Why the Mobile Phone 'Subsidy' is a Myth

Wednesday Mar 27th 2013 by Mike Elgan
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There are no "subsidies." What carriers like AT&T, Sprint and Verizon call a "subsidy" is actually a very high-interest loan.

You may have heard the news: T-Mobile announced a new mobile phone plan this week that involves no contract, and no phone subsidies.

What's most interesting about this news, and what nobody is talking about, is that other carriers don't have subsidies, either.

What is a subsidy?

The Merriam-Webster online dictionary defines a "subsidy" as "a grant or gift of money."

The word "subsidy" is usually associated with a government giving money to an industry or organization as a matter of policy.

The US government, for example, collects taxes from the public and then gives some of that money to specific industries in order to prop up and influence the direction of national energy supplies, infrastructure, food and so on.

In order for something to be considered a "subsidy," money must be transferred from one entity to another as both Merriam and Webster say as a "grant" or a "gift."

If you give me money, you're giving me a subsidy. If you give me money for now, but I have to give it back plus interest, that's a loan.

(Ironically, "telecommunications" is the third largest industry to get subsidies from the US government. That money comes from US taxpayers. That means if you pay taxes in the United States, you actually subsidize AT&T, Sprint and Verizon, not the other way around.)

Use of the word "subsidy" as it relates to an assumed discount when purchased with a carrier contract is a mis-use of that word, a euphemism, a misdirection, a lie.

Carriers give you loans, not subsidies

So let's be clear about your average mobile phone contract.

They claim their proposition is this: "If you sign a two-year contract for phone and data service with us, we'll pay for most of the cost of your smartphone."

But that’s just spin – conceptual packaging of costs designed to maximize what you’re willing to pay.

The truth is that they are not paying for most of the cost of your phone. Be assured that you are paying the full cost of that phone, and then some. The carriers are not going off and getting money from elsewhere and redirecting it to you. That would be a subsidy.

What they are in fact doing is selling you a phone and a plan at a price that fully covers the total cost of both the phone and the plan and also leaves a hefty pile of cash for them to keep as profit.

The contract is the legal requirement for you to pay for all that with monthly payments, plus penalty fees if you exceed the terms of the contract -- for example, if you exceed your "minutes."

Regarding the phone, they are giving you a loan. They're paying for the price of the phone up front, and then the repayment of that loan is built into your monthly payment, which you are required by contract to pay.

And that's the problem. The terms of the loan they give you is a rip-off.

When you buy into a "subsidized" phone with a two-year contract, some number of dollars you're paying each month is payment on that loan. Let's call it $20 per month, which is the amount T-Mobile charges per month for the repayment of their loans for iPhones after you pay $99 up front according to their new plan. (It's also the amount in a similar model outlined last week in the blog Phone Scoop.)

Because an average carrier contract has you paying typically about $200 up front for a high-end smartphone, we can assume that hypothetical $20 includes some interest. (An unlocked iPhone costs $649 from Apple. A "subsidized" phone from a carrier where, in our very conservative model, you're paying $20 per month in payments and interest on your loan works out to $680 -- the price of the phone, plus a total of $30 interest on the loan.)

If you immediately upgrade to a new phone after two years and sign a new, two-year contract, then you get another loan and the process continues.

If, however, you're among the majority that waits some time before getting a new phone, you continue to pay your monthly loan payments on the phone, even though it has been paid off.

It's like paying off your house and all the interest on your home loan after 15-years, but being required by the bank to continue paying your regular mortgage payments every month until you buy another house and get another loan.

That's why carriers love the whole "subsidy" shell game. It hides your loan payments in a murky payment plan that definitely covers the cost of your phone, interest on the loan they gave you, the costs associated with your actual service plus more money to profit the carrier.

There’s no "subsidy" anywhere in this plan. They use the word to confuse you into taking out a very bad loan.

The reason the scheme works and the reason consumers don't scrutinize what they're actually paying for is a flaw in human reasoning called "present bias." Humans will gladly pay more for something later if it means spending less now.

So how is T-Mobile different?

Interestingly, T-Mobile is also happy to give you a loan to buy your phone. But there are three differences.

First, when you've paid off the loan with T-Mobile, you stop making payments.

Second, they don't charge you interest on the loan.

And, third, they give you a discounted price for the phone -- for example (by the time you pay off your loan, you will have paid less than $600 for an iPhone 5).

You can also buy the unlocked phone at a discount price if you don’t take out the T-Mobile loan. For example, they charge $549.99 for the iPhone 5 ($100 less than Apple charges) if you pay the whole cost up front.

Or, you can just use the phone you already own.

In essence, they've de-coupled your monthly payment for wireless service from the loan they give you for your phone -- the cost of service is the same whether you get a loan from them to buy a discounted phone or whether you bring your existing phone onto their network.

Why T-Mobile's plan is good

Ultimately, it's all a shell game no matter what. Who knows, for example, if T-Mobile takes some of your money they charge you for the wireless service and use it to help discount the phone or carry the phone loans?

What's good about T-Mobile's plan is that the phones, loans and wireless service costs are all separated from each other.

T-Mobile’s new policies help shatter the "subsidy" scam that used to be nearly universal.

And the piece de resistance from T-Mobile's point of view is that their loan program exploits "present bias" even more than conventional plans do. The proposition for consumers is: "Pay $99 now and the rest later."

More importantly, though, I would like to destroy the absurd notion that subsidies exist anywhere in the industry. There are no subsidies. Subsidies are a myth.

The truth is that what carriers call "subsidies" are really very bad, very high-interest loans buried inside a shell game designed to confuse the public into spending far more for phones and wireless service than they really should.

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