably also willing to pay the termination fee. Even though it may not be a game changer, just offering the customers a choice is a positive step and will likely improve the carriers’ image with customers. If it proves successful in attracting more new customers, I suspect the other carriers will follow.