Editorial: the American phone subsidy model is a RAZR way of thinking in an iPhone world

The concept is simple enough -- pay more, get more. So it has gone (historically, anyway) with phone subsidies in this part of the world, a system that has served us admirably for well over a decade. It made sense, and although it was never spelled out at the customer service counter quite as clearly as any of us would've liked, it was fairly straightforward to understand: you bought a phone on a multi-dimensional sliding scale of attractiveness, functionality, and novelty. By and large, there was a pricing scale that matched up with it one-to-one. You understood that if you wanted a color external display, a megapixel camera, or MP3 playback, you'd pay a few more dollars, and you also understood that you could knock a couple hundred dollars off of that number by signing up to a two-year contract. In exchange for a guaranteed revenue stream, your carrier's willing to throw you a few bucks off a handset -- a square deal, all things considered. So why's the FCC in a tizzy, and how can we make it better?

The problem

The year is 2010 -- and things have changed. A multitude of market forces have dramatically and fundamentally altered the phone pricing landscape over the last 18 to 24 months in particular; carriers that once had a well-stratified range of feature phones priced between free and $100 plus a lone smartphone or two at the $200 price point now have a confusing jumble of smartphones and feature phones alike spanning the entire range. What's more, the supply chain has matured and R&D costs have been paid down -- a high-end handset that manufacturers needed to retail for, say, $650 five years ago before subsidy might run just $500 today (after adjusting for advances in technology). Confusing matters further is a continued push for relatively high-end feature phones like the HTC Smart, Samsung Wave, and LG Mini that often cost more than their smartphone counterparts.

Knowing full well that $199 is an unspoken psychological ceiling for most consumers, carriers are left with impossibly little room to price this amazing spread of devices. But it gets worse: these days, it's impossible to ignore the reality of the $99 iPhone 3G, a device that continues to set the benchmark for the level of functionality and capability that a midrange smartphone should deliver a year and a half after its introduction. The price pressure is enormous, and realistically, going above $99 on contract is now dangerous territory for anything short of a superphone -- pretty amazing when you consider that Cingular charged a heart-stopping $499.99 on a new two-year agreement for the RAZR V3 when it launched a little over five years ago.

In practice, what does this all mean? To put it bluntly, it means that customers who choose lower-end devices are getting screwed, because no amount of subsidy can make up for the fact that you're paying just $100 more upfront for an iPhone 3G than you are for a lowly Nokia 2230. Verizon has even plainly admitted this in its defense of the infamous $350 "advanced device" ETF to the FCC -- it simply costs more for a carrier to front you a good price on a smartphone than it does a dumbphone. Price pressure has excluded the consumer from feeling that difference, unless -- in the case of Verizon, anyway -- they opt to back out of a contract early, in which case they're met only with negative reinforcement.

The solution

I'm not advocating that good phones should cost more than they do today. Quite the contrary, actually -- the real problem is that American carriers have yet to fully acknowledge the new reality that high-performance smartphones are commodity items, even as they load their lineups with them, and you end up with a traffic jam of devices and no way to effectively price them. But I'm also not advocating that carriers thin out the herd (I'd never dream of suggesting such a thing). Instead, I'm arguing that carriers need to rethink everything about the way they incentivize commitments, and maybe even rethink the concept of a commitment altogether.

Most American carriers partly recoup deeper subsidies on higher-end devices by requiring lucrative data plans, and as annoying as that is, I think that it's the closest we've come to nailing the real fix. The next step is to come to terms with the fact that, for all practical purposes, $0 and $100 are the same thing -- over the course of a two-year contract, the upfront sticker price you pay for a phone is trivial. Seriously, it's a drop in the bucket: total cost of ownership for a smartphone on any of the US nationals can run beyond $3,000 by the time your 24 months is up.

European carriers -- operating in a more mature market than their American counterparts -- have long since figured this out, and have completely turned the subsidy model on its end. You can get virtually whatever phone you want for free, from the lowest of the low to the highest of the high -- the only difference is the required minimum monthly spend. It makes a lot of sense considering that carriers don't make money off your phone purchase, they make it off your plan -- it's not pure gravy for them, but it's close enough so that they're comfortable deeply subsidizing your hardware. Besides, higher-end phones have been proven to generate higher ARPU (average revenue per user), which only serves to validate the model further.

So, Verizon, AT&T, Sprint, T-Mobile, that's really all there is to it: crib off your European cousins. There's never been a better time, what with the boys and girls in Washington bearing down. Stop trying to play the pricing game from the moment a potential customer walks into the store, because it's only going to get harder -- and rest assured, the days of selling $500 clamshells on contract are definitely over.