During T-Mobile’s annual investor conference in Germany, newly-installed CEO John Legere dropped two bombshells. The first was that T-Mobile USA would finally begin offering the Apple iPhone next year. The second was that T-Mobile plans to eliminate subsidies on new phones, meaning phone buyers would either have to pay the full price for a new phone up front – perhaps $300 to a very daunting $800+ – or pay off their handset in installments tacked on to their monthly bill. The move will come with a shift as T-Mobile starts aggressively marketing itself as the “Un-Carrier,” free of the hassles and gotchas of traditional U.S. mobile services. T-Mobile will also be amping up its bring-your-own-device offerings: folks who have (or can get) a phone that works on T-Mobile’s network can bring it over, no questions asked.

Although Legere didn’t offer many specifics about either plan, both announcements represent fundamental shifts for T-Mobile. The company is essentially abandoning the subsidy models favored by U.S. carriers to put new phones in consumers’ hands for seemingly-low prices. It also plans to stop being the iPhone-less stepchild of the U.S. mobile industry.

Will these moves shake up the phone-buying experience? Will T-Mobile customers come out ahead?

Value without subsidies

In the United States, major mobile operators like Verizon Wireless, AT&T, Sprint, and T-Mobile have long followed a bizarre-yet-sly strategy: they subsidize the up-front cost of mobile devices, hiding the real cost of phones in the fees and charges of service contracts. It doesn’t take a rocket scientist to know a new Nokia Lumia 920 doesn’t cost $100, or an iPhone 4 $1 – but those are the kinds of price tags carriers hang on new devices to get customers to walk through the door (or click a Buy button). It was a strategy that encouraged consumers to adopt mobile phones (and drop landlines) by lowering up-front costs.

But the costs are still there. Smartphone buyers committing to a new two-year service agreement today are essentially agreeing to pay anywhere from $1,500 to $3,000 over the span of two years. Much of that money is for service – and operators’ profit margins – but some of it is the cost of the device. Consumers who want out of their contracts early wind up paying a termination fee that covers any outstanding costs of the handset – and often a wide assortment of creative “processing fees” mainly intended to make it painful to leave a carrier early.

In 2013, T-Mobile plans to stop subsidizing phones. Instead, new customers will be offered plans under T-Mobile’s Value Packages. Customers will have the option to:

  • Pay the full cost of a new device up-front
  • Pay for a new device in installments separately called out on their monthly bill
  • Bring their own device to T-Mobile

T-Mobile’s Value plans don’t earn the company as much money as its traditional (subsidized) Classic plans, but profits are no longer T-Mobile’s biggest problem. Since the end of 2011, T-Mobile has lost more than a million contract subscribers, totalling more than four percent of its total customer base. Sure, some of that churn is due to not having the iPhone and the turmoil surrounding the company’s aborted merger with AT&T, but some of it is because T-Mobile’s Classic plans just don’t offer the value many of its customers want.

However, T-Mobile says its Value plans are working. According to the company, roughly 80 percent of the customers who are signing up for contract service are opting for those Value plans – mostly because they’re already less expensive than comparable plans from other carriers. Moreover, roughly a third of those activations are for unlimited plans with no data caps and those Value plan customers tend to stick around one or two months longer than Classic subscribers. By eliminating phone subsidies, Value plan subscribers will be worth about $200 to $250 more to T-Mobile over a two year span.

What about customers who balk at paying hundreds of dollars up front for a new phone? T-Mobile hopes to be able to compete with the likes of Verizon, Sprint, and AT&T by letting customers pay for devices on installment plans tacked on to their bills. Legere describes the plans as enabling customers to pay $100 for the “most iconic device in the world” – he didn’t actually say iPhone – and pay an additional $15 to $20 a month for 20 months. If customers decide they want to upgrade, they’ll be able to bring the phone back to T-Mobile for a fair trade-in value toward a new phone.

T-Mobile’s value plans also appeal to people who want to bring up an existing phone on T-Mobile’s network: the company says 12 to 15 percent of its Value plan activations are from customers bringing their own devices. Many of those devices are iPhones: T-Mobile claims more than 1.7 million iPhones are operating on its network, and T-Mobile is happy to sell bare SIMs, micro SIMs, and nano SIMs. Those devices might be older T-Mobile or AT&T phones (most devices from Verizon and AT&T can’t be brought up on T-Mobile’s network), or unlocked GSM phones sold directly by retailers. Interestingly, that includes things like the iPhone 5: the Verizon version ships unlocked, carries a nano SIM, and can be brought up on T-Mobile’s network.

T-Mobile isn’t stopping there: the company is also looking to continue its aggressive promotion of contract-free service. One example is GoSmartMobile - you kind of have to look carefully to realize it’s T-Mobile – which starts at $30 a month for unlimited voice and messaging, up to $45 a month with high-speed unlimited Internet.

Doing the math

Will T-Mobile’s no-subsidies Value plans actually represent savings for customers compared to traditional two-year contracts? In most cases, the answer seems to be yes – even if customers opt to pay for their handsets in installments on their monthly bills.

As a baseline, a T-Mobile Value plan with unlimited voice, unlimited messaging, and 2 GB of “high speed” data runs $60 a month; over 24 months that rolls out to $1,440. Verizon charges $100 a month for a roughly equivalent plan ($2,400 a year), AT&T is $85 a month (for just 1 GB of data a month; $2,040 a year), and Sprint is $80 a month ($1,920 a year, although voice is limited to 450 minutes).

At face value, that means T-Mobile’s Value plans currently cost $480 to $960 less than major competitors over two years of service. If T-Mobile customers pay for a phone outright, they’d still come out ahead as long as they purchased a phone that cost less than $480 – or which added $20 or less to their monthly bill, padded out in installments. Sure, an unlocked iPhone might run from $650 to $850 from Apple, but to put that $480 in perspective T-Mobile is currently asking $330 for a Samsung Galaxy S3 after an instant rebate.

For cost-conscious customers, those numbers can be compelling. However, there are caveats. Although T-Mobile has been expanding its total coverage area and its service level in major markets through spectrum deals with AT&T and Verizon as well as merging with MetroPCS, there remain plenty of areas where T-Mobile just isn’t a realistic option for mobile users. T-Mobile does offer high-speed “4G” service, but its high-speed HSPA+ service only works on phones especially made for T-Mobile – which kind crimps the iPhone and bring-your-own-device possibilities – and the company’s LTE story is still evolving. T-Mobile plans to have 2×10 LTE coverage up and running in 90 percent of its top 25 service areas (covering 200 million people) by the end of 2013, with LTE coverage for about 100 million people in the first half of 2013. T-Mobile has been working to modernize its network to improve reliability and in-building coverage (the company is reporting a 15–20 percent improvement in in-home coverage and a 74 percent reduction in dropped calls), the nature of T-Mobile’s spectrum bands and coverage mean there are plenty of spots, even in markets with major coverage, where T-Mobile can just fall down. (As a personal aside, almost every week I’m in a spot on a line-of-sight with T-Mobile’s Bellevue, Washington, headquarters … and there’s no T-Mobile service whatsoever.) For many people T-Mobile service works great, or is at least good enough: for others, it’s a non-starter.

Consequences

T-Mobile’s move to do away with phone subsidies isn’t going to be a godsend for every American mobile user, but it does have the potential to disrupt business-as-usual for the top three carriers. Besides giving customers an option to just buy a phone outright, what impact could T-Mobile’s move have?

Transparency: Traditional phone contracts have always been a morass of fees, charges, addendums, overages, carry-overs, and figures. Eliminating subsidies or letting users pay for phones month-by-month (on what T-Mobile will apparently call “Equipment Installment Plans”) won’t end that, but it does enable customers to see how much they’re paying for their phones instead of hiding the true costs in service plans.

Alternative financing: Just because T-Mobile will offer to sell users a phone doesn’t mean they’ll be the only company offering to sell phones that work on T-Mobile. By doing away with subsidies, T-Mobile opens the door to everyone from device makers to electronics retailers offering their own financing options for phones that can be used on T-Mobile’s network. Think a cool new phone from (say) LG costs too much from T-Mobile? Maybe you’ll be able to get a better deal from Amazon – or better financing from Best Buy.

Used handset market: T-Mobile’s Value plans and pay-as-you go options will be particularly appealing for consumers willing to consider the used device market. Also, if smartphone users start to realize their devices cost $300 to $800 rather than throwaway prices like $99 or even free, they’ll be more likely to put those devices up for sale (or trade them in) when they upgrade. The upshot? A more-robust market for used and refurbished phones – and that means more potential customers for things like T-Mobile’s Value plans.

More handset choice: T-Mobile’s bring-your-own-device options may be particularly appealing to discontented AT&T customers (although not all capabilities of AT&T phones work on T-Mobile’s network), but they also means handset makers don’t need to strike deals with mobile operators to do business in the United States. This could create significant opportunities for companies like Huawei and ZTE (which are barely presences in the U.S. market right now), but could also present a major opportunity for companies like LG, Sony, and (particularly) Nokia.

Faster upgrades, less crapware? If T-Mobile’s subsidy-free strategy takes off and is adopted by other carriers, it could eventually reduce carrier’s locks on what what software and services are on phones. That would mean less carrier-branded crapware pre-installed on devices, and less dependence on carriers to deliver operating system upgrades to customers. T-Mobile doesn’t have the weight to effect this change on its own – and carriers do love locking customers in with custom software and add-on services, so don’t expect Verizon, AT&T, or Sprint to follow suit soon. But less crapware and a quicker upgrade path could become a key differentiation point for T-Mobile – particularly as it tries to position itself as the “Un-Carrier.”

So about the iPhone…

T-Mobile hasn’t revealed any specifics about it’s iPhone deal: they haven’t announced when it will start carrying the iPhone, how much it will cost, or any other details. It’s pretty fair to guess that T-Mobile will begin offering the iPhone only when it has significant LTE coverage up and running, so the timeframe might be around the middle of 2013. There’s some speculation that would coincide with Apple’s announcing its follow-up to the iPhone 5, although former Apple CEO John Scully apparently believes Apple is shifting to a six-month iPhone product cycle. Time will tell.

As the last major U.S. carrier to get the iPhone, T-Mobile can’t expect putting the iPhone on sale will bring the kind of revenue influx the device brought to AT&T and Verizon. However, simply being able to offer the iPhone removes some stigma from the T-Mobile brand and helps set T-Mobile on equal footing with Verizon, AT&T, and Sprint in some customers’ eyes.

“A certain number of people wouldn’t come to our stores if we didn’t have the iPhone,” T-Mobile CEO John Legere told investors.

However, being last to the iPhone may have financial advantages for T-Mobile: it was probably able to cut a less-desperate deal than Sprint. Sprint reportedly agreed to a four-year, $15+ billion deal with Apple and a commitment to sell from 25 to 30 million iPhones. Under terms like that, Apple is earning about $500 for every iPhone sold by Sprint: compare that to the average $280 smartphone subsidy reported by PricewaterhouseCoopers for 2011 (PDF). T-Mobile hasn’t revealed terms of its agreement with Apple, but Legere noted “We worked very hard for a deal that made sense for us.”

Bottom Line

T-Mobile’s move to eliminate phone subsidies is gutsy, but for people who are willing to plunk down the cash for a full-prices phone, the cost difference between subsidized and un-subsidized service on T-Mobile might be minimal. T-Mobile will still be a less expensive alternative to Verizon, AT&T, or Sprint – and for folks in areas with decent T-Mobile coverage, that’s compelling.

T-Mobile’s decision to eliminate subsidies will really only have a chance to pay off once the United States’ LTE market matures – which means 2014 to 2015. At that point, there will be a robust used and refurbished market of LTE-capable smartphones that can run on T-Mobile’s network. Combining smart bring-your-own-device options with the ability to offer the hottest new devices – including the iPhone – should give T-Mobile the opportunity to dominate the “value carrier” market.

It really is a case of T-Mobile trying its best to make lemonade when life handed it lemons, following Deutche Telekom’s decision to cease investing in the business and the abortive merger with AT&T. T-Mobile will almost certainly never be able to compete with Verizon, Sprint, and AT&T on spectrum and coverage, which means the company must compete with the bigger carriers on price and innovative offerings. Ending phone subsidies won’t catapult T-Mobile to the top of the U.S. market, but it is a smart way to clearly distinguish itself from the competition.