T-Mobile: Paying Customers Pays Off

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In the battle for customers, T-Mobile's aggressive tactics have paid off. The company has shaken up the wireless industry while adding customers and increasing revenue.

T-Mobile CEO John Legere launched the company's Uncarrier campaign -- in which the company redefined the traditional contract agreement, among other changes -- last year, threatening to turn wireless network operators' businesses on their heads. There's no denying Legere's strategy has had a positive effect, but there's a dark side to T-Mobile's success.

During the first quarter of the year, T-Mobile added 1.3 million postpaid customers -- more than AT&T, Sprint, and Verizon combined during the same period. T-Mobile says net customer additions, which include MetroPCS and other subscribers, reached 2.4 million. Revenue climbed, too, by 47% year-over-year, to nearly $6.9 billion. The company sold a record number of smartphones, 6.9 million. T-Mobile said 92% of its customers bought smartphones, compared to 91% during the fourth quarter of 2013. Smartphones now make up 81% of its customers, up from 79% during the fourth quarter.

T-Mobile has increased its total customer base from 34 million a year ago to 49 million. The company is within striking distance of Sprint, which continues to bleed customers (who are likely switching to T-Mobile). Sprint has 55 million customers. Both T-Mobile and Sprint trail AT&T and Verizon, however, by tens of millions of customers.

How did T-Mobile make such big wins? Hard work, a little business savvy... and cold, hard cash.

[Will LG's upcoming G3 smartphone help the company gain traction in the market? Read LG Makes Gains As G3 Debut Nears.]

T-Mobile's Uncarrier initiatives are certainly appealing to customers. The company abolished the idea of signing contracts. It separated the cost of the device from the cost of the service, which has helped give consumers a more realistic understanding of the costs of smartphones and other hardware. The company also allows customers to jump to new devices more frequently, playing on consumers' resentment at being stuck with the same phone for two years. Further, T-Mobile offers tablets 200 MB of free data with no contract. (T-Mobile added 69,000 tablet customers during the first quarter.) It offers free and low-cost service to customers who roam overseas. And finally, the company has aggressively improved its network with added coverage and faster service.

All these factors forced AT&T, Sprint, and Verizon to respond. T-Mobile's competitors have all introduced no-contract, early-upgrade plans. They've also reduced the pricing on some plans to better match T-Mobile's. So far, this is all good for the consumer.

T-Mobile did another thing, however, that used to be frowned upon in the industry: It put a bounty on new customers. In January, T-Mobile offered to pay consumers' early termination fees (ETFs) if they switched to T-Mobile. Further, the company said it would pay contract-breakers for their old handsets. That means new customers stand to each net $650 in credit with T-Mobile when they dump their carriers. That's a huge incentive for consumers to change carriers (which the industry calls churn). Carriers have tried to offer bounties for customers before, but the deals -- usually around $100 or $200 -- have never been so sweet. T-Mobile's offer is akin to paying for new customers.

These customer acquisition costs hurt T-Mobile's balance sheet during the first quarter, during which the company lost $156 million. T-Mobile said 21% of its postpaid additions, about 273,000 customers, asked for ETFs to be reimbursed. Before the program went into effect, T-Mobile estimated that it would end up spending about $300 on average (rather than $650) to acquire these customers, thanks to pro-rated ETFs and estimates on the cost of replacing phones. Using that figure, T-Mobile spent about $82 million to pay for these new customers -- more than half the company's recorded loss.

Since T-Mobile continues to offer this cash discount to new customers, it will surely hit the bottom line during the second quarter, too. It's a pricey way to swell the ranks -- one that the company can't afford to support indefinitely.

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