Do subsidized handsets have a future?

Citation

Curwen, P. (2009), "Do subsidized handsets have a future?", info, Vol. 11 No. 1. https://doi.org/10.1108/info.2009.27211aab.001

Do subsidized handsets have a future?

Article Type: Rearview From: info, Volume 11, Issue 1

A regular column on the information industries

On the face of it, the standard contractual model offered to potential customers in most countries contains an element of deceit. Provided the customer signs up to a contract of specified length, normally between one and two years, she/he will be sent a “free” handset. And not just a “good for making voice calls and not much else” handset but probably one equipped for 3G – not unreasonably, the operator wants to encourage data usage. Such handsets are not cheap to manufacture, so the customer appears to have little cause for complaint. After all, when the contract reaches its term, she/he can renegotiate the contract with the operator, specifying the receipt of a new, upgraded handset at the same monthly charge.

But operators are in business to make money, so clearly they cannot afford to subsidize handsets unless the customer starts using additional services beyond the agreed package of call minutes and texts. Or can they?

Indeed they can, because of the effect of inertia. What operators know from long experience is that large proportions of their customers are either unaware of the date on which their contract terminates, and hence can be renegotiated, or lack the assertiveness to engage in negotiations with their operator – if not both. Hence, provided a customer continues on the same tariff without a handset upgrade, that customer is effectively subsidizing all other customers who are demanding upgrades at the earliest opportunity.

There is little, if any, incentive for one operator to move away from this established model, for two main reasons. First, the model ensures that all operators enhance their profitability at the expense of a minority of their customers and, secondly, economic game theory long ago established that if one operator breaks ranks, and in so doing causes customers to switch to it from other operators, the latter will promptly follow suit resulting in a loss of profitability to them all.

So why we having this discussion, the reader may well ask? The answer is that a breaking of ranks, and a significant one at that, has recently occurred and the fall-out is now discernible. Some while ago, Vodafone sold its faltering operations in Japan to Softbank, and in January 2007, Softbank launched its “White Plan” which offered a tariff without a subsidized handset. The White Plan basically offered a bundle of “free” calls for the equivalent of just over $9 a month with the handset either being bought outright or paid for in instalments during the term of the contract. As predicted, its two rivals, NTT DoCoMo and KDDI, quickly followed suit with similar offers.

What followed was eminently predictable. Those (mainly elderly) customers who never bothered to upgrade benefited from a significant reduction in their monthly tariff while those (mainly younger) customers, who used to demand regular upgrades, either paid for a new handset independently of the operator or chose to keep their existing handset beyond the term of the contract. As a consequence, the average life of a handset rose from 31 months to roughly 37 months.

It is evident that this process has hurt the operators since competition has become more transparent – the customer merely needs to compare the prices of given bundles of services and hence any price reduction by one carrier is likely to be followed by the others. It may be noted that Softbank has been gaining a disproportionate share of new customers every month since April 2007.

But it has also hurt the handset manufacturers, given that total sales of new handsets are on a downward progression, even allowing for the emergence of brand-new customers – penetration is already very high and the great majority of customers already own a 3G-enabled handset. An added factor is that the Japanese market is not the mirror-image of, for example, Europe or the USA because the 2G technology was primarily the home-grown PDC and hence the market was largely left in the hands of domestic vendors. Nevertheless, these tended not to acquire large market shares: Sharp is the only vendor with more than a 20 per cent market share while only Fujitsu, NEC and Panasonic among the others (including Nokia) have in excess of 10 per cent.

M&A activity may be forthcoming as a result, but it is necessary to bear in mind that there are two variants of 3G in existence, namely W-CDMA (DoCoMo and Softbank) and cdma2000 1xEV-DO (KDDI) so it is problematic for vendors to compete successfully in both markets, not to mention the fact that Japanese handsets tend to be state-of-the-art, stuffed with clever technology capable inter alia of making payments and receiving TV.

It is always possible to treat this development as the exception that proves the rule, and to argue that the traditional contractual model will remain secure in Europe for the foreseeable future, even if he USA, with its comparable 3G technologies to Japan, appears to be more vulnerable. And even if Japanese vendors attempt to export their handsets more aggressively into foreign markets, it is by no means certain that their high-end handsets will find favour in sufficiently large numbers to impact operators’ behaviour. However, the recent market upheaval consequent on the launch of the iPhone around the world suggests that high-end models have a brighter future, and, indeed, the original marketing strategy for the iPhone was based on selling the handsets without subsidies even if AT&T was later allowed to apply them. However, the size of the subsidy is necessarily related to the cost of the handset, and hence subsidization of the likes of the iPhone implies that contracts will have to be lengthened to compensate, typically from 12 to 18 or 24 months.

In conclusion, it appears to be the case that the traditional model is safe for now outside Japan, but that the situation is becoming more unstable. The efforts of regulators such as European Commissioner Reding to make other kinds of inroads into the traditional model are a further source of potential instability even if not directed specifically at handset subsidies. And at the end of the day, there is no denying that the handset subsidy model is hardly driven by a desire to improve equity even if the operators consider that it is relatively efficient. It is also worth noting that even if the subsidization model survives in Europe, any attempt to lengthen contracts is unlikely to find favour with the Commission.

It is finally worth considering how what is clearly now a business recession is going to affect operators’ models. The reality appears to be “not much”, at least in the short term. For most people, keeping in touch is an essential activity, although they may well be prepared to delay upgrading their handsets. This is unlikely to be damaging to operators although the same clearly cannot be said of equipment manufacturers. And if some customers switch to pre-paid, then the consequent lower revenue will be offset initially by the removal of the subsidy.

Peter Curwen Visiting Professor of Telecommunications in the Department of Management Science, Strathclyde University, Glasgow, UK. E-mail pjcurwen@hotmail.com