ThoughtPiece: Do Phone Price Subsidies Really Save You Money?

15 Comments

I’ll bet that most of you thoughtful readers out there like discounts, and like free stuff even better. So it’s no surprise that one aspect of the cell phone market that most people like is the carrier practice of offering phone discounts or subsidies. Indeed, many phones are offered to the public at the magic price of “free.” Of course, in order to receive those subsidies, a consumer must agree to a service contract with the carrier.

Yet aside from the negatives of being locked into the contract, do these price discounts really save the consumer any money? Let’s look into this more deeply.

One of the fundamental rules of economics is summed up in the old saying that “there’s no such thing as a free lunch.” Every economic good or service has a cost; the only real question is who bears that cost. In the case of these cell phone discounts, who do you think really absorbs the cost of those subsidies? Hint: the carriers are not in it to offer you a phone discount as a charitable contribution. They do not eat the cost of that discount; rather, they pass it along to you, the consumer, in the form of higher monthly service fees.

Columbia Law Professor Tim Wu explains that in effect, they can sell telephones on a “buy-now-pay-later” basis, like an installment plan, as opposed to a lump sum purchase. There are some problems with that.

Consumers pay those higher monthly fees regardless of whether they take advantage of the price subsidy. So those of you who buy unlocked phones or phones at full retail end up paying for a discount you do not use. In reality, consumers should have the option of paying lower service charges if they do not take advantage of the price subsidy.

The same goes for those consumers who choose to keep their phones for a period of time longer than their contract. They should have their rates lowered after they have paid off their equipment.

But for me the greatest objection is this: we have no idea how much the carriers jack up their rates to justify the cost of this subsidy. As mentioned above, the system is really a form of installment purchasing, which is really a form of financing or a loan. With every other type of loan, there are numerous regulations mandating transparency as to the real cost of that loan to the consumer. With the cell phone industry there is no such disclosure.

Does anyone think for a moment that if you sign a two year contract, that it takes the full two years to pay off the price subsidy? I am willing to bet that if we knew the extra amount of money we pay on each monthly bill to cover the equipment subsidy and calculated the effective rate of interest, that we would be shocked. However, we can’t know that because the carriers don’t allow us to know.

The bottom line is this: In the cell phone business you as a consumer are forced to pay an installment loan on all or a portion of the price of that phone, with no disclosure as to what interest rate you are effectively being charged. There is no way to opt out of paying for this loan as long as you want cellular service, even if you bring your own equipment. So the next time you see that contract price discount on a cell phone you want, just remember that you are being asked to pay a premium for the illusion of a discount.

  • Daniel

    I used to live in Europe, and sold wireless there. In the UK, when your contract was over, and you’d paid off your subsidy – you could call the carrier and get a new, lower rate (at least for o2).

    In the US, people get so outraged about paying $250 + for a phone they’ll do anything to lock themselves in for the next 5 years just to get a free Razr. It’s ridiculous.

  • Daniel

    I used to live in Europe, and sold wireless there. In the UK, when your contract was over, and you’d paid off your subsidy – you could call the carrier and get a new, lower rate (at least for o2).

    In the US, people get so outraged about paying $250 + for a phone they’ll do anything to lock themselves in for the next 5 years just to get a free Razr. It’s ridiculous.

  • John

    I just paid to get out of my neverending contract from Nextel. Everything you did like add text messaging renewed your contract. It is terrible. My rate plan never changed. I check with all the carriers to make sure that I would not be suckered into something like this again, all over the price of a stupid phone. I paid a lot more than the original phone.

  • John

    I just paid to get out of my neverending contract from Nextel. Everything you did like add text messaging renewed your contract. It is terrible. My rate plan never changed. I check with all the carriers to make sure that I would not be suckered into something like this again, all over the price of a stupid phone. I paid a lot more than the original phone.

  • J

    yea, i understand the point that you’re trying to get at…

    but my question is why do people expect that their cell phone providers should not turn a profit, on both the hardware and the service…

    when you go buy a television, you don’t pay the price that the television cost to the dealer, you pay that price plus margin so that the company can stay in business…

    this is the same thing… cingular/verizon/t-mobile/sprint are all business and it is their right to turn a profit on their products (hardware and service)…

  • J

    yea, i understand the point that you’re trying to get at…

    but my question is why do people expect that their cell phone providers should not turn a profit, on both the hardware and the service…

    when you go buy a television, you don’t pay the price that the television cost to the dealer, you pay that price plus margin so that the company can stay in business…

    this is the same thing… cingular/verizon/t-mobile/sprint are all business and it is their right to turn a profit on their products (hardware and service)…

  • Thought

    Thanks for everyone’s great comments.

    #1: nice to know at least o2 does the right thing with their customers. You are correct in that what carriers play to is the instinct among consumers to go for the lowest price up front…which usually does not end up in the best deal for consumers.

    #3: I have nothing against companies making profits…you are absolutely correct in that profits are what enable companies to stay in business, not to mention pay salaries and benefits for employees, etc.
    However, part of the healthy dynamic in any market economy is for consumers to be informed so as to act as a check and balance on corporations.
    With your television analogy, the point is that when I buy a TV I don’t have to subscribe to a particular cable provider.
    But more importantly, as noted in my article, what I really object to is that the lack of transparency. If I want to buy my phone on the installment plan, I have a right to know the terms of that loan, just as with any financing agreement. That is what is lacking today, and no wonder: the system allows for carriers to build in all sorts of markups without the consumer knowing about it.

  • Thought

    Thanks for everyone’s great comments.

    #1: nice to know at least o2 does the right thing with their customers. You are correct in that what carriers play to is the instinct among consumers to go for the lowest price up front…which usually does not end up in the best deal for consumers.

    #3: I have nothing against companies making profits…you are absolutely correct in that profits are what enable companies to stay in business, not to mention pay salaries and benefits for employees, etc.
    However, part of the healthy dynamic in any market economy is for consumers to be informed so as to act as a check and balance on corporations.
    With your television analogy, the point is that when I buy a TV I don’t have to subscribe to a particular cable provider.
    But more importantly, as noted in my article, what I really object to is that the lack of transparency. If I want to buy my phone on the installment plan, I have a right to know the terms of that loan, just as with any financing agreement. That is what is lacking today, and no wonder: the system allows for carriers to build in all sorts of markups without the consumer knowing about it.

  • http://www.timwu.org/ Tim Wu

    From Tim Wu:

    I think this is the right discussion to be having. The cell phone selling practices are similar in some ways to other practices, like the way furniture is are sold in poor neighborhoods.

    There’s a nice example here: http://allfinancialmatters.com/2007/03/26/renting-furniture-is-a-bad-idea/

    You can get a couch for “no down payment,” and “low monthly payments,” but after 3 years of payment you may have had paid $2800 for a $100 couch.

    While no one is saying companies can’t try and make money, similarly, consumers don’t have to sit by and take whatever is thrown at them.

    In the cell world, since service is bundled with equipment, you don’t really have an option not to take the loan / low-monthly payment route.

  • http://www.timwu.org Tim Wu

    From Tim Wu:

    I think this is the right discussion to be having. The cell phone selling practices are similar in some ways to other practices, like the way furniture is are sold in poor neighborhoods.

    There’s a nice example here: http://allfinancialmatters.com/2007/03/26/renting-furniture-is-a-bad-idea/

    You can get a couch for “no down payment,” and “low monthly payments,” but after 3 years of payment you may have had paid $2800 for a $100 couch.

    While no one is saying companies can’t try and make money, similarly, consumers don’t have to sit by and take whatever is thrown at them.

    In the cell world, since service is bundled with equipment, you don’t really have an option not to take the loan / low-monthly payment route.

  • http://www.timwu.org/ Tim Wu

    That should be, a $1000 couch

  • http://www.timwu.org/ Tim Wu

    That should be, a $1000 couch

  • http://www.timwu.org Tim Wu

    That should be, a $1000 couch

  • Thought

    Tim,

    Thanks so very much for taking the time to comment. I am truly humbled, and have great admiration for your work.

  • Thought

    Tim,

    Thanks so very much for taking the time to comment. I am truly humbled, and have great admiration for your work.