Take a look at your smartphone.
How much did it cost? If you’re like most cell phone users, you probably paid around $150 or $200 for the device. If you’re an iPhone user, you most likely paid $200. So how much does that device cost? to worth?
Same question, right? Mistaken.
We are conditioned to believe, and for the most part it is true, that we pay for what a product is worth. The free market determines the price based on a large number of factors, including the cost of production 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 doesn’t follow those rules. According to IHS iSuppli, that iPhone in your hand cost Apple $188 to make. You probably think you have a robbery; after all, you paid $200. But that’s not the retail price; you paid the carrier’s subsidized price.
See, cell phone carriers want your business, so they want the most popular phones, and they want to offer them to you at a low price. So phone manufacturers, like Apple, make the product and then sell it to carriers. The carriers then give you a great deal on the device for signing a lengthy contract. Do you realize that people rarely buy phones without a contract? That’s because the retail price of an iPhone is $700.
That’s how it is; Apple is making $512 on each and every iPhone it sells. That’s a 272% profit margin. That’s also $200 more than the base iPad, and that device cost Apple just over $300 to make.
Simply put, it costs Apple $112 less to produce an iPhone compared to an iPad, but they sell the phone for $200 more.
This isn’t just Apple’s money-making trick though, while they’re certainly the worst offenders, this is the industry standard. Make a product for less than $200 and sell it to shippers for a ridiculous markup. It works because carriers need the best phones to attract customers, and customers have grown accustomed to paying less than $200 for a smartphone.
It has to change.
There are several problems with this current model. For starters, it locks users into unnecessarily long contracts with cell phone carriers, and worse, to a single phone for at least 18 months. Second, it allows cell phone manufacturers to charge cell phone companies exorbitant prices because they have the upper hand. Motorola, Apple and Samsung know that Verizon and the others need their phones to attract customers, so demand is driven by the cell phone company, not the consumer. And finally, it makes customers underestimate their devices.
T-Mobile’s chief marketing officer Cole Brodman agrees with that final point, saying in March: “I think it’s really difficult, especially from a consumer perspective, because it makes consumers completely devalue the hardware they’re using…it’s amazing hardware, but it’s become disposable. So, it’s unfortunate, you have dual-core multiprocessor devices with incredible HD displays that are thrown away after 18 months.”
Brodman’s right, the phones we’re using are almost as powerful as the iPad you spent $500 on, but most people don’t throw away their iPad and buy a new one in 18 months. However, most power users get sick of their phones after about a year.
You could even argue that getting rid of the stands could 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 carriers for slightly below retail cost, $620 per phone, meaning AT&T and Big Red had to subsidize $420 per device. Count that in and you’ll get total subsidies of $1.8 billion for AT&T and $1.3 billion for Verizon, in the first quarter alone. Assuming activations hold steady, and they probably won’t with a new iPhone expiring in October, they’re paying $7.2 billion and $5.2 billion per year respectively… on the iPhone alone.
Free up that expense and maybe, just maybe, your plans would be cheaper. I think they would, not because the subsidy spending would go away, but because cell phone carriers would start competing for the services they provide, rather than the phones they carry.
Millions of new customers turned 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 range of Android phones available, many Google fans have switched networks because their dream phone isn’t available on the network of their choice. If phones weren’t subsidized and consumers bought them at retail, carriers would have to start competing on their data plans, text message rates, and overall awesomeness.
But mobile phone operators would not be the only companies that would compete more, the mobile phone manufacturers themselves would have tougher competition. Currently, a Verizon phone doesn’t technically compete with an AT&T phone, it competes with other Verizon phones. In reality, device manufacturers operate in four separate markets; T-Mobile, AT&T, Verizon and Sprint customers. With the difficulty of switching carriers, phones on a different network just aren’t a threat.
For proof, look no further than HTC’s current lineup of 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, thus 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). Worse yet, the new HTC Droid Incredible 4G, which pales in comparison to the One X, is priced at $299.99 on Verizon.
Open up that market, and suddenly Verizon’s HTC Droid Incredible is competing directly with AT&T’s HTC One X, and prices would adjust. This would also force mobile phone manufacturers to make fewer models and instead make different variations (for each network infrastructure) of one or two models. So instead of HTC making eight to 10 devices a year, it would make two or three and make them available to all carriers.
So imagine 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 the phones are unsubsidized that doesn’t mean you can buy a phone and go on any network, every network has different infrastructure and therefore different phones have to be made for different networks. So if a phone maker only makes one model, it might not work on all networks, but as I mentioned earlier, I would imagine phone makers would just release a few phones and make them work on all networks.
The first difference with this new market? It will cost you more money. iPhone users currently pay $12 above cost to purchase an iPhone. The unsubsidized retail cost would probably be more like $300, or $112 over cost (i.e. Apple’s profit per device). But that’s only $100 more than the current subsidized cost, and you’re free to choose your provider and you wouldn’t have to sign a long-term contract. Also, if you decide to change your phone 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 don’t like your career anymore, 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’s why that will never happen. As much as cell phone subsidies cost carriers a lot of cash, they also force customers into long-term contracts, so it’s not all bad for the networks. Obviously, hardware manufacturers love subsidies because they can charge a ridiculous amount for their hardware and make an incredible amount of cash on each device. And to a degree, consumers like subsidies because it means buying an iPhone for just $12 above cost, and some won’t be willing to trade that for no long-term contracts and hardware freedom.
Personally, I would love to see a free and open hardware marketplace with a free and open services marketplace. Currently the two are combined, so it is 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 want. We need more competition in the cell phone market and networks, getting rid of the subsidy is the best way to do it.
