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Summary:

What if consumers actually enjoyed signing contracts? What if carriers just gave away phones — all of them — for free? John S. Wilson of Policy Diary imagines a world where carriers could entice consumers into signing four- or five-year contracts, with the right perks.

Contract

ContractCellphone contracts suck, but pretty much everyone in the U.S. still has one. For the vast majority of people, signing a contract is the only way to get the phone they want for a price they can afford. But contracts present problems: They’re 24 months long, but phones typically have issues after the first 12 months (when manufacturer’s warranties have expired); if a phone is lost, the contract still stands, yet the consumer has no phone; and newer phones that are far more desirable are released yearly or more frequently, yet consumers are stuck with the same old phone. But carriers need contracts about as much as consumers disdain them. It’s the only way to ensure that consumers will be there month after month, allowing carriers to recoup the investment they make in phone purchases. (Your typical iPhone is sold at retail for $200 but actually cost carriers $600-$660, and this price is increasing.)

But what if all of this changed? What if consumers actually enjoyed signing contracts? What if carriers just gave away phones — all of them —  for free?

What do consumers get?

Carriers need to rethink the current model of phone ownership. It’s not working for them or consumers. So let’s propose a new one: phone leasing. It would work like this. A consumer can get a free phone, any model they would like, and can keep it for 12 months. No charge aside from their monthly bill. If there are any issues with the phone, they would most likely still be covered by the manufacturer’s warranty. And any reasonable issues not covered by the manufacturer’s warranty would be covered by the carrier for free.

What’s the catch?

The carrier owns the phone, and it must be returned after the 12 months is up. Moreover, instead of signing a two-year contract, consumers would have to sign a four- to five-year one. But, and this is a big but, when a consumer gives that 12-month-old phone back to the carrier, they’ll get a brand-new one of their choice — every single year of the contract.

What do carriers get out of this model?

Three things: More phone “sales” — lowering the cost of phone acquisition will lead to more contracts; longer contract means more customer loyalty; and leasing instead of selling phones means the phones can be resold once the 12 months is up (a typical iPhone goes for $300-400 on Craigslist). So instead of a carrier purchasing a phone for, say, $650 from a manufacturer and only getting $200 at retail from a consumer, losing $450 in the process, they’ll be able to resell that phone after 12 months for $300-400. This process will be repeated until the contract ends.

But why would a carrier go this route when the churn rate (the percentage of consumers leaving) is so low? More profit. Smartphone adoption is growing, but it would be growing much faster if smartphones were free. Moreover, carriers are basically competing with the same phones (barring T-Mobile, which still doesn’t have the iPhone) and very similar monthly plans. Adding such a plan would be a game-changer that would provide a worthy competitive advantage. Lastly, churn may be low — Verizon, for instance, reported 1.1 percent among 88 million contract subscribers. That equates to 88,000 people, or nearly half the population of Richmond, Va., leaving every quarter. With each subscriber worth $54.89 of revenue, $4.8 million worth of churn walks away each quarter.

Why not prepaid instead?

Of course the prepaid phone market is an option, but for most consumers it is not a tantalizing one. Part of the reason could be due to the lack of cachet; the perception remains that prepaid users don’t have good enough credit to get a contract. But an even greater reason is the lack of cutting-edge phones the prepaid market offers. For instance, the iPhone (as well as many popular phones) isn’t available as a prepaid option. And for carriers, on average, prepaid has a higher churn rate and creates less revenue.

Carriers have little choice but to shake up the cellphone market. It’s ripe for a revolution.

John S. Wilson is a freelance writer who focuses on technology, politics and health policy. He writes for NewsOne, The Loop 21, and Mediaite, and can be reached on Twitter: @johnwilson

Image courtesy of Flickr user jason.lengstorf.

  1. My God this is such a horrific idea I don’t know where to begin. Let me get this straight, you want to give carriers even MORE power and entice consumers into even LONGER contracts?!
    Carriers have never and will never be a driving force “ripe for revolution.” Leave that to Silicon Valley. They are the ones who need to continue exerting downward force on OEM and service (carrier) pricing. What if an iPod Touch 3G (data only for Facetime and iMessage) or even an iPhone4 later this year would be $350 off-contract. THEN people could freely upgrade every year PLUS not be locked into a contract AND force carriers to compete on price. Get your head out of your posterior man!

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    1. John S. Wilson Sunday, January 22, 2012

      Verizon’s churn rate is 1.1%, which means their consumers are largely satisfied with their service. So what would be wrong if consumers had a CHOICE of entering into a longer contract and getting free phones every year? Moreover your scenario does nothing to help a consumer get a new iPod Touch every year. So I think my head is where it needs to be, thank you.

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  2. One problem: who are these carriers going to sell their used phones to, when everyone is getting a new one every year?

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    1. Exactly! Mr. Wilson totally didn’t think through this one. Why would I buy a used phone for $300 if I get a brand new one yearly for nothing?

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      1. John S. Wilson Sunday, January 22, 2012

        Because some folks don’t want contracts.

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  3. One of the reasons why so many, many more people these days are getting Android phones, more than any other kinds of phones out there, is because of the many choices in carriers, plan types, and phone forms. For example, Huawei’s IDEOS Android Phone is selling like hotcakes in Kenya.

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    1. I’m talking about the U.S. market specifically. And I don’t think there are that many differences between the major carriers here. Outside of Verizon who has 4G, you have AT&T which just rolled it out but it’s far too limited, and you have Sprint and Tmobile who are barely profitable and are fighting for crumbs on 3G. If Sprint implemented a plan like this it could certainly be a game-changer. If Verizon did it they could increase distance between themselves and AT&T.

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  4. The problem with this model is that it relies on carriers selling phones after one year, but the model would essentially kill the second hand market. Why would someone buy a used, 1 year old iPhone for $300-$400 when, under this plan, they could get a brand new one free?

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    1. Took the words righty out of my mouth.

      This proposal sounds like a win-win, except for the fact that it’s based on today’s resale pricing. If customers are not only getting smartphone upgrades every year, but FREE upgrades at that, they would have little incentive to pay that much.

      However, it still would be possible for the carriers to profit if they were able to resell their phones at $150-$200 with monthly revenue locked in for 4-5 years. Rate plans or data features would very likely increase, if slightly, to support this model.

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    2. That’s true. There would be less incentive for a person to do that, unless they didn’t want a 4- to 5-year contract. If they wanted a standard 2 year then they could have to go refurbished.

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    3. The current price is a balance between current supply and demand. Flood the market and the price will drop. The other issue is… who’d buy used phones? Unless I got a significant discount on my phone bill I’d be a) laying out several hundred dollars, b) getting a year old phone vs the new shiny and c) paying the same as someone who just got the new shiny.

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      1. Right, it is a balance between supply and demand, and so is the $650 carriers are paying now. That isn’t and less malleable than the used price. And plenty of folks purchase used phones. Craigslist is one thing but carriers sell refurbished phones on their sites all day long. Huge market for it. All things D did a great story on how profitable used phones are for carriers, because they don’t require a subsidy payment.

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      2. Sarah van wezer Sunday, January 22, 2012

        When people don’t want long term contracts, I don’t think they have to, cause how high would the cost get to break a five year contract. Ik you want a new smartphone each year I suggest that you make a contract available with the duration of one year and a higher monthly fee. Because now they pay a lot for old iphones but when they have a much higher amount of iphones every year i think that the recycling bonus will dropp down really fast.

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  5. NO NO NO — under this biz plan 1) the carriers have no reason to be competitive (long, long contracts way longer than the executives bonus periods and their employment half-life) and 2) the phone manufacturers have no reason to be competitive (carriers are their customers and the carriers have no reason to care what the price is [this is very much the reason medical care costs increase much, much faster than inflation or basics costs, i.e. the customer is too far away from the provider: everyone just passes the costs down the chain without shopping for the best deal)

    How ’bout the customer, you and me, buys our phone on the open market where every fone manufacturer competes: I get the features I want (including the ability to connect to every carrier), the carriers get out the the instrument biz and compete on speed, contract terms and price with each other.
    “The survival of the fittest”

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  6. I don’t believe this is a good idea, as it moves the cost and quality of mobile service backwards. The best thing for consumers would be to force unbundling of equipment and service, like they did in the 1980s with landline phones.

    Yes, iphones are sold to carriers for over $600, as are many other state-of-the-art smartphones. However, unlike all other consumer electronics, those prices give the manufacturers very high gross margins – probably as much as 60% or more. They are able to squeeze those prices because the true cost is hidden from the consumer. Smartphone prices are artificially kept high by the carrier subsidies, which are then offset by higher monthly fees for 24 months. If the subsidy is $350, and the carrier is charging an extra $25 per month to pay off the subsidy, the last 10 months of the contract yield an extra $250 of revenue, which falls straight to the bottom line (and comes directly from the consumer).

    If carriers charged solely for service, and let people finance their own phones, they would be less likely to replace them even after two years. This would slow down the rate of new phone introduction, which would be good for consumers and even manufacturers, as they could spend less on development, and deliver better products if they didn’t have to spit out new designs every few months. Cable and satellite companies don’t have to finance TV sets; cable and phone companies don’t subsidize computers; electric utilities don’t subsidize electric appliances; why should wireless carriers subsidize the equipment used with their service?

    The carriers use the contracts not only to extract more revenue, but to lock in subscribers. However, since all of the carriers have virtually the same phones to offer (except for T-Mobile with no iPhone), none of them have an advantage. They would be better off not not investing capital in the financing of phones, and instead invest that capital in improving and expanding the capacity of their network. That will be more likely to attract new subscribers than 3 months exclusive access to the latest new phone, and will be more likely to retain those customers once the contract is up.

    I can understand why ATT doesn’t like this idea, as they do not have good service or a good network, but I don’t understand why Verizon doesn’t employ this strategy. They have a good network, and they are constantly adding capacity – if they started to charge a lower price to customers who brought their own phones with them, they would steal a lot of subscirbers from the other carriers. Competition would be based on service (which, after all, is what they sell), and their profits would be more directly correlated to their service, instead of how well they design their contracts.

    I like new gadgets as much as the next guy (o.k., maybe a little more), but that doesn’t mean we should adopt policies that encourage replacing phones every year. Three year-old computers are still pretty useful, and as the rate of advancement in 4G networks slows, there is no reason why mobile phones can’t enjoy the same lifetimes as computers. Mandatory bundling is illegal in almost every industry in the U.S., but for some reason, the carriers are getting away with it. Once that practice is ended, the industry will become more efficient, and will not absorb as much capital as it does now, leaving consumers with more money to spend on other things.

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    1. Your reasoning is flawed here. The last 10 months revenue you mention is not straight to the bottom line. The cost of maintaining a network, labor costs, etc… have to be factored in. Quality of the network is greatly exaggerated as well. There is truly minimal difference in network between the nationwide carriers. Perception is reality obviously, but the quality of the network will vary by your location. When drop rates nationwide are well below 1% for all carriers, even this is not going to be a big factor.

      Also, you mention the rate of advancement in 4G networks is slow…? 3 years ago we were in a 2G, 250kb/s download speeds. Today, every large city in the country has the ability to reach speeds in excess of 10mb/s – and much faster in some cases on LTE.

      Lastly, carriers do not force customers to sign contracts. Every customer has the option to buy devices outright with no contract attached. Customers are the ones choosing to enter into these contracts because the choose the lower pricepoint. Carriers are not the bad guys in this scenario. If you have paid attention to earnings reports, it’s not the carriers who are turning in huge profits. It’s quite the opposite actually as many carriers are struggling (i.e. Sprint, T-Mobile) financially to maintain and upgrade their networks and not be in the red.

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  7. Didn’t the concept of owning a phone only come about in the 70s or early 80s? The telcos owned the phones and leased them out. This is not a new or revolutionary idea.

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    1. That was outlawed in the 1980s. It is a de-evolutionary idea.

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      1. Precisely.

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    2. T-Mobile’s Value Plans are exactly this. The rates have between lowered to cover only service costs, and customers purchase handsets at full price with the option to finance the purchase over 20 months with no interest. It’s pure and simple, but overall customers are confused and repelled by this model.

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    3. Actually it is a revolutionary idea. Takes the cost of ownership to 0, which is a big deal to those who are not able to cough up the $200.

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      1. The cost of ownership is not 0, it’s just hidden (and inflated) inside the cost of the service.

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  8. Interesting, but incomplete, you totally dismissed the prepaid market, why, because of the lack of quality smartphones? Let me introduce u to http://www.beigephone.com. The revolution you spoke of began the day beigephone launched. iphone service on prepaid phones; not to mention, look at the growth of metropcs over the last 4 years.

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  9. Worst article I think I’ve read, ever. Verizon, AT&T, and co. are in the business of wireless service, not cellphone sales.

    Separating the phone from the plan is key. Then phone manufacturers and the service providers can truly compete on price and quality and not some rather absurd hybrid market. Most other countries have very advanced prepaid markets, and yes, iphones on prepaid plans. Don’t for a second think that the US can’t manage the same system.

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    1. Um, prepaid market has been in the US for many many years. And yet it still hasn’t taken off. As I point out, that market has more churn and less profits for carriers, so why would they invest in it more?

      Additionally, carriers are in whatever works in bringing more profit. Heck, a few years ago they were focused on ringtone sales. Why? Profit. Moreover, did you miss the part where I talk about a 5 year contract that will allow them to gain more customers and keep them longer?

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  10. Check your math.. 1.1% of 88mil = 968000/year.. 242000/quarter = 13283380..

    And if you’re going to suggest something radical, how about what they do in Europe. Buy your own phone, but the contracts don’t have that hidden cost, and result in much lower rates.. I’d take that in a second.

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    1. Because folks have an aversion in the US to paying that much for phones. Those that do value the no-contract approach, but it’s a much smaller group than those willing to go for a contract.

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