Did you know that the latest iPhone costs north of US$600? Even the most passionate Apple aficionado can be forgiven for not knowing when they are likely to have shelled less than half of this amount upfront when they bought the device. They may have even got an older model for free on the back of a hefty phone plan. In many mature markets – and in the US and Western Europe, in particular – the operator subsidy model is so well entrenched that the RRP for the latest smartphone is often only of academic interest to the end-consumer.

The practice of subsiding the latest phones to attract customers to their networks and locking them into lengthy contracts predates the smartphone revolution by about a decade, but it is increasingly becoming an unsustainable model for operators.

Rather than subsidising phones, operators are now underwriting the very latest computing technology that just happens to be in a handset form-factor. The iPhone, for example, costs more than the iPad (which isn’t subsidised) and is about twice what you would pay for a reasonably specced desktop PC. In the case of the iPhone, the operator also needs to pay substantial additional fees to Apple for the privilege of carrying the device as well as taking on a heavily-mortgaged customer. This makes the stakes very high for a struggling operator such as Sprint, which needs the iPhone to pull in a substantial amount of subscribers churning from rivals for the strategy to make any financial sense.

Cole Brodman, CMO at T-Mobile USA (which doesn’t offer the iPhone) raised the smartphone subsidy issue at GeekWire’s technology summit in Seattle earlier this month. “It actually distorts what devices actually cost and it causes OEMs, carriers — everybody to compete on different playing fields,” he says. “It causes consumers to devalue completely the hardware they are using.”

Brodmon suggests that subsidising encourages “dual-core, multiprocessor devices with amazing HD screens” to be simply “thrown away at 18 months” when the contract runs out and the process begins again. It’s certainly true that consumers expect a much longer period of service from, say, a laptop, which has probably cost a lot less than the latest smartphone.

Smartphone subsidies will not disappear anytime soon. Consumer purchasing decisions are usually based on acquiring the device they want with the choice of network usually an afterthought, which makes attractive subsidies a vital customer acquisition tool for the operators. As Brodmon conceded, phasing out subsidies would only work if T-Mobile’s rivals did the same, which is unlikely to ever happen.

Nevertheless, operators are now looking at alternative methods in a bid to reduce their customer retention and acquisition costs. In Spain this week, Vodafone – the country’s number-two player -–announced that it was ending smartphone subsidies for new customers, following a similar announcement by market-leader Movistar (Telefonica) earlier in the month. Vodafone Spain, which recorded customer costs in the year to Q3 2011 of £2.1 billion – equivalent to almost half its revenue – will instead offer free finance programmes for the purchase of new handsets and introduce a scheme to buy back old phones from upgrading customers.

As a new Wireless Intelligence report points out this week, the high level of smartphone subsidies commonplace in Western European risk “wiping out the gains made in terms of data revenue growth.” It notes that Vodafone’s latest available Opex figures (for the year to Q3 2011) show that while other expenses lessened, ‘acquisition and retention costs’ were up 12.4 percent on the same period in 2010, and is now a significant drag on earnings.

This is now a key challenge for operators in advanced markets. Revenue growth is coming from data; and data use is rising in line with growing smartphone penetration. But unless operators can figure out a more cost-effective way of getting the latest phones to their subscribers, they risk losing out on much of the upside.

Matt Ablott

The editorial views expressed in this article are solely those of the author(s) and will not necessarily reflect the views of the GSMA, its Members or Associate Members