Subsidy Sticker Shock: The Cost of Phones

Samsung and Verizon made some waves today when they announced that the newly minted Tab would run for $599.99, and no contract options.  For those of you not familiar with the device, the Tab is the first Android tablet to officially come with the Google marketplace in tow and major carrier support.  It’s a 7″ all touchscreen device, and features 16gb of memory (expandable to 32gb), a 1ghz processor and both a rear and front facing camera.

Sounds great right?

Most of you are likely thinking “Not really.  Look at that price!”  To paraphrase  one internet commenter; “Why would i get something that is only 3″ bigger than my Fascinate and 3x the cost?”  When I first heard the cost, I thought the same thing.  Then I remembered that the Fascinate is actually $589.99 so for an extra $10, you get a noticeably larger device.

The problem is that as consumers, we’re trained to think of anything cellphone related in terms of contracts and subsidies.  We don’t care how much a device costs because we only have to pay a fraction of that cost with our contracts.  We’re pretty vocal about allowing unlocked devices on our network of choice.  Getting used to the unsubsidized cost of a phone is just the first step towards carrier independence.

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Before I go any further, let me make it clear that I know that the “retail” prices of devices aren’t their actual cost.  This is how retail works.  When you buy a device, you’re often paying the cost as well as a substantial profit margin.  When you buy something, you never buy anything at “cost.”

But when a market is almost wholly subsidized, it’s a lot harder to figure out what the actual retail cost is.  What I can tell you is that most of this markup is not from the carriers.  For example, Verizon adds between $20 and $60 to their cost to make the retail pricing.  Sure, this sounds like a “lot” but if you’re talking about a device that is $589.99, that’s not much of a margin.

The people making most of that profit are handset makers.  Here’s why:  While a carrier might sell a couple of phones at retail cost, the handset maker sells Every. Single. One. of the phones at markup.  If it’s a smartphone, they often get a slice of the data revenue, we know that at least Apple and Blackberry do, and I can’t imagine Motorola and Samsung leaving that money on the table.  Sure, they’re not the ones collecting $100 a month (or more) from you, but they also don’t have to deal with most customer service, technical, or network issues either.

That being said, Cellphones are expensive to make.  There are so many patents to license (if lawsuits teach us anything, they teach us this) and making technology that powerful and sticking it in a small package isn’t cheap.  The problem isn’t that Hardware makers and Carriers are making a profit, but rather that what their making isn’t subject to competition like we think it is.

Limited competition=higher prices.

As consumers, we’ve become addicted to the idea of subsidies.  Despite how we might grumble and complain about policies, most of us are more than content with staying with a given carrier for a few years in exchange for a cheap(er) product.   The average cellphone user has no idea how much their phone costs, and the only time they really find out is if they break their device and don’t have insurance.  I can’t even remember how many customer’s I’ve had that come into the store and say they want a new phone and then balk when I tell them what the non-upgrade price is (a lot of customers still assume listed price is new customers, upgrade is free, no matter what).

As someone who’s purchased his last three devices at full price, I’ll be the first one to say that buying them this way is painful on your wallet.  But because I buy the devices on my terms, I’m not tied into any specific contract with any carrier.  So if someone comes out with something I REALLY want, I can go over there without having to worry about an ETF.

But why are phones so expensive?  You can buy a computer (two computers even) for less than a high end smartphone.  Even a netbook (or tablets like the iPad) can be had for the same price, or cheaper, than a phone.  Making a device smaller does increase the costs, but are phones really that expensive?  The truth is we don’t know, and that’s the problem.

Unlike the netbook market, you can’t just go to Best Buy to pick up a phone and carry it out.  Well..  you technically can, but you’re limited on what that device can do.  Want an HTC Evo?  I hope you love Sprint’s pricing, customer service, and network.  Dying for the latest iPhone?  Att’s right over there.  You can’t even buy the phones retail and move them between carriers unless you’re ok with hacking your device and potentially turning it into your phone into a brick.  Exclusivity is a big problem, one that will be addressed if you get rid of the larger issue:  Carrier subsidies.

If you have a cellphone, you know what a subsidy is.  You walk into a store, and if you agree to pay Verizon/ATT/Whoever for two years. then in exchange they give you a phone to use for free, or at a very steep discount.  Most people don’t even look at the actual cost.  In fact, a lot of people don’t realize they’re getting as large of a discount as they really are.  As a rep, I’ve lost track of the number of customers who refer to the listed (contract) price as “retail.”   But, what does this have to do with limiting competition?

Since most phone purchases in the US are subsidized, we’re not the one setting phone prices, because we don’t care how much a phone costs, just how much it costs on contracts.  Carriers don’t have the final say either, contrary to what some might think.  Sure, they can refuse a device if it’s priced too high, but “too high” is subjective, and guided largely by consumer demand and manufacturers know this.  Create a device that consumers will sign contracts for, and they can charge a higher price for it.

Some would argue that this is simple economics at work, supply and demand.  But supply and demand breaks down once you add subsidies into the mix.  As a consumer, I expect to pay $199 AT MOST for the current high end smartphones.  I expect everything else to be cheaper (and basic phones to be free).  Motorola knows that most customers will never pay what they charge Verizon for the DroidX, so why sell them to Verizon for $400 when they can sell them at $550 and I, as a consumer, end up paying $199 anyway?  And if we pay that $199,$99,$350 or if we get them buy one get one, Motorola still gets full price for both handsets.

I’m not saying that Motorola could sell the DroidX for $400 and still make a profit, for all we know these devices actually do cost $550.  What I’m trying to get across is that we have no idea what these devices would cost if subsidies were removed and Motorola had to compete directly against Samsung for our business instead of using Verizon as a middleman.  Maybe they would remain at $550 a piece, but I doubt it.  Why?  Because of Apple.  If you read this article, you’ll see that even though Apple only controls 2.8% of the mobile handset market, their share of industry profits was greater than 39%.  Apple’s traditionally had a much higher profit margin on their products than other industries, but those numbers are impressive even for them.  What would those numbers look like if they tried selling every iphone to customers for $599?

Companies deserve to make a profit if they develop a product consumers love, I’m not trying to say otherwise.  If Apple can convince customer to pay a premium for their product in the open market, they deserve every dollar they can get.  I’m also not trying to imply that if all handsets suddenly became unsubsidized we as consumers will end up paying less for our devices.  We won’t.  In fact, most people will end up paying more for their devices initially, but I feel that they will be much happier with their purchases.

What I’m saying is that as consumers we need to tell Hardware Manufacturers and Carriers that the age of heavily subsidized, bloated, carrier locked phones is over.

Why the future is unsubsidized

Why should you demand to pay more for a product?  Because it puts control over the device back into your hands.  If Samsung, Motorola, HTC, etc. had to meet your needs and not your carrier, what would the device look like?  Do you really think Verizon could get away with installing City ID on your phone and not give you a way to uninstall it?  Or AT&T could still block you ability to side-load applications?  I doubt it.  If Motorola had to entice me as a customer and not as a Verizon subscriber, you can bet I would demand a device without a hint of V-Cast.

If devices are purchased unlocked and unbranded, Carriers couldn’t sucker us into a contract with an exclusive device anymore.  Instead they’d need to offer other incentives to keep us as customers, from discounts on our monthly bills to overage rates that actually make sense.

But will the carrier’s let this happen?  Honestly, I don’t think they have a choice.  Mobile is the future of the internet and because of this, there are going to be devices launching to take advantage of LTE and WIMAX that have nothing to do with cellular technology.  It would be impossible for Verizon, or AT&T, or anyone to distribute all of these products, but ignoring them is leaving a LOT of data revenue on the table.  It’s not all bad for carrier’s either.  They spend a ton of money every year on phone tech support, warranty claims, etc.  If the devices are sold without contract directly from Samsung (or by third party companies) then most tech support can be dropped or handed over to other companies.  Then carriers can focus on just their networks instead of “I dropped my phone in the pool and now it won’t work, what do I do?”

Verizon and T-Mobile already see the writing on the wall.  If you bring your phone to T-mobile’s service, you’ll actually get a discount on your monthly plan (even more+).  Verizon is the second carrier (after T-mobile) to offer nearly their entire lineup on prepaid plans that don’t cost you an arm and a leg like they used to.  In fact, some of their prepaid data plans (specifically with tablets like the iPad and Tab) are better on prepaid than anything currently offered to traditional contract subscribers.  For example, 5GB of data on a prepaid iPad tablet plan will set you back $50 and that same exact plan is $60 if you get the mifi on contract.

I’m not saying that the change will happen instantly, or that carrier’s won’t try and delay wholly unsubsidized pricing for as long as possible, but unless we as consumers actively fight against it, in a few short years we should be able to choose any device we wish, on any carrier we wish, all for the low cost of paying a bit more for our phones up front.  The first step is changing how we think about phone pricing, and the second is voting with our wallets by supporting companies that give us something back when we buy a device at retail pricing.

Wrap-up

Which brings us back to the Galaxy Tab.  The Tab is an interesting experiment for Verizon.  It’s still carrier branded to some degree (though thankfully without Bing), but it’s sold completely contract free.  The Tab will also be available on every major carrier, as well as a WiFi only version.  While the device itself is not exclusive, the Verizon device won’t be able to operate on other carriers (this is unfortunate).  I do think that the price is a little high for Verizon’s first attempt at an unsubsidized tablet.  I understand that it’s only $10  more than the Fascinate, but I feel that if they launched this at $500, or even $529 the potential market would be a lot greater.  But I don’t think it’s “overpriced” just not priced where it should be to really move units.

We need to change the way we think about cellphones and cellphone contracts.  Cellphones shouldn’t be impulse purchases whenever we renew our contracts.  If you’re not willing to drop the retail price on a device, then why are you signing two years of your life away to get it a little cheaper?  If you have the choice between a locked down, subsidized device and an “open” device, do yourself a favor and choose the “open” device.  The future of the mobile web is in unsubsidized, it’s just up to us to choose how quickly that future arrives.

I’m not sure if I’ll purchase a tab yet.  I’m close enough to an LTE city that I want to see what is announced at CES.  But I haven’t signed a contract for my cellphone in over four years, and I don’t plan on ever signing one again.  We won’t get “any device, any network” unless we show we won’t settle for anything less.  What do you think?