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Cellphones Businesses Handhelds The Almighty Buck

Really, Why Are Smartphones Still Tied To Contracts? 482

Bennett Haselton writes: "It's not trivial to explain why cell phone companies find it profitable to sell phones at a deep up-front discount and make it back over a two-year contract. Why don't other companies sell similarly-priced goods the same way? (And why, for that matter, has T-Mobile found it more profitable to do the opposite, selling the phone and the service separately?) I'm trying to come up with an explanation that makes realistic and consistent assumptions about the stupidity of the buying public, and still makes sense." Read on for the rest of Bennett's thoughts.

Matthew Yglesias at Slate wrote a year and a half ago about T-Mobile up-ending the cell phone industry by starting to sell phones and phone service separately. Yglesias wrote about the prevailing cell phone business model up to that point:

The customer walks out thrilled with the deal he got on his phone. Only later, when his ridiculous, complicated, and obscenely high bill comes, does he realize he has been fleeced.
The subsidy model is basically a scam, but it only arose thanks to our own collective mental failings. A phone-buying public used to getting high-end devices for $200 or $300 may simply balk at the discovery that a pocket-sized computer’s actual price is twice that or more. Until now, limited competition in the industry has let us optimistically believe that the American phone-buying public is the victim of unscrupulous business practices. But if T-Mobile can’t make this work, the lesson will be that the real fault lies with ourselves.

I always thought the underlying question was more complicated than that. First of all, if customers really realized that they had been "fleeced" after the first of their 24 monthly bills came in, that scam should only work on a particular customer for... two years, and then they would be wiser the second time around. But plenty of users stay with Verizon and AT&T year after year, getting new free phone "upgrades" that lock them into extended contracts. And besides, are so many phone buyers really that dumb, that they would take a "free" phone while entering into a two-year recurring billing contract, without thinking about how much that would commit them to paying in the long run? This is why I think that explanation doesn't meet the criteria of making realistic assumptions about how easy it is to fool the public.

Or if you think people really are that gullible, then the obvious question is why that tactic doesn't work for other products sold just a few feet away at the same Best Buy. While cars and other big-ticket items are often advertised for "No money down and just 24 monthly payments of $X", the vast majority of laptops and other expensive consumer goods are simply advertised with their sale price, and if you want to pay for them in installments, you can work that out at the time of purchase. If consumers are really dumb enough to be swindled into overpaying for their cell phones over two years, why aren't laptops and other items advertised in terms of two-year monthly payment contracts? This explanation makes inconsistent assumptions about how dumb we are.

And it can't be as simple as "Some people don't have the money to pay for the phone up front," because most places you enter into a cell phone service contract, will also let you buy the phone outright and set up an installment plan to pay it off (which of course is basically the same thing as paying it off over your two-year contract). You have to get a credit check to get on an installment plan, but you have to get a credit check to get on a cell service contract too. So that can't be the complete explanation either.

And then there's the twin mystery of why T-Mobile finds it profitable to do the opposite and avoid contracts entirely. This, at least, has a plausible explanation -- T-Mobile, with the smallest coverage area of the major cell providers, was looking for a way to differentiate itself from competitors that didn't involve slashing prices in proportion to their smaller coverage. So their phones don't work out in the boonies, but you know exactly what you're paying for when you buy the phone, and when you buy the service plan.

But why does everyone else continue to sell phones on contracts? Why do we still fall for it? And why don't the same tricks work for other expensive electronic goods?

The best explanation I've heard so far involves a combination of the following:

  • Cell phones, unlike cars and laptops, don't look like they should cost as much as they do. (Electronics engineers know that of course it's harder and more expensive to fit fancy circuitry into a smaller space, but regular phone buyers instinctively think smaller should be cheaper.) So people would instinctively balk at the sticker price of a smartphone, even if it were payable in installments so they didn't have to have the cash up front. As a result, they pay instead through a more expensive service contract, even though the total ends up being more than if they had just bought the phone and paid in installments.
  • Cell phones, unlike cars and laptops, are only useful when tied to recurring purchases of another product, the cell phone service plan. This presents an opportunity to confuse buyers who have no idea how much that service plan should actually cost, so they don't realize how much the service plan fee has been inflated to cover the cost of the phone. A laptop, by contrast, may only be useful when connected to the Internet, but there isn't a one-to-one pairing of laptops with Internet service contracts because multiple laptops in the same household usually share the same WiFi bill. And all cars require gas, but it would be hard to sell someone a cheap subsidized car and then require them to buy all of their gas from one overpriced vendor for the next two years.

These explanations are at least internally consistent, so they could be true. Who knows if they actually are true. Can you think of others?

The good news is that other cell phone companies are catching on: When I called the local AT&T store to ask if they had any "free" phones that came with a two-year contract, the salesman immediately steered me towards purchasing the phone and the plan separately, T-Mobile-style, saying it was cheaper. He said I could get a Nokia 920 for free with a two-year contract to pay $40/month, or I could buy the phone outright and pay it off in installments of $11/month, while meanwhile using the service plan for $25/month, for a lower combined price of $36/month. The local Verizon store said I could get the latest Droid for free with a 2-year contract paying $75/month, or I could pay the phone off in installments of $16/month while getting a discounted non-contract service plan for $65/month. So Verizon in this case doesn't actually make it cheaper to buy the phone outright and pay it off in installments, but at least it's a step in the right direction. (When I bought a phone from Verizon two years ago, they didn't offer any discount on their monthly service plan even if you bought the device outright. It has always been possible to buy cell phones at a full retail price, but of course it didn't make sense unless you would get a corresponding discount on the service plan.)

So this is good news, but it makes the relevant question even more difficult: Why is it that cell phone companies previously found it profitable only to sell phones on contracts, and now find it profitable to move slightly in the opposite direction? With any luck, soon the question will be a historic one: "How come cell phone companies used to confuse us about what we were really paying for our cell phones, and why did we put up with it?"

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Really, Why Are Smartphones Still Tied To Contracts?

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  • by wiredog ( 43288 ) on Thursday May 01, 2014 @01:51PM (#46891243) Journal

    T-Mobile is losing money. Something in the $100m/year range.

  • Because it works (Score:4, Informative)

    by Registered Coward v2 ( 447531 ) on Thursday May 01, 2014 @01:58PM (#46891361)

    So this is good news, but it makes the relevant question even more difficult: Why is it that cell phone companies previously found it profitable only to sell phones on contracts, and now find it profitable to move slightly in the opposite direction? With any luck, soon the question will be a historic one: "How come cell phone companies used to confuse us about what we were really paying for our cell phones, and why did we put up with it?"

    As TFA points out, it's generally a pricing perception issue. People will part with $0 upfront and pay $XX per month rather that $600 up front and $YY per month; even if the second option is cheaper. Since the first option results in more money companies do that

    Why did T-Mobile decide to do it differently? The cell phone business is a high fixed cost (the network) low variable (carrying a call) cost industry. T-Mobile, as TFA points out is a much smaller #3. Even so, their fixed costs are probably not proportionately smaller since they still have a similar service footprint except perhaps in low density rural areas. So they need as many subscribers as possible to cover the fixed costs; hence a move to differentiate themselves in the market.

  • by Shakrai ( 717556 ) * on Thursday May 01, 2014 @02:16PM (#46891613) Journal

    That's because no amount of creative pricing and sexy marketing (random musing: CZJ was way better than pink motorcycle lady with annoying voice) can hide the fact that T-Mobile has a 1990s network in 2014. Seriously, it's pathetic unless you live in a major city, and even then you'll have to deal with inferior indoor coverage as compared to carriers with 850mhz licenses.

    Here in Upstate NY your options as soon as you leave the city limits range from EDGE to "roaming on AT&T" (if T-Mo allows it where you're at, they don't in all areas) to "no service at all". I experimented with T-Mobile back in 2007-2008 when I couldn't afford to pay Verizon's premium prices and had to deal with zero coverage for the last ten minutes of my thirty minute daily commute. They've not really improved all that much since then, at least if their coverage maps are any indication.

    The analogy that I've long used is that Verizon is the hottest girl at the prom, and worse, she knows it.

  • Doy (Score:5, Informative)

    by CanHasDIY ( 1672858 ) on Thursday May 01, 2014 @02:16PM (#46891617) Homepage Journal

    Because they make more money that way, doofus.

    Seriously, who is upvoting this guy's blog posts in the firehose? Or does he have some dirt on the editors? Can't figure out why these BS BH posts keep making it to the front page...

  • by kyrsjo ( 2420192 ) on Thursday May 01, 2014 @02:18PM (#46891633)

    The title of the article is:
    "Really, Why Are Smartphones Still Tied To Contracts?"

    However, this is really an American phenomenon - in most of the world the most common is to buy the phone you want "cash", then get a SIM card from the provider you want (or just move over your old SIM).

    This also means that it's common to get a prepaid SIM if one goes abroad for more than a few days, in order to call/receive calls for cheap, and use data without being fleeced. It also means that the phones are not branded the same as the network, but branded as Samsung / HTC / Apple / etc.

  • by Daetrin ( 576516 ) on Thursday May 01, 2014 @02:55PM (#46892129)
    I'm obviously at in advantage because i live in SoCal, but when i switched to T-Mobile at the start of 2010 i thought their 3G network was pretty good. When my phone started malfunctioning in... mid 2011 i think? and couldn't hold a 3G connection anymore, i thought their Edge network was slow, but i made do. When i got my new phone in late 2013 i thought 4G was blazing fast. Fast enough that i don't even bother switching to wireless at home. (That choice is influenced by being on the $30/month unlimited data plan and the fact that our wireless router can be a bit wonky at times.)

    I haven't found anywhere outside in OC or LA where i can't get signal, except for some spots near the top of the Runyon Canyon Park, which i can live with. When i was on 3G or Edge there were a couple buildings that i couldn't get signal inside of very well (unfortunately one of those buildings was my office =) but since switching to 4G that problem seems to have disappeared.

    (Except for the lunch room at work. I can't get signal in the lunch room. No one, no matter what their carrier, can get signal in the lunch room. They must have built it out of lead or something.)

    (random musing: I like pink motorcycle lady, and don't remember anything distinctive about her voice at all. I don't really think she's any better or worse than CZJ was.)
  • Re:That's easy (Score:4, Informative)

    by FireFury03 ( 653718 ) <> on Thursday May 01, 2014 @03:43PM (#46892763) Homepage

    It was impossible to do this until the past 2-3 years.


    In 2004 I bought my last subsidised phone - a Sony Ericsson P900. And the only reason I did this was because there was a loophole in the Orange contracts that meant I could get it dirt cheap by getting it on an expensive tariff and then change to a cheap tariff after the first month (they closed this loophole shortly after). My next phone was an HTC Dream in 2009, bought used off eBay. On Three's PAYG tariff that worked out pretty cheap. When the HTC Dream died in 2012, I imported a Samsung Captivate Glide and just swapped my Three SIM into it.

    So the option to buy a handset and put it on a tariff of your choice has been there for years, if you actually look. But almost no one *advertises* off-contract handsets, so a lot of people don't even realise that you can do this, so they get a standard subsidised handset on, what they seem to think, is a good deal because they pay a low low upfront price and then a fixed monthly fee which gives them way more inclusive minutes/texts/data than they are ever going to use. If they had actually investigated their options, a lot of people would've realised that it was cheaper for them to buy a handset and put a PAYG SIM in it, because they're never *really* going to use those 10,000 minutes per month that they would've got with the subsidised phone.

    Then, after 1-2 years, the MNO writes to their customer to say they can get a "free" (or low price) upgrade if they renew their contract, and you'd be stupid to turn down "free", right? Again, people don't investigate their options - if they did they would often realise it would be better to stick with their existing phone and move it onto a cheaper tariff.

    And of course, no one in the industry wants to change this - the MNOs are making lots of money through these overpriced contracts, the phone vendors love the fact that everyone chucks away their perfectly good phone every 2 years and gets a replacement, and the customers usually don't know any better.

    I guess add to that that for some crazy reason, phones are seen as a status symbol and therefore everyone's always got to have a brand new phone. TBH, from my perspective, the more recent phones don't seem anywhere near as good as the older ones, so I am loath to "upgrade" my phone. The HTC Dream may have been slow, but the form factor was fantastic; the Samsung Captivate Glide that I replaced it with is verging on the "slightly too big" side and the keyboard isn't anywhere near as nice to use; If I had to upgrade now, I'd be hard pressed to find anything to replace it with - none of the current phones have hard keyboards at all and screen sizes seem to have become stupid - everyone seems to be competing to be the first to make a phone that's even less likely to fit in your pocket/hand than their competetor's. Yes, the internals of phones are getting way better, but the form factors are far worse.

  • by WaywardGeek ( 1480513 ) on Thursday May 01, 2014 @04:14PM (#46893169) Journal

    It's not just the dumb 2-year contract scam. We're also being fleeced for voice contracts, on both our land-line and mobile, because the phone companies prefer to continue charging a 1970's service charge for something that modern networks deliver practically for free. T-Mobile doesn't need 850MHz spectrum. They need free VoIP over WiFi whenever you're indoors at work, home, or a friend's house.

    Fortunately, there's a new kid on the block, Republic Wireless, who is doing contract-free ultra-cheap service. By offloading traffic to your own home wifi, RW can in theory make money $25/mo for Sprint 3G "unlimited" service. That's the plan I have, and I have the $10 plan for my kids. Verizon 4G LTE was great (my previous phone was a Verizon/Google Galaxy Nexus), but for the $60/month savings on just one phone, I'll live with Sprint. Also, they've got the Moto-X for $300, contract free, and it's hands down the best phone I've had. Time will tell if sane service providers have a chance in this country.

  • by Shakrai ( 717556 ) * on Thursday May 01, 2014 @05:49PM (#46894245) Journal

    Actually it's a T-Mobile created problem. Nothing stopped them from bidding in the 700mhz auction, except for the part where they blew all their money (billions in fact) on the earlier 1700/2100mhz AWS auction. Nobody forced T-Mobile to do that. A lot of industry watchers scratched their head at that move, wondering why T-Mobile was buying high frequency spectrum to build out a last generation UMTS network when LTE and the 700mhz auction were already on the horizon.

    More to the point, there are whole swathes of the United States where they hold valid PCS licenses that they've never used. It's not a spectrum limitation in these markets, it's an unwillingness to invest the required monies to service them. T-Mobile will never match Verizon or AT&T's footprint. One they don't have the money, two they're on record saying they don't believe that sort of coverage is important to their customers. On that last point they may be right, there's certainly room in the market for a value oriented competitor to the big boys, but so long as they have grossly inferior coverage they'll never really be in a position to dethrone Verizon or AT&T.

    Verizon and AT&T are often condemned for the behaviors of their wireline divisions, wherein they seemingly cherry pick the most profitable markets for FiOS and uVerse, leaving the rest to rot on last generation DSL service. The irony is that T-Mobile does the exact same thing with wireless but is rarely condemned out for such business decisions.

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