What is All This Nonsense about Smartphone Early Termination Fees?

by on January 26, 2010 · 5 comments

Worth It?

OK, time for a quick rant. What is all this confusion and consternation over early termination fees (ETFs) for high-end smartphones?  I mean, seriously, how hard is this process to understand?  The FCC has worked itself into a lather over this and is bombarding wireless operators and Google with hate mail letters of inquiry harassing asking them about their ETF policies.  I just don’t get it.  Let’s review some simple realities:

  • Smartphones — especially high-end devices like the iPhone, the Droid, and the Nexus One — are basically mobile mini computers.
  • Mini mobile computers do not grow on trees; someone has to make them and sell them at a profit or else no one would offer them to begin with.
  • But the people who make and sell these devices (and wireless service for these devices) want to ensure rapid, widespread distribution to win over customers and recoup their costs.
  • So, they offer a classic business inducement — an upfront subsidy for the product in exchange for monthly payments to amortize the upfront “loan” they have given the customer;
  • AND THEN THEY FORM A CONTRACT WITH THE BUYER TO MAKE THE DEAL WORK. And that contract obligates both sides to live up to their end of the deal.
  • Hey… did I mention they need to form a contract to make the deal worth it? OK, good, wanted to make sure I got that point across.
  • Then they give you a nice shiny new mobile mini-computer that for some reason we Americans still insist on calling a cell phone.
  • Then you start paying off the “loan” they’ve given you for that device over the span of the service contract. This is called “prorating.”
  • But, if you default on that loan by breaking your contract, you’ll be hit with a penalty — an early termination fee — since it would leave the carrier without a way to recoup the cost of that shiny new mobile mini-computer that they handed you on the cheap when you just absolutely had to have the hot new toy in town.

Is this process really all that complicated? And why is it so controversial? It certainly shouldn’t be. Prorating happens every day in countless ways in a capitalist economy.  And yet in the apparent techno-entitlement society we live in these days, some people seem to think there’s something scandalous about this process when it happens with our beloved mobile devices.  In reality, the smartphone subsidy and prorated contract system is really one of the great pro-consumer accomplishments of our time. With various inducements and buyer loyalty credits, I recently got my Motorola Droid from Verizon for just $99 bucks. Like the iPhone and Google’s new Nexus One, the Droid is worth over $500 bucks, and yet millions of Americans have been able to obtain these spectacular devices because of this system of upfront subsidies and prorating. And it’s not like Lucifer is present at the signing of the contract asking for a blood offering or your first born as part of the exchange. Nobody forces you to buy a $500 phone!

Moreover, if you really want, there are plenty of “unlocked” mobile devices you can pay full freight for and then take to any carrier you want to get service. Needless to say, not a lot of people bother. I think that tells us something. And, again, who can really blame consumers… just look at the prices of these unsubsidized phones! $574.99 for the Droid, $649.99 for the Nexus One, and $909.99 for the Sony Ericsson Xperia!  You could buy a used car for that kind of money.

Look, I can appreciate arguments about “better transparency” in this process to make sure consumers know what they are getting into, but you don’t need a PhD in economics to understand that you’ll have to make some payments over the long haul to pay off what you got up front on the cheap. My guess is that most people who buy an expensive smartphone have likely also has had a car or home loan at some point in their lives–or any loan for that matter.  The principle in all cases is the same: There is no free lunch.

  • Andy

    You are of course right that's there is no mystery to an ETF, it's a pretty standard contractual agreement.

    There are several problems with ETF's, however. I'm not sure if the FCC has addressed them properly in its letters, but here are a few that bother me the most:

    If part of my monthly service plan is to recoup the cost of the device, why doesn't that service plan get cheaper after X months, when the discount is completely absorbed?

    If I do go buy an unlocked phone, how come my service plan isn't cheaper since there's no discount recouping to be done?

    The providers claim all day long that ETFs are there to recoup device discounts, but they will tell you absolutely nothing about how long that recouping takes, or when it ends and becomes pure gravy for them. Device discounts are a shiny carrot to lure in new customers or retain existing ones, and ETFs are merely a lock-in strategy. I want to see more proof that the two practices are even related at all.

  • MikeRT

    I think Verizon's financial stats provide some clue as to why these companies are so abusive. Verizon's certainly a lot more profitable than Ford, but at a glance, their cash-debt ratio makes the US auto industry look tame by comparison (Ford has a $32B:$132B cash-debt ratio; Verizon has a $1.6B:$63B cash-debt ratio).

    AT&T is not much better off and Sprint has been hemmorhaging customers for several quarters now. Companies in their position (deep in debt, fiercely competitive, lower profit margins) are going to be weasely and try to lock in their customers–out of necessity.

  • http://srynas.blogspot.com/ Steve R.

    Adam, you wrote: “AND THEN THEY FORM A CONTRACT WITH THE BUYER TO MAKE THE DEAL WORK. And that contract obligates both sides to live up to their end of the deal.

    Can you name any instance of a consumer actually negotiating (forming) a contract? Have you seen any contract form that allows the consumer to make changes to the “contract” before signing..

    Most terms of service exempt the carrier from being “obligated” in any manner. See: Can Verizon Wireless Change This Agreement or My Service?

    “We may change prices or any other term of your Service or this agreement at any time, but we'll send you written notice first. If you use your Service after the change takes effect, that means you're accepting the change. But if a change to your Plan or this agreement has a material adverse effect on you, you can cancel the line of Service that has been affected within 60 days of receiving the notice with no early termination fee..

    Even though consumers seemingly “agree” by clicking, I would not consider them to be valid contracts. Furthermore, it seems that the entire industry is following this unfortunate practice. So where is customer choice then? So in the face of this unfortunate practice, why isn't there a call to reform this onerous practice so that the consumer can actually enter into a valid contract?

  • MikeRT

    I think Verizon's financial stats provide some clue as to why these companies are so abusive. Verizon's certainly a lot more profitable than Ford, but at a glance, their cash-debt ratio makes the US auto industry look tame by comparison (Ford has a $32B:$132B cash-debt ratio; Verizon has a $1.6B:$63B cash-debt ratio).

    AT&T is not much better off and Sprint has been hemmorhaging customers for several quarters now. Companies in their position (deep in debt, fiercely competitive, lower profit margins) are going to be weasely and try to lock in their customers–out of necessity.

  • http://srynas.blogspot.com/ Steve R.

    Adam, you wrote: “AND THEN THEY FORM A CONTRACT WITH THE BUYER TO MAKE THE DEAL WORK. And that contract obligates both sides to live up to their end of the deal.

    Can you name any instance of a consumer actually negotiating (forming) a contract? Have you seen any contract form that allows the consumer to make changes to the “contract” before signing?

    Most terms of service exempt the carrier from being “obligated” in any manner. See: Can Verizon Wireless Change This Agreement or My Service?

    “We may change prices or any other term of your Service or this agreement at any time, but we'll send you written notice first. If you use your Service after the change takes effect, that means you're accepting the change. But if a change to your Plan or this agreement has a material adverse effect on you, you can cancel the line of Service that has been affected within 60 days of receiving the notice with no early termination fee..

    Even though consumers seemingly “agree” by clicking, I would not consider them to be valid contracts. Furthermore, it seems that the entire industry is following this unfortunate practice. So where is customer choice then? So in the face of this unfortunate practice, why isn't there a call to reform this onerous practice so that the consumer can actually enter into a valid contract?

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