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Evolution in European smart phone market

London, 11 May 2016

Consumers used to buying their new smart phones from phone service providers are finding new options are now available as companies in Europe break with traditional purchasing methods in a bid to increase profits.

The popular subsidy plan – where a buyer gets a heavily subsidised handset after an upfront payment that is later topped up by an additional monthly fee – is losing ground with European consumers.

Two other purchasing methods: equipment instalment plans, where clients pay the handset back over a period of time, and leasing plans, where the buyer never owns the piece and can return it for an upgrade after a certain period have become more prevalent over the last 12 months.

Guy Peddy, Macquarie Securities Head of European telecoms research, says the trend will see consumers holding on to their smartphones for longer and the second-hand market broadening.

Consumers are buying their smart phones in different ways, which we think has massive and underappreciated implications for the handset supply chain.

The trend is mainly driven by operators seeking to refocus on selling a service and away from financing clients' purchases.

"As smartphones approach full penetration in developed markets and wireless economics become more challenging, we think carriers are less focused on pushing people onto new smartphones and focused more on increasing cash flow," says Peddy.

"Consumers are buying their smartphones in different ways, which we think has massive and underappreciated implications for the handset supply chain."

Incentives

For carriers, subsidising phone handsets has proven to be an expensive operation as it soaks up initial investment capital, even if the customer pays a higher monthly fee and is locked into a payment plan for up to two years.

Equipment instalment plans remove that subsidy, and carriers then issue an interest-free loan to the client, whose monthly service payments are additionally reduced. In leasing, the carrier offloads the handset cost burden onto a third party that acts as a financial lender.

"Operators are trying to break the association between buying a phone contract service and buying the handset," says Peddy. "To do that, what they have effectively done is added to the mechanisms for financing."

For consumers, the focus is on avoiding lock-up periods and upfront costs, and saving on handsets.

Peddy, who has covered the industry since 1997, says the trend will most definitely grow, with carriers directing marketing and sales efforts towards new plans away from subsidies.

Distribution disruption

Increases in equipment instalment plans, leasing and recycling will lead to a decrease in the number of new handset shipments.

Macquarie Research estimates, for example, that for every 100 basis-point increase in equipment installment plans there will be an 86 basis-point decrease in 2016 smartphone shipment growth.

The same increase in leasing would lead to a 5 basis point decrease in 2017 growth. A 100 basis-point increase in recycling would see 2016 shipment growth decline by 72-basis-points.

The trend is already denting growth patterns. Macquarie estimates the market may grow about seven per cent in 2016, or two percentage points below current market estimates.

Longer life cycle

Without a subsidy, clients are rewarded for keeping their phones for longer, as their bills fall after the phone is fully paid off. For example, in Japan, where equipment instalment plans offerings were introduced in 2007, the average handset life expanded from about two to more than three years.

"If consumers don't have to spend €30 or €40 a month on a handset, they are not going to," says Peddy. "They might delay an upgrade for six months until their device cracks."

In the US, annual smartphone activation growth declined in the first quarter of 2015 for the first time in the five years. Activations at the big four US carriers as a percentage of smartphones shipped is increasing, probably explained by a growing secondary market where more second hand devices are being activated.

Peddy says the trend is explained by high mobile penetration, operators are spending less in handset subsidies, handsets are lasting longer and each iteration of the iPhone is less of a meaningful spend.

Growing second-hand market

The second-hand market is now being fuelled by operators re-selling returned handsets and by consumers opting out of subsidy plans. According to consumer analytics site NPD, 55 per cent of consumers plan on using carrier trade-in programs the next time they upgrade, compared with only 13 per cent of users utilising the trade-in service during their prior upgrade.

Macquarie Research puts the size of the global used smartphone market at roughly 83 million units, and predicts it may grow about 24 per cent a year to reach 158 million units by 2018.

Macquarie Research estimates that discounts offered by handset manufacturers - including Apple, Samsung and HTC - to earlier flagship phone models, are in the range of 15 per cent to 26 per cent. The secondary market pricing offers further discounts that typically range between 10 per cent and 30 per cent below manufacturers' deals.

Winners and losers

Peddy believes the market for used phones will impact principally on providers of mid-range and low-end handsets, as the specifications and price points for a two-year-old, high-end phone are very competitive. Apple, whose phones are among the most expensive but also the most desired, will benefit from this.

The disruption is likely to be neutral for carriers, which will lose some of their grip on clients but face lower subsidies and get a new revenue source from used smartphone distribution, however it may be negative for manufacturers of parts for Android-based smartphones.

For more information on the report "Global Technology: Smart phone distribution disruption" (6 October 2015) contact Macquarie Research.