Take a look at your smartphone.
How much did it cost? If you are like the majority of cell phone users, you probably shelled out in the neighborhood of $150 or $200 for the device. If you are an iPhone user, you more than likely paid $200. So how much is that device worth?
Same question, right? Wrong.
We are conditioned to believe, and it is mostly true, that we pay for what a product is worth. The free market determines the price based on a whole host of factors including production cost and supply and demand. The price fluctuates based on how much it is worth to the company and to the consumer.
Unfortunately the cell phone industry does not play by those rules. According to IHS iSuppli, that iPhone in your hand cost Apple $188 to manufacture. You probably think you got a steal; after all you paid $200. But that is not the retail price; you paid the carrier subsidized price.
See, cell phone carriers want your business, so they want the hottest phones, and they want to offer them to you at a low price. So handset makers, like Apple, manufacture the product and then sell it to carriers. Then the carriers give you a screamin' deal on the device for signing a lengthy contract. Notice how people rarely buy phones off contract? That's because the retail price of an iPhone is $700.
That's right; Apple is making a cool $512 on each and every iPhone it sells. That's a 272% markup. That is also $200 more than the base iPad, and that device cost Apple just north of $300 to manufacture.
To put it simply, it costs Apple $112 less to produce an iPhone compared to an iPad, but they sell the phone for $200 more.
However, this is not just an Apple money making trick, although they are undoubtedly the worst offender, this is the industry standard. Manufacture a product for under $200, and sell it to carriers for a ridiculous markup. It works because the carriers need the best phones to lure in customers and customers have grown accustomed to paying under $200 for a smartphone.
It needs to change.
There are several problems with this current model. For starters, it locks users into unnecessarily lengthy contracts with cell carriers, and even worse into one phone for at least 18 months. Second, it allows handset makers to charge outrageous prices to cell companies because they have the upper hand. Motorola, Apple, and Samsung know Verizon and the others need their phones to attract customers, so the demand is fueled by the cell phone company, not the consumer. And finally, it makes customers under-value their devices.
T-Mobile's Chief Marketing Officer Cole Brodman agrees with that final point, saying back in March, "I think it is really difficult, especially from a consumer perspective, because it causes consumers to devalue completely the hardware they are using....It is amazing hardware, but it has become kind of throw away. So, it is unfortunate, you've got dual-core, multiprocessor devices with amazing HD screens that get thrown away at 18 months."
Brodman is right, the phones we are using are nearly as powerful as that iPad you spent $500 on, but most people don't junk their iPad and buy a new one in 18 months. However, most power users grow tired of their phones after about a year.
You could even make the argument that ditching subsidies might lower your phone bill.
In the first quarter of this year, AT&T activated 4.3 million iPhones and Verizon activated 3.2 million. Apple reportedly sells the devices to the carriers slightly under retail cost, $620 per phone, which means AT&T and Big Red had to subsidize $420 per device. Tally that up and you get total subsidies of $1.8 billion for AT&T and $1.3 billion for Verizon, in the first quarter alone. Assuming activations stay flat, and they probably won't with a new iPhone due in October, they are paying $7.2 billion and $5.2 billion per year respectively...just on the iPhone.
Free up that expense and maybe, just maybe, their plans would be cheaper. I think they would, not because the subsidy expense would vanish, but because cell phone carriers would actually begin competing on the services they provide, instead of the phones they carry.
Millions of new customers flocked to AT&T in 2007, not because they had better coverage, customer service, or faster data; but because they sold the iPhone. With a wide array of Android phones available, many Google fans have switched networks because the phone of their dreams is not available on their network of choice. If phones were not subsidized and instead purchased retail by consumers, carriers would have to start competing on their data plans, text messaging rates, and overall awesomeness.
But the cell carriers would not be the only companies competing more, the handset makers themselves would have stiffer competition. Currently, a phone on Verizon does not technically compete with a phone on AT&T, it competes with other phones on Verizon. In reality, device makers are dealing in four separate markets; T-Mobile, AT&T, Verizon, and Sprint customers. With the difficulty of switching carriers, phones on a different network just are not a threat.
For proof look no further than the current lineup of HTC phones. The HTC One line consists of three phones; the One X, the One S, and the One V. They are ordered in terms of power and specs, therefore the One X is more powerful than the One S, etc. However, the One X on AT&T is priced at $199.99, while the One S on T-Mobile is also $199.99 (after a $50 mail-in rebate). Even worse the new HTC Droid Incredible 4G, which pales in comparison to the One X, is set to be priced at $299.99 on Verizon.
Open that market up, and all of a sudden Verizon's HTC Droid Incredible is competing directly with AT&T's HTC One X - and the prices would adjust. This would also force handset makers to manufacture less models, and instead make different variations (for each network infrastructure) of one or two models. So instead of HTC making eight to ten devices a year, they would make two or three, and make them available on every carrier.
So let's envision a world without cell phone subsidies, where the consumer walks into a store, buys a phone, and activates it on whatever network they choose. Quick disclaimer, even if phones go unsubsidized, that does not mean you can buy a phone and go to any network, each network has different infrastructure, and therefore different phones have to be manufactured for different networks. So if a handset maker only makes one model, it might not work on all networks, but as I alluded to above, I imagine handset makers would simply release a few phones and make them work on every network.
The first difference with this new market? It is going to cost you more money. Currently iPhone users pay $12 over cost to buy an iPhone. The retail cost without subsidies would probably be more like $300, or $112 over cost (i.e. Apple's profit per device). But that is only $100 more than the current subsidized cost, and you are free to choose your carrier and you would not have to sign a long term contract. Furthermore, if you decide to change phones in a year, you are free to do so. Sell your old iPhone for $150 and go buy a new phone for around $300.
Even better, if you decide you no longer like your carrier, no problem. End your contract at the end of the month, keep your phone, and go somewhere else (assuming your phone works on their network).
Wouldn't life be nice?
Here is why that will never happen. As much as cell phone subsidies cost carriers a boat load of cash, they also force customers into long term contracts, so it's not all bad for the networks. Obviously hardware makers love the subsidies because they can charge a ridiculous amount for their hardware and make an incredible amount of cash on each device. And to some degree consumers like the subsidies because it means buying an iPhone for only $12 above cost, and some will not be willing to trade that for no long term contracts and hardware freedom.
Personally, I'd love to see an open and free hardware market with an open and free service market. Currently the two are combined, making neither open nor free. Sure, we get subsidized hardware, but I'll pay $100 more for my device if it means choosing my network and being able to upgrade my phone whenever I'd like. We need more competition in the cell phone and network market, ditching the subsidy is the best way to do it.
Jacob Bodnar is the host and producer of the weekly social media and technology podcast Status Update at http://www.redtie.tv/. He also hosts and produces a daily tech and social media new podcast titled Tech Daily. You can read and listen to all of his content at http://www.jacobbodnar.com/.
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