Absurdity of Mobile Phone Subsidies

The issue of mobile phone subsidies and early termination fees has been getting a lot of extra attention lately. The FCC has asked Verizon to explain its early termination fees, and why they are requiring higher fees for users of certain phones. Their answer is, of course, ludicrous. But the fees were ludicrous to begin with. These problems are well known even outside of tech circles, but lets examine it much closer, shall we?

The fundamental problem here is that people want fancy phones. The thing is, fancy phones cost a whole lot of money. If you pay full retail price for an unlocked smartphone, it can cost up to $1000, depending on the phone. You can get a really big TV for $1000. Most people, in the US at least, won’t pay that kind of money for a tiny phone, even though it is something they use constantly.

The solution is to subsidize the phones. Sell the phone for $200 or $100. Then, simply require the customer to stick with your service for two years. Over the course of those two years, you will make back the cost of the phone. If they leave early, you’ll take a loss, so charge them an early termination fee. Makes perfect sense, on paper.

In reality, it just doesn’t add up. Let’s say I already own an unlocked phone. I go to a carrier and ask for service. Even if I don’t get a contract, I’ll be paying the same data and voice rates as someone who had their phone subsidized by the carrier. Shouldn’t my monthly fees for data and voice be less? The carrier didn’t subsidize a phone for me, but I still have to pay them just as much money as if they had? If I stick with them for two years, then I’ve paid for a phone subsidy without receiving a heavily discounted phone! People who did not have their phones subsidized should pay less monthly than those who have.

Also, keep in mind that early termination fees never reduce to zero. The fee exists, supposedly, only because of the phone subsidy. Therefore, the cost of the ETF should be equal to the remaining unpaid value of the phone. Let’s say I get a phone and $400 of the price was subsidized down to $0 with a two year contract. 400 divided by 24 is about $17. The fee in the first month of service should be $400. The fee should then decrease by $17 each month, and in the final month the fee should be $17.

Wait, this payment structure sounds familiar. That’s right, it’s called a loan! Actually, it’s a 0% interest loan. It’s also exactly what mobile phone carriers need to replace subsidies with.

Step one is to lower all voice/data/text charges. They are absurdly high. Because there will be no more subsidies, there will be no more need for that kind of ripoff. Existing users with subsidized phones will still pay the old fees, or early termination fees, to grandfather them into the new pricing structure.

Step two is to advertise the true cost of phones. Let everyone know the full MSRP of each and every phone. This allows the customer to make a much more informed decision when they select a phone. It also gives people the option of buying phones without service. Carriers won’t like this, because most people will opt for the cheap phones once they realize the trust cost of the expensive ones. Those cheap phones don’t require the data plans and other features that the carriers also like to charge an arm and a leg for.

The final step is to offer financing. Even affluent people don’t want to shell out that much money on a phone all at once. Instead, the carrier offers financing at zero or a very low interest rate, obviously depending on the customer’s credit rating and such. The monthly payments for this loan will be included in the monthly bill for voice and data. Even if someone cancels their voice and data contract, they will still have to pay off the device itself, or return it.

This is really a win win solution. Carriers will save money from subsidies, and maybe make money with a small and reasonable amount of interest on the financing. Customers will have the freedom to switch carriers as they please, and pay reasonable prices for voice and data service.

The last piece of the puzzle are the device manufacturers. Because of carrier lock-in and subsidies, most handset manufacturers are really selling their product to carriers, not to customers. Motorola and LG make a handset that Verizon loves, not one that you and I love. I think that Apple has demonstrated with the iPhone that by creating a handset for the customer, you can make the real bank. If subsidies go away, perhaps we will see some real competition between the manufacturers for the consumer’s love. That should result in the current phone arms race escalating and resulting in better cheaper devices for everybody.

Kill subsidies. Get rid of the contracts. Charge full price for devices, but allow financing. Problem solved. Do it now.