Tuesday, 19 October 2010
Estimated equivalent APR up to 33% for latest smartphone on contract
In fact many phones are advertised as "free", but lock you into a contract typically 18-24 months in duration. It's from this contract that the network claws back the cost of the phone.
It's no different really to a loan, which is why most phone companies will run a credit reference check on you before letting you walk out of the store with a shiny new phone.
But unlike a loan, mobile phone companies don't show you the cost of borrowing, ie. the Annual Percentage Rate (APR) they add as interest over the lifetime of the contract.
Many would assume the market is competitive: all the phone companies want your custom, and therefore you're bound to get a good deal, right? Not exactly. The phone companies are competing against each other, and each offer slightly different deals in terms of free minutes, inclusive data and texts.
But this leads to confusion in the market and consequently it can be hard to compare the value of packages from different operators. Also the varying merits of each network in terms of quality and coverage adds to consumer confusion, before even considering so-called Value Added Services such as music bundles or free cinema tickets, which each network believes adds value to their offering.
The networks don't release a breakdown of their costs, so it's almost impossible to get any idea of how much money the networks are making on the phone hardware itself or the financing via contract. No-one outside the network knows the base cost of a 100 minutes/month with 500MB of inclusive data and unlimited text messages.
However a virtual mobile network operator called giffgaff will put a customer's existing mobile phone on the O2 network with a SIM-only deal that includes bundled minutes, unlimited texts and bundled data on a pay-as-you-go basis with no ties. In terms of performance your phone's on the same network, however sales and customer relations are handled by giffgaff staff instead of O2.
Using the prices charged for equivalent or better giffgaff bundles as an indicator of the base cost of O2 contracts it's possible to estimate the cost of "borrowing" to buy a phone on contract.
The results surprised me, with the worst deal - an 18-month contract with 100 inclusive minutes and 500MB of data - having an estimated equivalent APR of 33%.
Method and calculations
I looked at 4 deals to buy the Samsung Galaxy S I9000 8GB phone from O2, with 2 on an 18-month contract and 2 on 24-months. I then checked several stores to get a good estimate of the cost of the phone "SIM free" (unlocked). £429.99 seemed a fair comparison price (including delivery) being the cheapest amongst the mainstream retailers (in this case Play.com) but not the cheapest I saw advertised. It also happens to be the price I paid for my Galaxy S I9000!.
I then deducted the cost of the package (including minutes, texts and internet) using the prices charged for an equivalent giffgaff bundle. In fact in each case giffgaff offered a better inclusive bundle to the service charge used in my estimation.
The maths is fairly complicated but it's here on a Google Docs spreadsheet if you want to verify my sums.
Results and summary
The best deal I looked at was a 24-month contract with 300 inclusive minutes, where the estimated equivalent APR fell to 8.2% - a fair price in my view. The 300-minutes deal on an 18-month contract for this handset carried an estimated equivalent APR of 10.8% - not bad - but a 100-minutes deal on a 24-month contract had an estimated APR of 25.0%. The worst I looked at was the previously mentioned deal at 33% (estimated).
Remember - this is my estimate of the profit O2 make just from lending you the money to buy a handset from them, and is completely separate from any profit made selling the phone itself, since my guide price for the handset was a retail price - not a wholesale price. It's fair to assume Play.com will make a profit selling the handset at £429.99.
Of course this is just an estimate to highlight a point, O2 might argue that giffgaff don't give value in other areas they do, or are running such bundles as a "loss leader". I'm happy to publish any rebuttal of my method if O2 provide me with new information.
But it's worth noting that the giffgaff bundles offer a better deal than O2's - with 150 inclusive minutes compared to 100 from O2, and in both cases giffgaff claim to offer "unlimited" data compared to 500MB from O2.
Remember also purchasing the handset up-front removes any ties, leaving you free to move to the best deal available at any point over the period you'd otherwise be locked into a contract.
There's one lesson beyond dispute - a portion of the contract cost is paying for the handset, so it's important to renegotiate your deal the month the contract period ends, otherwise you're paying for a phone you already own!
Note: other than using their network and hardware I have no association whatsoever with giffgaff, O2 or Samsung. This piece is the opinion of the author and all estimates and assumptions are stated or linked from the article. Any statement from any of the companies listed should be sent to email@example.com