[Info] Why Phone Contract Plans Are Often a Bad Deal

As the Galaxy S6 enjoys the spotlight momentarily, I’ve been fascinated by the phone contract plans themselves. More often than not, if somebody asks ‘How much does X phone cost?’, the response will be given in a monthly cost, rather than an outright cost. Ever since I got my first brick Nokia phone back in the late 90s, phone contract plans, at least here in Australia anyway, have been mostly the same structure. Since then, I’ve only purchased a few phones on contracts, and none recently. But is it really a bad deal? Let’s boil down to the nitty gritty.

First off, the basics. You probably know how a contract plan works, but let’s recap for everybody else. A monthly minimum payment to a carrier, nearly always tied to a 24-month contract, that provides you a network connection in addition to a new handset. The carrier amortizes the cost of the handset over the entire period, discouraging you from leaving early by implementing ETF’s (Early Termination Fees). For many, contracts are tempting, because the initial payment (say $50/month) is low compared to the outright cost of the buying the handset at retail (which could be up to $1000).

How much are you really paying?

At least in this country, carriers are required to disclose the entire cost to the consumer after 24-months. For flagship devices, this total usually ends up being around the $1500-$2000 mark over the entire period. Subtract the cost of buying the phone outright, leaving the service cost. Dividing this further by 24, then leaves the monthly service cost, which, as if by magic, is usually less than the cost of bringing your own phone (BYO) and buying a SIM-only plan. In theory, this seems tempting, after all it’s cheaper than getting the same phone and a SIM-only plan, right? You get a crispy fresh, brand new model and your service sorted out for the next 24 months, for minimum out of pocket cost. Win win right? Not so quick.

I’m a firm believer in graphs, so here’s a simple one I’ve put together to better illustrate this. The blue line is a normal contract – $75 a month for either a Galaxy S6 or iPhone6. You get a handset, and you pay every month, pretty straightforward. At the end of 24 months, you keep the handset and you get stern encouragement to buy another one. The orange line is buying a 1-year old device (ie. iPhone 5S or Galaxy S5) brand new and a SIM-only plan with the same call/data allowance as the blue line. It’s a higher upfront cost, but at around month 11, it pays for itself, and you start saving from then on.

The yellow line is buying a 2-year old device (iPhone 5 or Galaxy S4), an even lower upfront cost, paying for itself after only 8 months, which is a big deal. In fact, it’s nearly $800 ahead by the time the contract ends, and there’s no reason why you couldn’t keep using it after that. The interesting line is the green line, it’s buying last year’s model, as above, but at the one year mark, you then buy the new model (which by then is one year old). By the end of the 24-month contract, you’re STILL ahead of the contract plan, except now you have two phones on hand, and you’ve even saved money. You could have even sold the first one, been doubly ahead, and still enjoyed using the ‘currently new’ model. Such is the effect of depreciation.

contractvsbyograph

What are the other downsides to contracts?

The obvious catch is, you’re locked into one carrier for two years. If another company has a promotion or offer during this time, you’re stuck, unless you pay the steep termination fees to break the contract. This is pertinent as carriers nowadays often have promotions and specials for SIM-only plans. In addition, carrier phones tend to have hardware/software branding or custom OS’s tailored for that carrier. These are worth less on the second-hand market than unlocked devices. Sometimes, they even get software updates slower, as the carrier needs to customize or test it further.

Then, there’s the cost – low upfront, but you’re effectively paying a loan of the phone off. The loan is based on providing 24 months of service and the handset at full RRP. Which means, in 12 months time, you’ll still be paying chunks of the original RRP off, even as the handset value has plummeted. We’ll get into depreciation specifics later on, but keep this in mind for now.

The carriers love contracts, because they will know the number of secured customers and bandwidth allocation required for the next 24 months. This is extremely valuable – network capacity planning is critical, because severe congestion can lead to huge backlash and damage to their brand, as Vodafone discovered a few years ago. Keeping customers happy is far cheaper than obtaining new ones, carriers will thus incentivize heavily to make sure you sign up to a contract and stay there, in a predictable fashion.

Before you think that carriers are eating a dirt sandwich on each new contract, they’re not – their cost of purchasing these handsets is far lower than you or I would be able to purchase them at retail. On top of that, handset manufacturers often subsidize the cost of handsets and even offer to take back unsold inventory, anything to get the handset some promotional and sales priority. They also know that the vast majority of people don’t use anywhere near the data or voice allowances built into their contracts, just like insurance companies know that not everybody claims all the time.

One of the lowlights of a contract is the tiered structure, usually in the from of low, medium and high usage plans. Most people will opt for the next level higher than their worst case prediction, in order to avoid high penalty unit rates for exceeding the quota. As a result, many people often end up purchasing plenty of quota or call allowances which they have little use for. Similar to bundled cable TV packages, you end up paying for things that you don’t use, a very lucrative deal for the carrier. The truly flexible ‘pay as you use’ plans offered by carriers nearly always have incredibly expensive per-use rates, to further encourage contract deals.

Exactly how much depreciation do smartphones suffer?

If you thought buying a new car from a showroom was bad, smartphones are far worse. This is important, because it shows that by waiting 1 year, or even 6 months, you’d be far better off. The figures I’ve used below are in US Dollars, for smartphones at release date (RRP), compared to 12 months and 24 months later, still new stock from retailers at Amazon. The beautiful thing about smartphones is that, unlike cars, the old model is still sold for at least 12-24 months alongside the new one, and still boxed and new. For second-hand devices, this drop is even more dramatic, you can sniff out eBay and other sites for an indicator.

As you can see in the graph below, the iOS devices hold their value about 12% better than Android devices. On average, Android flagships lose an incredible 46% of value in just the first 12 months, and more than 65% by the second year. In some very rare cases, value can actually see a slight uptick after the 24 month period as supplies dry up, particularly if the replacement model is a bit of a lemon (see Nexus 5/7). On iOS devices, 34% of value is lost in the 1st year, and 59% by the second year, still quite substantial. Smartphones are designed to be obsolete, and the values reflect the fickle nature of consumers and our dependence on 2-year contracts.

Thus, we can predict with reasonable accuracy that the Galaxy S6 (priced today at $1149 AUD), will be worth $628 in April 2016, and $412 in April 2017. Adjust to suit your local currency. Due to the popularity of these devices, it’d be safe to say that a good condition second-hand device will be <$500 in a year, and $350 in two years. A >$600 saving just for waiting 12 months, with no change to data or voice allowances. In short, there’s a sharp premium for the early adopters.

depreciation

What does this mean for us?

Financially, whichever way you look at it, the drop in value is substantial for even slightly old phones. There’s not many goods which suffer such a massive plunge in value after the first year. Borrowing ahead, like with the cost of a contract plan, to amortize the cost of an expensive flagship that we know will suffer a dramatic drop in value, makes little financial sense. Holding out for just 12 months leads to an average of $348 USD yearly saving, purely for NOT purchasing anything. You can begin to see now why carriers and manufacturers would rather everybody, like clockwork, buy a new device in 24 months, whether we really need it or not. Suddenly, all that appeal to emotion in smartphone advertising makes more sense, because the numbers point in the other direction.

As for functionality, ask most average consumers and nearly all of them would be satisfied using a model from a year or two ago, probably older. Smartphones have advanced to the stage where performance iterations are not particularly noticeable, and battery life has stagnated. In some cases, like the Galaxy S6, LG G3 and HTC One M9, battery life has actually regressed slightly. The camera or screen sometimes improves, but we’ve reached the stage where realistically, any flagship in the last 2-3 years is perfectly fine for the vast majority of people. In short, the more sensible phone to get, is usually last year’s model.

Even if the pricing was the same between both options, I would argue that the freedom to choose carriers and devices at will, is worth a lot. How much, depends on the person. If it came down to it, I’d be willing to pay slightly more, to be free from a fixed contract. But as it turns out, this options is nearly always cheaper anyway. It’s the two-year contract which keeps people buying on schedule, but as we’ve seen, it’s not a free upgrade.

How does it compare to BYO (SIM-only) plans?

At first glance, as mentioned before, contract plans are priced to make them slightly more attractive than buying the same phone at the same time, and a suitable SIM-only plan. However, this makes a huge assumption – that you MUST change your phone right now. Unless your phone is falling apart in your hands (and is otherwise unrepairable), it nearly never makes sense to do this.

But enough with the chit-chat, let’s crunch the numbers. I gathered a selection of contract plans for two comparable and popular phones, the Samsung Galaxy S6 64GB and Apple iPhone 6 64GB, on the four major carriers in this country. All prices are current as of today. Listed alongside are the SIM-only plans with comparable data and voice allowances. All figures are in Australian Dollars (AUD).

If you don’t want to parse the table, here’s the summary. Firstly, as we predicted, buying a contract plan is cheaper than buying the flagship separately with a SIM-only plan, to the tune of about $350 over 2 years. This is the only circumstance which a contract plan is cheaper – where you absolutely must buy the hottest thing within a few months of it being released. Once you wait for a few months, then it’s cheaper to get the phone separately with a SIM-only plan. You end up saving anywhere from $400 to $750, for devices that are 12-24 months older. All for not doing anything, just waiting. This could extend to well over $1,000 for a second-hand device. Those monthly payments add up rapidly.

byovscontract

What about modders?

I try to avoid factory ROMs for a variety of reasons. An inconsistent user experience between devices, bloated footprints, unwanted apps, clunky frameworks, nefarious monitoring software. AOSP and CyanogenOS do a perfectly fine job of maintaining a consistent environment and enhanced feature set across devices. The increased speed is just a bonus. I often choose devices based on how healthy the third-party mod community is. However, it takes time for the ROMs to roll out and be fine tuned, on top of the time it takes for the manufacturer to release sources for their hardware. It’s a trade-off. On one hand, I won’t use a newly released device, like the Galaxy S6, as stable and polished ROMs won’t be available for at least 6 months, if not more. But on the other hand, by that time, there are plenty of accessories and bugfixes available too. Hardware issues by that stage are well known (such as the LG G3’s heat and cracking issues). It’s often the case that choosing an older device benefits a modder far more than a newer one, you can check XDA to see if there’s active development.

When should you buy on contract?

There are a few reasons why you would be inclined to buy on contract, some are arguably borderline cases. The first reason is where you have the uncontrollable urge to have the newest, to which I can empathise entirely. If you are buying a newly released model within the first 3-4 months, it will be cheaper on a contract, almost universally. The second is that your current phone is falling apart and is unrepairable. This doesn’t necessarily mean you have to buy the best device right now. Or, it could be the case that the previous model is thoroughly unloved (like the big-hearted but dog-faced Galaxy S5). Finally, the situation where your contract is expiring, which essentially is a self-perpetuating problem that never ends. Use this instead as a good reason to switch OUT of a contract plan onto a SIM-only plan, but hold onto your handset and use it for as long as you can. The exception to this is if your carrier is bundling other services in, such as broadband or family plans, in which case that’s a separate calculation.

The Summary

Here’s a simple checklist and guide on what I would recommend anybody do, assuming you don’t fall into the above categories:

Deciding if you need a new phone:

  • Do you really need a new phone? Will it make a substantial improvement in your quality of life? Do your friends and family get tired of you buried in your phone? In gadget lust, we’ll come up with fascinating justifications for why small improvements are life-changing. The reality is, nobody really cares if you’re using model 8 over model 6.
  • If your phone has been grinding to a halt, assess what the cause is, rather than blindly throwing more hardware at it. It could be a rogue app, or maybe the 150 single-use apps that you’ve installed over the years, which could be easily replaced by bookmarks. A thorough cleaning or factory reset can often be very effective.
  • If it’s your battery life becoming shoddy, investigate replacing the battery, which often costs less than $50 for a genuine OEM part (or $79 for iPhones). If it lets you squeeze out another year or two of use, it’s money well spent.
  • If you contract is expiring and your current phone is fine, switch to a cheaper SIM-only plan, despite your carrier’s protestations. A free upgrade is not a free upgrade. Use the phone as long as you can, or until a very good deal comes along.
  • If your current phone is broken or worn out, consider repairing it. There are plenty of cheap replacement components, video guides and failing that, repair shops available. Basic phone repair should be in the same category as changing a flat tire. By opening up and repairing your tools, you gain a finer appreciation for them. Remember that companies want to force obsolescence, and laziness enables this.
  • Ideally, just ignore the temptation of buying a new phone till the old one fails catastrophically, which is probably quite a few years away. This saves an incredible number of brain CPU cycles and time.
  • Speaking of brain cycles, not worrying about breaking a cheap phone is worth mountains over having to constantly baby a $1000+ device. The guy paying a loan off on a Ferrari is likely far more stressed by everyday dings than the guy thrashing his beater around.
  • If you absolutely no longer want your phone, wipe it first and sell it, it’s pointless to keep it around unused as it will just depreciate further and eventually add to toxic landfill. Hopefully it’s not chipped or scratched up. Or you can use it as a dedicated music player or GPS device.

Deciding on what phone to buy:

  • Ideally, buy a flagship from two years ago if it’s satisfactory. The Galaxy S4, the iPhone 5, the LG G2, the Moto X and the Sony Xperia Z2 are all perfectly capable handsets. 2014’s flagships often shared many of the same innards as 2013’s models. Alternatively, a 12 month old model, where there are actually substantial improvements. As we saw above with depreciation, even waiting 6 months after release can often be worthwhile. All of these will have steep discounts over a newly-released model. Sometimes, the newer model is actually more expensive AND measurably worse than the older model.
  • You can often still find these older models on display at stores, or you’ll probably know somebody who has had them in the past. If you do go to a store, ensure that you don’t impulsively buy it on the spot without having a chance to research prices elsewhere.
  • Never buy a brand new model just because it’s new. This is how people accumulate garages of junk and mountains of debts. In 6 months, something shinier and newer will make this one look old. Don’t tie value to having the shiniest things. Go on holiday or pay a loan off instead with that $1000 you saved.
  • Choose a device based on what criteria are especially important to you (photo quality, screen size, etc), rather than what everybody else is buying, or worse, the badge on the back. Even a few hours of research could save you years of frustration.
  • Be sure to pick one which supports LTE bands that your carrier uses or is rolling out. At the moment, all the local carriers are rolling out 4G on new spectrum, including aggregation. This makes a noticeable difference in speed.
  • When you choose a phone, also consider the serviceability of the device. Popular devices tend to be supported for longer and have a better choice of second-hand devices and parts available. Some devices are nearly impossible to take apart without wrecking them, such as the HTC One range.
  • Avoid buying notoriously fragile devices, such as the Xperia Z1/Z3 Compact, or the iPhone 4/4S, or iPhone 6 Plus. A porcelain bowling ball, is still porcelain.
  • The models which suffer the most depreciation are usually ones which are mainstream, but comparatively unloved (Galaxy S5, iPhone 5), or were released one year before very popular models. These can often be exceptionally good bang-for-buck and retailers will be willing to discount to clear stock.

Deciding on what SIM-only plan to buy:

  • When you choose a plan, pick based on network quality, then perks (like free calls, rollovers, bonuses) and finally, price. Having a good carrier and network quality is far more important than having a slightly newer phone on poor network.
  • Always ring up to purchase the plan, and negotiate with patience and the numbers in front of you. Carriers will always having some leeway to persuade you to join. I nearly doubled my data allowance, and secured a healthy monthly discount over the phone when I called about a SIM-only plan years ago, which I’m still on. Once every 6 months or so, I’ll browse around and see if the deals have improved. They haven’t, it’s too profitable.
  • Phone plans are obscenely overpriced for the quota that you get. If you can, cache or pre-download your content on your home/office wifi network before heading out. There are plenty of apps that will automatically do this for you. If this allows you to knock down your data plan to a lower level, it could end up saving you a fair amount. Data rollover is becoming popular now as well, which allows for a buffer effect on data allowance.

If I have missed some important information, or you’d like to share your thoughts, please leave a comment.

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