Why do mobile carriers sell phones with a subscription?  My roommate and I were debating this the other night.  Most other popular electronics devices aren’t sold this way.  Cable and satellite companies don’t sell televisions with their video service.  ISPs don’t sell laptops and desktops with their Internet service.  Bundling phones with mobile service subscriptions is pretty unique.  (The only mass-market analogs I can think of are satellite radio and GPS service.)

Why might this be?  Some might think that US carriers need control over the phones sold to their customers because roughly half of US subscribers use GSM phones (AT&T and T-Mobile) and half use CDMA phones (Verizon and Sprint), but that can’t be the reason because GSM is the standard in Europe yet bundling phones with subscriptions occurs.

Some say it occurs because it benefits carriers at the expense of consumers.  A law review article written a few years ago said bundling profitably exploits the misperceptions of consumers and the value they place on mobile services.  Tim Wu has said that selling phones is an anticompetitive response that allows carriers to control the platform and disable features (WiFi, Bluetooth, VoIP) that might eat into the carriers’ existing revenue streams.  But even if that’s true I don’t think that’s the whole answer.  If network services have that much control over the devices used for their services, why don’t cable, satellite, and Internet service providers sell TVs and computers that only work with their service?  At the very least, if we assume, as Wu does, that carrier control removes features consumers really want, consumers could simply purchase phones directly from phone makers–Apple, Motorola, Samsung, LG–with full functionality intact.

I don’t know the best answer, and maybe commenters can chime in, but I suspect phones and contracts are primarily sold together because of the engineering challenges presented by a device using radio spectrum.   (This would explain why GPS and satellite radio service providers also bundle devices with service.)  Different carriers purchase licenses to use different swaths of spectrum, and these different frequencies require different radio receivers.  Phones, then, need to have radios installed that are tailored for the particular carrier.

In any case, throughout most of the world, phones are sold with subscriptions.  Some on the left, like Wu, say that bundling shouldn’t be permitted because it enables large carriers to exclude competitors and remove functionality consumers want.  To that end, he proposes regulations that require all handsets to work with all carriers.  Despite these objections, I’ll push back on the claim that consumers are being duped or that competition is seriously harmed.  Bundling handsets with subscriptions has several pro-competitive and pro-consumer justifications.

1.  Acts as an installment plan

This may be the most powerful reason selling phones with subscriptions is near-universal:  consumers like it.  Modern smartphones are expensive consumer products costing hundreds of dollars.  Wherever you see expensive consumer products (home appliances, furniture, computers, clothes) you find retailers offering installment plans so that consumers don’t have to pay hundreds or thousands of dollars up-front.  By locking consumers into a two-year contract, carriers can offer heavily subsidized advanced handsets–that they usually sell at an initial loss–and charge more for services over two years.

Consumers seem to prefer bundling since it acts as a de facto financing agreement.  Noncontract prepaid plans are offered by every US carrier, yet the vast majority of Americans still use post-paid plans with contracts in large part because the (subsidized) phones offered are so much cheaper and more attractive deals.  (See my prior post on the subject.)  Further evidence that consumers really value this installment plan option comes from Belgium, where bundling phones with subscriptions was illegal years ago.  That all changed in 2008 when the iPhone 3G came out.  Belgians complained about the fact that their iPhones started at €525 when their neighbors, like those in the Netherlands (who allowed bundling), could get a subsidized phone for as little as €1.  Within a year, with support from a competition minister, the law was changed to allow phones to be sold with subscriptions.  Predictably, the up-front costs of Belgian phones subsequently dropped as carriers subsidized the phones, and broadband penetration increased.

2.  Reduces transactions costs for consumers

Consumers also benefit from having a one-stop shop for their mobile needs.  Instead of needing to go to a phone retailer like Best Buy and then to a carrier’s retail store, consumers can get everything at the carrier’s retail store.  This may sound like a small benefit, but I imagine this especially benefits rural Americans who don’t have the retail options city-dwellers do.

3.  Aids carriers’ marketing and improves competition

It’s probable that bundling phones with subscriptions makes carriers more competitive.  There’s a textbook antitrust justification for why this is true.  Vertical contracts with suppliers aligns the interests of the retailer (carrier) with the supplier (phone maker).  DROID is a good example.  It’s a brand used by Verizon to market higher-end Android smartphones to tech-savvy early adopters.  This is a case of vertical restraints that prevent free-riding on Verizon’s brand promotion since no other carrier can offer DROID phones.  By most accounts, creating the DROID brand was a lucrative marketing move that helped Verizon’s Android phones compete with iPhones.  While DROID is probably the most successful example, all carriers have phones they market and sell exclusively.

4.  Improves carriers’ bargaining power with handset makers (and improves phones)

Selling phones with subscriptions allows carriers to strengthen their position in the value chain.  Carriers don’t want to be passive bit-pipes.  They know crushing price competition between carriers would result.  (Not to mention, being “dumb pipes” would make carriers more susceptible to net neutrality rules.)  Carriers are already being squeezed by handset suppliers, namely Apple, with high prices, so it’s to their benefit to make the handsets complementary to a specific network and not easily interoperable with other carriers.  And by selling differentiated handsets to their customers, the carriers demand innovative handsets from suppliers to differentiate their brand from other carriers and make their network ecosystem attractive to consumers.  If phones worked on all networks, a mandate Wu and others seek, each carrier’s demand for innovative phones from their suppliers would subside.  (Then competition would be driven by consumer demands, but it’s my impression that phone makers prefer to deal with carriers.  Responding directly to consumer demands would tend to fragment the hardware market even more than the existing market, which would add to their costs.)

5.  Smooths revenue streams for carriers (and improves networks)

Finally, locking consumers into a two-year contract, with a subsidized phone as a carrot, gives some predictability to carriers’ revenue streams.  Lumpy revenue streams and high churn is a killer for long-term network investment plans.  Without the ability to sell phones with subscriptions, churn rates would be much higher since few customers would want to be in a long contract.

This is what happened in Finland for years, when regulators banned bundling.  After having one of the best networks when cell phones first became popular in the late 1990s, there was intense price competition for voice and text.  And while Finnish prices were low, the investments in a 3G data network fell far behind other countries.  No bundling led to very high churn rates and made price competition–not advanced services like broadband–the focus of carriers.  Seeing that the lack of network investment was brought on by the ban on bundling, the Finnish equivalent of the FCC repealed the anti-bundling law in 2005.  With the new ability to lock customers into contracts, phone prices fell and network investment into mobile broadband improved.

I expect selling phones with subscriptions will continue for the foreseeable future, absent regulation.  And, for the reasons I’ve outlined, the ability to sell phones with subscriptions is likely a good thing for consumers and the industry.

Finally, though, I’ll note that inexpensive high-end smartphones could upset this entire bundling regime.  Cheap phones would mean carriers are less able to lock consumers into contracts.  We’re not there yet, but phones like the LG Nexus 4–an unlocked high-end Android starting at $300–indicates the day may come when consumers can’t be bribed into contracts by subsidized phones any longer.  Consumers, at that point, will prefer to pay full price up-front and have the ability to switch carriers at any time.  I don’t know how the radio engineering issues would be overcome, but this would be a major disruption of the wireless market and would have some ambiguous effects on competition, network investment, and consumers.  And, it’s important to note that we may enter Wu’s desired world of phone interoperability without regulatory mandates.

Jeff Winkler of The Daily Caller was kind enough to call me for comment after seeing some tweets of mine about a new proposal floated by U.S. Transportation Secretary Ray LaHood to potentially mandate cell phone jamming technology be embedded in every car to minimize the risk of distracted driving.  While I am sympathetic to the concerns he and others have raised about the serious dangers associated with distracted driving, LaHood has been continuously upping the ante in terms of proposed regulatory responses to the problem.

Back in October, La Hood suggested that a ban on all cell phone communications in cars might be needed. He argued that even hands-free phone conversations are a “cognitive distraction” and should be prohibited and has also suggested that such a ban should extend to in-vehicle information and entertainment systems such as Ford Motor Co.’s Sync and General Motors Co.’s OnStar system. This means almost every conceivable in-vehicle technology could be regulated under LaHood’s “cognitive distraction” paradigm, including your car stereo and GPS system.  This week LaHood went further and suggested that it may be necessary to also mandate some sort of scrambling technology be embedded in all vehicles to completely block any potential wireless communications or connectivity.

My comments on that proposal appear in Winkler’s piece today, although Winkler notes that LaHood appears now to be backing off the idea.  However, just in case this idea (or the idea of banning all communications devices from cars more generally) pops up again, here’s what I find wrong with LaHood’s approach:

1. Not practical: It’s simply not possible to eliminate all technology from cars, at least not with creating an Auto Police State — and a huge headache for law enforcement officers to boot.  Even if you banned integration at the factory of in-vehicle technologies, plenty of people would find after-market alternatives.  There’s just no stopping people from lugging their devices around with them wherever they go and finding ways to connect. And even if government forced signal jammers to be embedded in every vehicle, determined hackers would likely find a way around them fairly quickly and then tell the public how to defeat those systems.
2. Potential unintended safety consequences:  We simply can’t eliminate every risk from life and trying to do so can have equally dangerous unintended consequences. For example, if all communications devices were banned from automobiles and then jamming devices were mandated for good measure, what happens when a driver veers of a snowy road into a ditch and needs to call or text for help? Perhaps there will be a switch to disable the jammer in a time of emergency, but wouldn’t people just flick it off preemptively, undercutting the ban entirely?
3. Contradicts other laws: For some of the reasons listed in (2), the Federal Communications Commission generally disallows jamming technologies that would create negative externalities for others on the network through excessive signal interference. (See Section 333 of the Communications Act.)
4. There are better solutions: There are more constructive solutions than outright technology bans or extreme measures like mandatory jammers. First, use technology to solve a problem technology has created.  Most new communications and computing devices have increasingly sophisticated voice-activated / hands-free features that make them safer to use.  Second, more driver education – especially for younger drivers — is also a big part of the solution. We need to step up those efforts. Finally, stiffer fines for erratic driving infractions may be necessary.
5. It’s a local issue: On that last point, is there anything that lends itself better to state and local experimentation than road safety?  Seems to me that this is a good chance to let federalism work and see what various communities come up with in terms of solutions. Of course, wireless communications is regulated at the national level and efforts by local officials to take LaHood extreme approach could run afoul of federal wireless rules.  However, as noted in (4) there are plenty of alternative approaches that they could consider.
6. Just too intrusive: I’m no anarchist; we do need some rules of the road to ensure driver safety. But there should also be some limits.  Conversations (and arguments) between passengers are a huge distracted driving problem, too, but we wouldn’t ban them. Nor would we ban singing at the wheel. Your liberties don’t completely disappear when you get in your car. Policymakers needs to avoid extreme solution such as those suggested by LaHood and instead find more constructive approaches that balance safety and liberty.

Distracted driving is a serious problem. When you’re flying down the road at speed maneuvering a 2-ton piece of machinery, you need to be paying attention to the road to keep yourself, and others around you, safe.  Distractions of any sort can be dangerous and undercut the driver’s ability to stay focused.  And it’s certainly true that digital devices can be among the biggest distractions. But I think we have to ask some practical questions about just how far law can and should go to minimize that distraction.

I raise this issue because, according to this Bloomberg article yesterday, “U.S. Transportation Secretary Ray LaHood says he believes motorists are distracted by any use of mobile phones while driving, including hands-free calls, as his department begins research that may lead him to push for a ban.”  Sec. LaHood believes that even hands-free phone conversations are a “cognitive distraction” and should be prohibited.  Also, “his concerns extend to vehicle information and entertainment systems such as Ford Motor Co.’s Sync and General Motors Co.’s OnStar,” which means that almost every conceivable in-vehicle technology could be regulated under LaHood’s scheme.

To be clear, I’m not necessarily opposed to laws addressing talking on phones or texting while driving since those actions can have dangerous consequences. But I’ve always preferred a more generic enforcement strategy when it comes to distracted driving laws.  As I noted in my old 2007 essay, “Banning In-Car Technologies Won’t Work,” to the extent law enforcement needs to be brought into the picture it should be done in a technology-agnostic or activity-agnostic fashion. I went on to argue:

Instead of trying to ban technologies (cell phones, radios, MP3 players, navigation devices, etc.) or specific activities (conversations, singing, smoking, etc.) inside the cabin of an automobile, police officers should simply enforce those laws already on the books dealing with reckless or negligent driving.  If a driver is weaving in and out of traffic lanes, or posing a serious threat to others on the road for any reason, they should be pulled over and probably ticketed if the infraction is serious enough.  For starters, I’d like to see some of those stupid idiots I see eating while driving, or worse yet, putting on make-up behind the wheel, pulled over and ticketed when they are driving erratically. But the same goes for anyone who is operating a vehicle in a dangerous fashion. Again, enforce basic traffic safety rules and focus on educating drivers about vehicle safety. Don’t ban new technologies.

That’s still where I stand on this issue.  Moreover, I keep coming back to the practicality of the sort of sweeping technology bans that Sec. LaHood and others advocate.  I just don’t think it’s possible to eliminate all these devices and activities from cars, at least not with creating an Auto Police State, and a huge headache for law enforcement officers to boot.  Even if you banned integration at the factory of in-vehicle technologies, plenty of people would find after-market alternatives.  And you just can’t stop people from lugging their digital devices around with them wherever they go.

Thus, to reiterate, the better solution here is to:

1. Continue to make those technologies more road-friendly by integrating in more safety features. As I noted in this CNBC interview earlier this year, Ford’s new systems, for example, have some very impressive voice-activated features. And others are following suit.
2. Educate drivers about safer vehicle operation & proper technology use.  For more on that, see Berin Szoka’s excellent post, “Texting While Driving: Regulate or Empower & Educate?”
3. Apply stiffer fines to erratic driving infractions. Again, if a driver is posing a threat others on the road for any reason, they should be penalized for that behavior.

I want to raise a final proposal. If Sec. LaHood and others are serious about minimizing distracting in-vehicle conversations, then I would ask them to find to a solution to the greatest threat to driver safety: nagging spouses and poorly-behaved children!  Seriously, there is no greater “cognitive distraction” to a driver than family fights and bad kids.

National Economic Council Director Lawrence Summers made a major policy speech yesterday at the New America Foundation, announcing the adminstration’s plan to find an additional 500 megaherz of spectrum for wireless broadband service by the end of the decade. The spectrum will come from two places: federal agencies who currently under-utilize their spectrum, and commercial users who volunteer to participate in “incentive auctions.”

In an incentive auction, the current spectrum user receives part of the proceeds in exchange for making the spectrum available for reallocation. Within the current US system of spectrum allocation, it’s about as close as we can come to allowing spectrum holders to sell their spectrum licenses to someone else who can put the spectrum to a more valuable use. 

Summers even mentioned broadcasters specifically, noting that a local television station with a few hundred millions of dollars of revenue may currently control spectrum worth hundreds of millions of dollars. Federal agencies would get to use some of the proceeds to adopt “state-of-the-art communications.” Presumably this would include new equipment that doesn’t use so much spectrum.

In his speech, Summers gave appropriate credit to the Federal Communications Commission, which surfaced many of these ideas in its National Broadband Plan. Even more appropriately, the former Harvard University president and academic economist assigned proper credit for the original source of the idea: 

Most of the freed-up spectrum will be auctioned off for use by mobile broadband providers. As the great law and economics scholar Ronald Coase originally pointed out, auctions ensure that spectrum is devoted to its most productive uses because it is determined by investors’ willingness to pay for it.

There are, of course, a few unanswered questions. How much of the spectrum will actually get auctioned for mobile broadband, rather than reserved for unlicensed use? Will the buyers have to use the spectrum for mobile broadband, or will the license be sufficiently broad that they could use it for other forms of personal communication that perhaps haven’t even been invented yet? Do we really have to wait ten years for this? Will the Ronald Coase Institute get any royalties for the government’s use of its namesake’s intellectual property? (Academics will recognize the joke in the last question.)

For now I’ll just say, “Bravo, Dr. Summers!”

Texting while driving is generally a bad idea, since it involves taking one’s hands off the wheel and eyes off the road. While not wearing your seatbelt in a car or a helmet on a motorcycle probably only risks your own life, there’s a good argument to be made that distracted drivers put the lives of others at risk. The WSJ reports that 17 states have banned texting while driving outright. But is such regulation really the best way to address the problem?

Technological Empowerment. The WSJ highlights innovative technological solutions that:

1. Block calls and texts while the user is driving; OR
2. Let drivers “speak” their texts using voice-to-text technology.

Those who consider even hands-free cell phone use unsafe will probably insist on the more draconian blocking solution—and want government to mandate it! Such mandates would indeed probably be more effective than relying on the police write tickets to drivers they see texting while driving (especially since such offenses, like calling while driving, usually require some other, more serious offense before an officer can pull over a driver). But do we really need the government telling us when we can use a technology that really might be essential in certain circumstances, or totally safe in others (say, when we’re behind the wheel but stopped at a long light or in a traffic jam)?

The fascinating thing is that these solutions need not be mandated by government: At least some users will actually pay for them! Why? Because, sometimes we’re better off by being able to “bind” our future selves—just as Ulysses asked his crew to tie him to his ship’s mast so he could enjoy the Siren’s enchanting song without giving in to their spell. Similarly, these texting-blocking technologies empower users in three senses:

1. Some users know they shouldn’t text while driving but—like smokers and people who casually pick their noses—just can’t stop, so they want external discipline;
2. Others just want the monthly discount on their car insurance; and
3. Parents want to make sure they can discipline their children, who have a hard time resisting the impulse to pick up the phone.

Obviously, there are limits to how far reasons 1 and 3 can go.  Reason #1 requires at least a desire to change: As the young playboy Saint Augustine prayed, “Lord, make me chaste—but not yet!” Reason #3 requires private sector paternalism in the most literal sense. But reason #2 requires nothing more than the self-interest of users and insurance companies, which can happily coincide with road safety given the right technology. I suspect this solution is much more likely to be effective than simple government mandates, much as insurance company discounts for having smoke detectors, fire extinguishers and sprinkler systems in your home or office are probably more effective at promoting such technologies than the threat of a fine from a government inspector.

Education. Here, as elsewhere, the “less restrictive” alternative to regulation isn’t technological empowerment alone, but empowerment in combination with education. As Adam said in 2007 of anti-cell phone effort: “Banning In-Car Technologies Won’t Work.”

The proper solution here is education, not regulation. During driver training education, teenagers and other new drivers need to be taught the importance of keeping both hands on the wheel and their eyes pointed straight ahead at the road. Operating a vehicle is serious business with serious repercussions if you ignore basic rules of driving safety. But that doesn’t mean you shouldn’t have access to communications / entertainment devices while in your car. We just need to teach new drivers how (and when) to use them properly. For example, set up playlists in your iPod and start them running before you pull out of the driveway. And program the preset buttons on your car stereo or satellite radio device so you can switch stations without looking. If you have to scroll to find something new to listen to, try to do it when you’re at a stop light, not when you’re driving down a busy street with a lot of pedestrians around.

If governments really want to “do something” for road safety, they should build awareness of technological empowerment solutions, especially among parents and kids. They can also fund public service announcements like this one, which is not for the faint of heart:

http://www.youtube.com/v/DGE8LzRaySk&eurl

Looks like we can count on another tax landing on our cell phones soon thanks to the taxaholics in the Obama Administration.  According to Jeff Silva of RCR Wireless:

Though details on the Obama budget are few and far between, some information was made available. The administration estimates that spectrum license fees would raise $4.8 billion over the next 10 years.

Don’t be fooled into thinking that wireless carriers will just eat those fees.  Those fees will be coming to bill near you soon in the form of another stupid government tax burden on our wireless phones.

You know, because we’re not already paying enough in taxes on our phones.

(P.S.  I’m actually a little surprised that the “progressives” in this administration would support this proposal since a tax on mobile phones will end up being about as regressive as taxes can get.)