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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 TrollstonButterbeans ( 2914995 ) on Thursday May 01, 2014 @02:14PM (#46891581)
    This article is pretty bad from this prespective. It raises certain questions and explores them, while ignoring all other possible questions.

    Which is a very pretentious way of thinking.

    A few of the comments here hit it head on (i.e. upfront costs too high, lock-in, etc.).

    But a really large factor = in the 1990s there were tons of cell phone companies and it was an emerging market.

    And these cell phone companies had major infrastructure expenditures because at the time coverage was mostly near major cities.

    The typical WIN-WIN arrangement with customer and provider is the customer gets a low price (and all the greatness of a phone that works anywhere, unlike a landline) and the provider gets the security of having a stable cashflow to continue to improve their product and experience.

    But Verizon and AT&T are monopoly utilities, thank goodness there is still T-Mobile as a 3rd option.

    I am disappointed by this article, even in a few of the question are good, in that apparently the author of the article didn't think that any history of the cell phone industry was important to see the present in context of the past. History always sheds quite a bit of light on the present.
  • Re:Seriously? (Score:5, Interesting)

    by mythosaz ( 572040 ) on Thursday May 01, 2014 @02:16PM (#46891607)

    What are you talking about? Of fucking course we can do that here in the good 'ol U.S. of A.

    What do you think happens with every Google Play Edition HTC One, or every Google Nexus?

    The fact is that most people prefer to pay $25/mo burried in a contract over two years to pay for their new $600 cell phone, because this is America, the land of revolving credit and low, low monthly payments.

    I've lost count of how many phones I've bought and just thrown my SIM in. The most difficult task I've had to ever do is walk into my provider and ask for a Micro-SIM card when I got a newer phone. The next time I get any hardware from them will be when I need a Nano-SIM.

    That isn't to say that you can't use a plan to your advantage: I once got the entire family an "upgrade" for $25/mo on the package -- and got a whole pile of crappy Android 2.2 devices they were dumping -- but only because they lowered my service plan by $25/mo as incentive. [No doubt the sales associate got a perk for making the sale, and used their latitude in retention offers to lower my plan rate. Everyone won that day.] When the payment plan ended, my bill ultimately went down by $25 forever (or at least until they fuck all their customers again), and I had a pile of emergency phones I could just throw a SIM in when one of the kids invariably lost theirs.

    Since I don't use their shitty "loan you $600, just sign up for two more years" upgrade plans, I'm always free to walk, and always free to negotiate the best rate for my plan or move to another carrier. So the next time they globally try to screw people, I can walk away without as much of a care, and put the next provider's SIM in my phone.

    For that, I have to buy my phones outright -- like a responsible adult not living on the credit treadmill.

  • by raymorris ( 2726007 ) on Thursday May 01, 2014 @02:42PM (#46891983) Journal

    > For a purchase, you make payments on a $50K loan.
    > For a lease, you make payments on a $25K loan, and at then end you either buy the car for $25K, or return it.

    Not so much. For a lease, there is often a leasing company that makes the payments on the loan, collects the payments from the driver, and has a 35%-40% gross profit. In other words, the driver is paying 35%-40% more by leasing.

    You can put actual numbers for a specific lease offer in this calculator to compare: []

    I think you'll find it's more like:

    For a purchase, you make payments on a $50K loan.
    For a lease, you make payments similar to a $35K loan, and at then end you either buy the car for $35K, or return it and pay mileage and other charges.

    Meanwhile, I just paid $12K cash for a 2011 model. While you're paying $700 / month to appear wealthy, I'm investing that $700 / month to be wealthy.

  • by shitzu ( 931108 ) on Thursday May 01, 2014 @03:40PM (#46892723)

    I live in Europe.

    First of all - the networks were not built after the technology was mature. We REPLACED the old network (NMT) with a newer network (GSM) which has been steadily evolving since then (3G, 4G). The 4G is basically a new network again, but as the phones are backwards compatible, the coverage is not such a big issue - if 4G stations cannot be reached, the phone uses 3G or older stations seamlessly.

    Also - socialism or regulation is not the root cause. I think the root cause is that all our networks use the same standard and you have always been able to slap your SIM card into any phone you buy since 1995 or so. At the same time US phones were tied to a carrier - they did not work in another network - therefore you bought your phone from your carrier. In Europe you always bought your phone from an electronics shop and SIM from a carrier.

    The main regulatory trick that further fueled competition was when you could switch networks without changing your number. After that the competition went insane and prices went clise to zero. I pay for "unlimited" data (they start to cap speeds at some point if you torrent with it which i don't know exactly as i haven't hit the trigger) and calls by the minute - which amounts to around 6-7euros a month ($8-9ish). Paying 40-60$ a month sounds like a pure insanity - my mobile bills were that high in the nineties.

In 1869 the waffle iron was invented for people who had wrinkled waffles.