Thanks to AT&T CEO Randall Stephenson, subsidies are once again in the news:

AT&T’s top executive says the era of big subsidies for devices is coming to an end, as wireless operators can no longer afford to fund a constant smartphone upgrade cycle.

Speaking at an investor conference in New York City on Tuesday, AT&T CEO Randall Stephenson said that with smartphone penetration at over 75 percent and soon reaching 90 percent, wireless operators need to work harder to get customers to use more of the network rather than simply getting on the network.

“When you’re growing the business initially, you have to do aggressive device subsidies to get people on the network,” he said. “But as you approach 90 percent penetration, you move into maintenance mode. That means more device upgrades. And the model has to change. You can’t afford to subsidize devices like that.”

Last week, AT&T introduced a new pricing plan that offers an incentive to customers who keep their older phones, allowing them to save $15 a month on their service bill.

The knee-jerk reaction of many, particularly Apple bears, was to paint this as the end of subsidies. This, of course, is nonsense.

• First off, as Jean-Louis Gassee notes today, the very word “subsidy” is problematic:
  

  I don’t know if Stephenson is speaking out of cultural deafness or cynicism, but he’s obscuring the point: There is no subsidy. Carriers extend a loan that users pay back as part of the monthly service payment. Like any loan shark, the carrier likes its subscriber to stay indefinitely in debt, to always come back for more, for a new phone and its ever-revolving payments stream.

• As Horace Dediu has written multiple times, most recently today, subsidies are the carriers best friend.
  

  It may be an illusion, but a cheap phone (with a long-term contract) is a fundamental innovation devised by telco operators even before the phone became mobile. Operators have come to love it and no matter how many technology generations go by; how many family plans, bucket plans, weekend minutes, rollovers, and data packages; no matter how many tweaks and re-brands the model gets, it will persist. There simply isn’t sufficient win-win value in alternatives.

• The iPhone is a particularly special case: as I wrote last April, it not only helps carriers sell network access – as does any smartphone – but it also punishes carriers who refuse Apple’s demands by virtue of Apple’s customer loyalty:
  

  • The carriers see the iPhone as a strategic threat because Apple owns the customer relationship; the carrier is reduced to a utility. Therefore the leading carriers do not carry the iPhone
  • Customers strongly prefer the iPhone; in fact, they prefer it so much that they switch carriers to get the iPhone (something that is very difficult and rare). Second-and-third place carriers add the iPhone in order to steal customers from the leader
  • The leading carrier is forced to choose between losing the customer relationship to Apple or losing the customer completely

  The fact that iPhone users are fabulously profitable makes this situation (and the associated subsidies) tolerable.

So Stephenson’s speech was so much bluster and safe to ignore, right?

Actually, not quite so fast. To be sure, Stephenson was being quite duplicitous, but the true meaning behind AT&T’s recent actions speak to a very important shift happening in the telecom industry, and the US is in the forefront: smartphones are reaching saturation, and that means the end of easy earnings growth for telecoms.

Broadly speaking, there are three ways to grow: increase prices, lower costs, or gain new customers. The iPhone was such a coup for AT&T because it accomplished two of those: the Average Price Per User (ARPU) of an iPhone user was significantly higher than a feature phone user (increased prices), and AT&T stole Apple-loyal customers from the other carriers, particularly Verizon (gain new customers). Over time, more smartphones came into the market, and the iPhone spread to other carriers, but all those smartphones had the same higher ARPU. AT&T and all the other carriers could achieve earnings growth simply by selling feature phone customers smartphones and the associated higher monthly fees that accompanied them.

That gravy train is nearly over though, and once it becomes more difficult to raise prices (because there are no more feature phone customers to upgrade to smartphones), the remaining option for growth is gaining new users. And, given the fact that nearly everyone in America will soon have a smartphone, that means stealing customers from other carriers.

In fact, it’s this dynamic that explains AT&T’s decision to reduce your phone bill by $15 once your phone is fully paid for. This is obviously a response to T-Mobile’s “uncarrier” initiative which clearly delineated what you paid for cell phone service from what you paid for your phone, and quite successfully at that:

T-Mobile US Inc, the No. 4 U.S. mobile provider, reported much better-than-expected subscriber growth, outpacing bigger rival AT&T and also putting pressure on other competitors, including market leader Verizon Wireless.

This was the second straight quarter of growth after four years of customer losses at T-Mobile US, which is 74 percent owned by Deutsche Telekom AG. It made inroads against bigger rivals by criticizing them in its marketing and selling itself as more consumer-friendly with cheaper prices and more flexibility.

Make no mistake – AT&T would rather not give this discount (and that is what makes Stephenson’s remarks duplicitous); until now, smartphone customers spent some number of months paying off their phones with higher bills, and then, once the phone was paid for, postpaid subscribers effectively gave AT&T cash equivalent to their phone’s monthly payoff amount because they didn’t know any better. People who kept phones longer than two years, for example, presuming that ~$20 of every month’s bill was intended for phone payoff, effectively gave AT&T et al. $240 of pure profit in that third year. T-Mobile exposed that, and AT&T is giving some of that money back.

This has interesting implications for smartphone manufacturers. As a group, it is bad news; alerting customers to the fact they can save money by not buying a new device increases the likelihood customers find their current phone “good enough.” As Microsoft is painfully learning in the PC world, any extension in device replacement time is a loss.

For Apple, though, while this bad news does apply to them equally, they on balance come out better than their competitors by virtue of selling the most expensive devices. In other words, $20 of your AT&T bill may go to pay for your iPhone, while only $14 goes to pay for your HTC. But, because AT&T is pricing the discount at $15 regardless of your phone, the iPhone’s higher price will continue to be disguised from consumers, to the benefit of Apple’s margins. Update: As Sameer Singh pointed out on Twitter, AT&T is in fact exposing the price of the devices, just as T-Mobile is. I will expand on the implications of this tomorrow, but it is not as good for Apple.

Ultimately, smartphone saturation is good news for consumers and bad for device manufacturers and carriers. Carriers have spent the last 6 years competing not for each others’ customers but rather in their efficiency in wringing more money out of their existing customer base through smartphone sales. Moving forward, though, the best means for growth is stealing customers, and the increase competition will mean lower prices and more transparency of the sort we are already seeing from T-Mobile and AT&T.