Mobile phones have changed enormously over the past six years, but the mobile phone business model has not. You buy a magical device for practically nothing, then find yourself locked into a two-year contract with a baffling, shockingly expensive monthly bill. Not coincidentally, the companies that have led the smartphone revolution—Apple and Google—are consistently among the most admired in America while everybody hates Verizon and AT&T, the leading cellphone operators. The gadgets are great, the billing process is a nightmare.
Now T-Mobile, the longtime also-ran of the U.S. mobile phone market wants to shake things up by offering mobile service that’s not a horrible scam. But will people be smart enough to figure out that they can get a genuinely better deal?
The key to understanding the mobile phone economy is that it features extremely high barriers to entry. Given the difficulty and cost of buying broadband spectrum and constructing a network, it is basically impossible to launch a new nationwide cellphone company. That means potentially staggering profits for incumbents.
On the other hand, the huge costs involved in upgrading a network to state-of-the-art infrastructure mean that fixed costs are much bigger than the marginal cost of serving an additional customer. So once you’ve built the network, you need to scramble like crazy to sign up as many people as possible. So far, operators have done that primarily with a bait-and-switch. Rather than tempt you in the door with low monthly bills, they induce you to switch by offering a discounted price for the latest and greatest phones, with the iPhone being the biggest prize of all. 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.
This game’s been working great for Verizon and AT&T, but much less so for T-Mobile. The subsidiary of Germany’s Deutsche Telekom has failed to achieve the scale to compete with the big two, and its corporate masters decided they didn’t want to make a risky investment by growing the company. Plan A to sell T-Mobile to AT&T was blocked by the Justice Department and the FCC, who wanted to preserve competition in the marketplace.
Now T-Mobile’s gearing up to try to compete by changing the game. They’ve finally secured a deal to put the iPhone on their network. They have made the radical and perhaps brilliant decision to sell it and other smartphones without subsidy. That’ll make the devices a lot more expensive. Consumers will be surprised to learn that the $199 iPhone 5 actually retails for $649. AT&T and Verizon essentially pay Apple the full price, sell it to you for the low price, and make it up by charging you more every month.
But that subsidy is quite costly for customers. If you buy a subsidized iPhone 5 from AT&T, the cheapest plan available costs $85 per month and only comes with 1 GB of data, a minimum of $2,040 over the two years of the contract. A basic T-Mobile unlimited voice plan with 2 GB of data costs $59.99 per month, $1,440 over the two years. In order to get that $450 iPhone discount, you would end up paying $600 more to AT&T over the life of the contract, and get less data.
A plan with a subsidized phone is a bit like a house with a mortgage. Your upfront costs are lower, but total costs go up because you have to pay off the loan. The difference is that there are actually good reasons to finance houses with loans. One, the interest is tax deductible, which limits the total cost. Two, houses are incredibly expensive and saving up to buy one in cash could take decades, not months. And three, the underlying house is an extremely durable asset, so it makes sense for banks to extend credit on generous terms.
Smartphones, by contrast, suffer from rapid depreciation because of technological obsolescence. Paying the full up-front cost, saving on a cheaper cellphone bill, and then assessing your desire to buy a new model down the road based on the actual merits of the upgrade rather than your wireless provider’s upgrade cycle makes much more sense.
Until recently, it’s been extremely difficult for customers to do this sensible thing. The big two haven’t offered discounted data plans to people who are willing to buy an unsubsidized phone. T-Mobile has offered this, but it wasn’t the emphasis of their marketing, and the latest and greatest phones typically haven’t been designed to work optimally with their network.
That’s why last week’s announcement is such a game-changer. By dropping the subsidy model entirely, T-Mobile is committing itself to marketing the virtues of honest billing practices. And by securing official Apple support for its network, T-Mobile will be able to compete head-to-head with the other players in terms of handset functionality. If high-end consumers realize what a better deal you can get with the nonsubsidized model, then ultimately AT&T and Verizon will have to start offering that option to compete.
Of course, customers have to actually recognize that the new deal is better. 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.
