BusinessWeek: Assurance Wireless and Safelink offer free cells phones at government expense

There’s a big controversy on blogs across the internet as to whether or not free cell phones from Safelink Wireless, Assurance Wireless, ReachOut Wireless and perhaps others are ultimately funded by the taxpayer or not. Yes, there is no federal or state income tax that directly supports the program. But the Universal Service Fee found on phone bills and assessed to telecommunication companies is set and required by the government.

BusinessWeek recently wrote an article on the issue. But they placed their focus not on the benefit of those who receive the free cell phone, but on the benefit to the companies who supply them. In the case of this particular article, they focus on Sprint Nextel, which provides the cell phones for free through their brand Assurance Wireless, and Tracfone and their Safelink Wireless brand.

While there’s no free lunch, Evan Mensch recently discovered that there are free cell phones. After losing his sales job, the 37-year-old single father of two from Perry, Md., couldn’t afford to continue his regular wireless contract. After learning of the federal program that provides wireless service to the oft-unemployed poor, Mensch signed up for a free Kyocera (KYO) cell phone with 250 free minutes of calling a month through Assurance Wireless, a brand run by Sprint Nextel (S). “Because of Assurance, I was able to get a call back from an employer,” says Mensch, who received a job offer in November after nearly two years without a job.

Sprint Nextel isn’t driven by altruism. Serving cash-pinched customers like Mensch can pay off due to federal government subsidies. And finding new customers isn’t hard. With unemployment at 9.4 percent and one in six Americans living in poverty, Sprint and rival América Movíl’s (AMX) TracFone unit have seen an explosion in sign-ups for the government-subsidized free wireless services they’ve offered for more than a year. In some financial reporting periods, Assurance accounts for up to 60 percent of new subscribers to Sprint’s prepaid cellular plans, which don’t require an annual contract, estimates Michael McCormack, an analyst with Nomura Securities International. “There’s a growth opportunity here,” he says. “There’s an untapped market still.”

How does the free cell phone provider benefit? Mobile phone companies live and die by the “churn rate.” which is the rate at which customers drop service, and by acquisition costs, which is the cost of marketing and phone subsidization required to snag a new customer. Both of these are much, much lower for brands like Safelink, Assurance and ReachOut.

The Universal Service Administrative Company (USAC)—which manages a federal fund to which U.S. telecom companies are required to contribute fees—pays carriers up to $10 per subscriber per month. While that amount may sound meager, it translates into roughly the same per-minute rate spent by the average paying U.S. wireless user. Meanwhile, Sprint’s costs of recruiting and keeping these customers are likely lower: Although more than half of regular prepaid wireless subscribers drop their service every year, Assurance users stay put. “We’ve seen very, very low churn,” Boehm says.

Until 2008 the government simply subsidized between $3 and $10 of qualifying low-income consumers’ monthly wireless bills as a way to assure their access to basic phone service; customers paid the rest out of pocket. (Uncle Sam offers similar subsidies for landline customers.) But since TracFone started offering totally free service in August 2008, paid directly by the subsidy, demand has soared. USAC’s annual disbursements to telcos providing low-income phone service rose 52 percent, to $1.25 billion, between 2008 and 2010. Free wireless is the biggest reason for the increase, with the new market generating hundreds of millions of dollars for service providers.

How well are the companies doing?

Free cellular plans continue to spread across the map. In January, Sprint began offering Assurance service in five more states, and it hopes eventually to serve the entire country. Rival TracFone now offers its SafeLink Wireless service in 30 states, as well as in Washington and Puerto Rico. It has applied to provide the service in six more states. A dozen other carriers have recently applied for or received governmental approvals to offer free service.

The bottom line: Wireless operators like Sprint Nextel are building a big business providing free cellular service to the poor. Washington picks up the tab.

Source: BusinessWeek