I’ve recently been in the market for new wireless service given the exorbitant costs of my current contract for 4 lines with Verizon. While researching plans, it’s occurred to me that wireless contracts in the US are headed toward extinction, but not for the simple reasons widely discussed. Instead, we are at a unique intersection of heated competition by service providers, diminishing BOM costs for phones and commoditization of multi-band chipsets.
Heated Carrier Competition
The failed bid by AT&T to acquire T-Mobile has initiated a period of fierce competition amongst the four major carriers. Armed with additional spectrum and cash from the breakup fee structure, T-Mobile has eliminated contracts and device subsidies while creating simpler plans for consumers to evaluate. This has applied pressure for the other 3 carriers to follow suit in offering non-contract plans that are free of subsidies as well.
Eliminating the quid pro quo of a contract agreement in exchange for a device subsidy has allowed T-Mobile to advertise lower monthly charges. To create stickiness with the customer without a service contract, T-Mobile provides an installment payment plan option to diffuse the upfront cost of a new phone. This creates a similar effect to a service contract but without the negative associations customers have with them. An interesting byproduct of this approach is the creation of a compelling option for subscribers to bring their own phone.
As an example, looking at AT&T’s plan for a family of 4 shows that non-contract plans without device subsidies are $60 to $100 cheaper per month or $1440 to $2400 cheaper over the life of the contract. Spending less than $360 per phone over a 2 year period guarantees that you will come ahead financially and not have the obligation of a contract. As it turns out, now is a great time to find a smartphone at an affordable price due to dropping BOM costs.
Diminishing BOM Costs For Smartphones
One of the key promises of Android as an open source mobile operating system was its ability to dramatically reduce the cost of bringing a smartphone to market. The past couple of years have borne this out with Android hoarding in excess of 70% market share with phones at nearly every price point imaginable. This is a direct reflection of the drop in BOM (bill of materials) cost for developing and manufacturing smartphones. Part of this is attributable to Android and its growth and part of this is attributable to the volume in which common components are being manufactured for mobile devices.
There are a few great examples of how the drop in these costs are reflecting savings passed along to the consumer. I was at T-Mobile when we launched the first free after contract Android smartphone in 2011, implying an unsubsidized cost of $200-$350. This was a low spec phone with a barely passable user experience but it was a key milestone. Google soon followed with the development of their Nexus line of devices, establishing a pattern of high spec offerings sold off contract at a cost that just covers the BOM. In other words, Google is selling the devices at cost and not making any material profit on device sales. Other manufacturers like OnePlus are following suit. The result is a series of competitive devices selling for nearly half the price of their unsubsidized competitors without the obligation of a wireless contract.
My favorite, more recent example of diminishing BOM costs is the introduction of 3 Motorola devices in the past year: the Moto X, Moto G and Moto E. By segmenting the market into 3 tiers, Motorola offers a device for each tier that hits the value sweet spot by balancing cost and capabilities.
The Moto X is a high spec phone with a unique and innovative feature not previously seen on a smartphone: an always on microphone associated with a dedicated to capture hands-free voice commands at any time. The device is priced at $399 for the 16GB version without a contract and arguably competes well with other top tier Android devices selling for $200 more around the time of its introduction. Motorola is targeting the enthusiast demographic that is interested in having a hot and trendy phone. There’s a good 5-way comparison at digitaltrends.com showcasing the strengths and weaknesses of the Moto X compared to top tier smartphones. It’s important to note that the off-contract prices for the S4, G2, and HTC One were $550, $600 and $600 respectively at the time of the comparison, which the article fails to list.
The Moto G is a mid spec phone priced at $179 that targets budget-conscious smartphone switchers. These are consumers that have previously owned a smartphone and are looking for an economical option that still delivers a great device experience. I was surprised when my co-founder opted for a Moto G when he was shopping for a contract-free phone as I was expecting him to go for a Nexus 5 or Moto X.
Lastly, the Moto E is a low spec phone priced at $129 that targets budget-conscious first-time smartphone users. It may seem like everyone you know has a smartphone but penetration in the US is just over 50%. Nearly every phone offered by the big four carriers is a smartphone now so that penetration rate will steadily increase over time. As it does, late adopters that have relented on switching to a smartphone will be looking for budget options like the Moto E to switch.
It’s interesting to note that the differentiation in features, capabilities and experience between top tier devices (Galaxy, iPhone) and mid-tier devices (Moto X, Nexus 5) is rapidly diminishing, calling into question the value received for an additional $200-300 premium. This is driven by the commoditization and decreasing price of previously differentiated components of a device (CPU, screen, storage) and mobile operating system and app resource needs.
Commoditization of Multi-band Chipsets
Just a few years ago, the market offered few truly global phones that would work across most GSM and CDMA service providers. Nokia had the first pentaband UMTS phone in the Nokia N8 in late 2010. Since then, there has been a rapid commoditization of multi-band chipsets and the iPhone 5S is perhaps the best example. The Verizon version supports a wide variety of LTE and GSM bands making it compatible with all major US carriers and the vast majority of overseas markets. It turns out there is tremendous complexity for a universal phone that supports all GSM, CDMA and LTE bands given legacy networks and protocols, but these new multi-band chipsets go a long way to ensuring wide coverage support along with access to top speeds and low latency.
The key customer benefit of this multi-network compatibility is the ability to more easily switch carriers. Combined with lower cost phones and non-contract plans, this is positioning the subscriber with great flexibility to move to the carrier that services them best.
We are nearing a plateau where dollars going into additional hardware will not result in a stair step difference in features, capabilities and user experience for smartphones. It’s unclear how long this plateau will last as software consistently pushes the boundaries of hardware to realize new features and performance. Until we see the next escalation in hardware demands by the OS and apps, this plateau will help drive mid-tier phone sales and the erosion of service contracts.