Beyond smartphones: is subsidization the future of everything?

Beyond smartphones: is subsidization the future of everything?

Summary: From the Kindle to Xbox, the subsidization model of product sales is proving to be a viable option for a variety of industries.

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The general knee-jerk reaction to Microsoft's $99 Xbox plan is that it's crazy, odd, a bad deal.

But the move is really the latest in a long line of similar efforts to get consumers to plunk down cash for things they would otherwise be unwilling to pay quite so much for.

The subsidization model does a few things well. Most obviously, it keeps prices low, reducing the barrier for entry and opening up and increasing the revenue streams elsewhere. We've already seen this on multiple fronts, from free-to-play games like Angry Birds and Team Fortress 2, to, most notably, the smartphones industry.

Even Amazon introduced a similar effort last year when it announced the Kindle with Special Offers, an ad-subsidized version of the device that ran for $25 less than the ad-free version. The idea? Amazon takes a hit on the Kindle sale, but gets to put advertisements in front of far more consumers. (Kobo also tried something similar.)

Video game consoles have run on a less overt subsidization model: Sell consoles at a loss and make up the cash on games sales. The $99 Xbox deal pushes that a bit further, cutting the entry price by a significant margin to attract new buyers. The difference here lies in the contract, which binds the consumer to Microsoft for two years. This, as ZDNet's Mary Jo-Foley notes, makes it more likely that consumers will opt into other purchases.

And then there are the cell phone carriers, which take a hit on cell phone sales in exchange for two-year contracts. Not that it's been entirely rosy here. Subsides are notoriously disastrous for the profit margins of the cell phone carriers: The more smartphones Verizon and AT&T and Sprint sell, the more they have to shell out to subsidize the purchases. (See: the ongoing snafu over the iPhone.)

This reality prompted T-Mobile Chief Marketing Officer Cole Brodman to publicly decry the carrier subsidization model that his industry has come to rely on. “It actually distorts what devices actually cost and it causes OEMs, carriers — everybody to compete on different playing fields,” Brodman said last month.

Clearly, subsides have been a major double-edged sword for carriers -- not that that will prevent other industries from also experimenting with them.

These kinds of subsides work by pushing the complete financial picture far into the general haze of the future, where short-term benefits far outweigh long-term costs: Be happy now, worry about consequences later.

With the $99 Xbox deal, this means that consumers ultimately pay more for something that they can get for a lower price now. But here's the thing: Most consumers aren't going to run those calculations; they'll only see the $99 price tag. And the price difference after two years? That simply becomes the cost of financing.

That's why subsidies work for both consumers and companies, and also why the model seems like a logical next step for other device's and industries. Assuming that Microsoft's $99 Xbox test works out, it's likely that we will end up seeing similar efforts with the next Xbox as well. And the sky's the limit from there.

Topics: Amazon, Hardware, iPhone, Microsoft, Smartphones, Tablets, Telcos, AT&T, Verizon

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5 comments
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  • Yes

    In a content / services driven model I would say that it is the future of quite a bit of things.
    slickjim
  • I do not believe in subsidization.

    I will buy XBOX 360 at full price but don't care for Kinect. I will buy a T-Mobile smartphone at full price and go with T-Mobile Monthly4G at $3/24 hours for unlimited minutes, unlimited texting, and 200 MB of data. I will buy a nice superphone/tablet at a full price whether it be this year or next year.

    Let me say that I am taking advantage of Amazon's monthly payment and I have good credit since I've never been late in monthly payments. I got myself a Samsung Exhibit II 4G for $170 used, rooted it, and since I'm almost got my laptop paid for, I'm paying $100 a month to pay off my laptop (HP Pavilion dv7-6168nr) and my smartphone.

    If your phone costs $180, you can pay $30 for 6 months while still keeping with a $3/24 hour plan from T-Mobile. Once your phone pays off, you can then switch over to $30/month with 100 minutes of voice, unlimited texting, and 5GB of 4G data. But if you can do $90/month, your phone will be paid in 2 months as long as you don't be late for your payments.

    Here's another example: I went into Amazon.com, searched for XBOX 360 4GB model (I don't care for downloadable content, but that's just me) and it sells for $199. Assuming that shipping is free, I divide $199 by 6 and it comes to approximately $33.17 (rounded up from $33.1666 with a repeating decimal). This is without a Kinect. Pay $100 for two months and your XBOX is already paid for!

    But remember, only pay what you can afford and as long as you don't get charged an interest rate for your purchased product. I'm unsure if being charged an interest rate if not paid in full will lower your credit score, but I do know that missing your monthly payment will lower your credit score. I am going to pay whatever I have in full, as well as my credit card from Bank of America. I have not missed my payment ever since I got my credit card in 2008 and my Amazon credit card as of late last year.

    And do not bother with subsidization and contracts if at all possible. Save that $99 and get a $399 XBOX with Kinect once you can afford it.

    PS: I love my Exhibit II 4G once I've rooted it and put in Cyanogen Mod 9, but then I do miss the use of camera, which I can make do with Optimus V (I've deactivated my service with Virgin Mobile). Say "Hello" to SIM cards! :) But I don't think anyone in the US would care for it. Heh heh! :)
    Grayson Peddie
  • Forever tied to MS or anyone else?

    I fear the changes that the "controlling" vendor may pull in a pursuit of fatter revenue streams. One thing I've learned, "Don't trust the big companies to be nice once they have you by the short "n curlies.

    Buy your stuff outright, or don't. Music, I buy the CD and then OWN the music, in it's mp3 format. No downloads for me.
    pessimist
  • Before the mid-70's we all paid rent on our telephones

    This is kind of the same idea (but maybe less of a rip off). We are hiding the cost of the hardware in a subscription - a bundle of services - and a commitment.

    We'll see how far it goes.
    Schoolboy Bob
  • I don't know about all of the carriers...

    But the last time I got new phone, there were different rate plans depending on whether I chose a subsidized phone or not. I was on a no-contract plan prior to this, and if I wanted to keep the plan I had to buy the phone outright. If I took a subsided phone, the monthly plan for the same service would have been $25 per month more. When all was said and done, the subsidized plan would have given T-Mobile an extra $125 over the life of the contract. Having no contract also gives me the ability to switch carriers on a whim should a better deal come along.
    jvitous