There’s been a resurgence in interest in non-contract (prepaid) phone plans and MVNOs in tech reporting lately, which makes sense given recent market dynamics.  Prepaid subscriptions number over 100 million, are now 25% of the mobile subscriber market, and Ars Technica recently reported that post-paid subscriptions declined for the first time ever in mid-2012.  Prepaid is definitely attracting people other than the usual lower-income folks, students, and the tech-savvy, who have the patience (or need) to navigate the hurdles prepaid sometimes presents.  The prepaid market has come a long way since Adam wrote about Straight Talk three years ago, and as one of the newest customers of Straight Talk—an MVNO that leases their networks from the Big Four carriers—I’d like to weigh in on these prepaid market challengers.

This post is mostly inspired by a conversation I had with a telecom expert at a recent event.  I asked her if she thought Americans would, like the Europeans have, shift towards prepaid in the next few years.  I was optimistic but she didn’t think Americans would go to a prepaid model anytime soon.  (She did say, however, that some carriers would prefer we switch to a prepaid model.)  So why hasn’t the US market shifted towards prepaid plans like much of the world?  I suspect if we polled economists, carriers, and tech writers, most would agree that prepaid is a better model.  It’s almost always cheaper to use a prepaid plan and you can avoid a two-year contract.  So why hasn’t there been even more adoption of prepaid?  I offer a few possibilities from the demand side (there are likely supply-side issues too, but let’s save that for another day).

1.   Crappy phones

Perhaps this is a symptom of weak demand for prepaid, not a cause, but the sub-par nature of many phones offered by prepaid carriers is certainly a deterrent for many people.  Prepaid evokes images of smartphones your grandma would be embarrassed to own and clunky feature phones.  Prepaid plan customers tend to be budget-conscious and don’t need the newest, most advanced hardware, so this may be a demand issue – if prepaid carriers offered nice phones, few would purchase them.

But prepaid does not mean you’re stuck with a lame phone.  (Straight Talk has some respectable smartphones, but most can be described as “entry-level” at best.)  Consumers willing to do a little research can have their cheap plan, no contract, and a good phone.  Before moving to Straight Talk from AT&T, I made sure I bought a phone that I’d be happy to use for awhile.  I purchased an unlocked Google Galaxy Nexus, popped in the activated Straight Talk SIM, and a few minutes later I was up and running.  Really, any consumer with an unlocked or already-purchased GSM phone doesn’t need to sacrifice phone quality by moving to a prepaid MVNO.  Likewise, I imagine consumers with CDMA (Sprint and Verizon) phones could also enjoy their phone of choice in prepaid, which brings me to my next reason I believe consumers don’t flock to prepaid….

2.   Two Technology Standards

Particularly when switching to an MVNO like Straight Talk, which leases networks from both CDMA and GSM carriers, figuring out which prepaid plan suits your current phone can be a deterrent.  The US is unique in that neither GSM nor CDMA has prevailed as the dominant technology in mobile phones.  Even the four major carriers mirror this phenomenon.  Sprint and Verizon are CDMA, AT&T and T-Mobile are GSM.  I suspect your average consumer doesn’t want to shop around and investigate whether they can bring their phone to, say, Virgin Mobile, or whether the Straight Talk or MetroPCS network is compatible.  This dual-standard problem may lessen in the next few years, however, if all carriers shift to voice-over-LTE.  If that does happen, we can expect more folks to switch out of two-year contracts since another hurdle is removed.

3.   Sticker Shock to Unlocked Phones

Many Americans have spent their phone-owning lives on post-paid plans, enjoying the subsidized phones they receive in exchange for a binding two-year contract.  Of course, the phone is not truly cheaper; the costs are simply spread out over the two-year contract, which you can get out of only at great expense.  Nevertheless, paying $700 -$900 for an unlocked iPhone 5 knowing that it’s available (subsidized) with AT&T for $200-$400 is daunting.  Even I wasn’t immune to this irrationality.  While I would have liked a Galaxy S III, and it costs around $200 when offered by AT&T, it’s $800 when not subsidized by a carrier.  At $350, my Galaxy Nexus was much less painful (and comes with Jelly Bean).  I’m not sure this sticker shock effect is going away soon.  Subsidized phones are an established norm in the US, and until we become accustomed to the truer cost of our phones, most will be reluctant to drop several hundred dollars on a phone, even if it means their monthly phone bill is cut in half, or more.

There may be other reasons people aren’t fleeing to prepaid.  Retail operations for smaller carriers seem meager (Straight Talk is an exception since they’ve paired up with Walmart for distribution.)  The chipset in your phone might not allow you to change carriers.  I’ve seen rumors on online forums that the larger carriers prioritize their own traffic over that of the MVNOs they lease to, which will degrade service quality.  And customer service may be more of an issue with prepaid carriers as well (I had one minor issue here during activation).  But for me, a month into my Straight Talk switch, I don’t plan on going back to expensive two-year contracts anytime soon.  I like having my HSPA+ phone, paying only $45 per month for (basically) unlimited data, text, and minutes, and no contract.

Five years into a recession, these budget-friendly plans should only become more popular and should provide some effective price competition to the major carriers.  It will be interesting to see how the major carriers respond to these prepaid challengers if trends continue.  After years of benign neglect of prepaid customers (I think all major carriers have small prepaid offerings), I doubt they’ll stand for the cannibalization of their post-paid subscribers to the MVNO carriers they lease networks to.  And it seems the major carriers are becoming interested in capturing budget-conscious consumers, if the proposed T-Mobile – MetroPCS merger is any indication.  Time will tell.

Wal-Mart is often cast as a villain by some labor unions, local politicians and small retailers, but for the average consumer Wal-Mart has been a savior: A relentless price-cutting machine that instantly changes the dynamics of every market it touches. Indeed, when Wal-Mart decides to jump into a sector by offering a new good or service in its stores, something akin to “the Southwest effect” on steroids kicks in: That market segment is often transformed overnight in that the good or service Wal-Mart starts delivering is essentially instantly commoditized. For the seller of that good or service, this is both a blessing and a curse: They gain the massive market reach that goes along with being in Wal-Mart’s 8,000 retail stores. On the other hand, they instantly surrender any semblance of pricing power they once had.  And this typically also puts downward pressure on prices not just for the particular good carried in the Wal-Mart stores, but for that entire market segment more generally. [This exact scenario is currently playing out in the book marketplace as Wal-Mart has gone to war with Amazon in cost-cutting bonanza.]

The reason I bring all this up is because, as most of you probably already heard, Wal-Mart jumped into the prepaid cell phone business this week with the launch of Straight Talk:

a new solution in no-contract cellular, exclusively at more than 3,200 Walmart stores nationwide starting October 18, 2009. Straight Talk will bring to the market a new low price for no-contract wireless service with two prepaid plans now available to customers nationwide at $30 and $45 a month. Straight Talk will only be available in Walmart stores and online at www.Walmart.com and www.StraightTalk.com. The average U.S. adult spends $78 on his or her cell phone bill to receive 1000 minutes a month. By switching to the $30 Straight Talk plan, for example, the average 1,000 minutes-per-month consumer could save more than $500 per year and still be on a reliable nationwide network.

I don’t want to overplay the significance of this development, but I really do believe that Wal-Mart’s presence in this field is significant, at least for entry-level mobile phones. While it would be easy for those of us who use more advanced smartphones to shrug off the Wal-Mart announcement, it would be a mistake for reasons made clear by David Worthington over at Technologizer:

As a technophile, it’s tempting for me to point out the short comings of those devices. There are only a few stock applications available, and unlimited data on a flip phone does not translate to the same experience that I have surfing the Web on my iPhone. But that does not matter, because the people who would buy these phones wouldn’t care. … It’s.. an economical choice for families with shoestring budgets. Leading wireless companies provide family plans, but they aren’t cheap, and usually require a commitment. … A pre-paid plan doesn’t require families to purchase much more than what they want to pay for. Whether Wal-Mart becomes a viable wireless company or not is up to the market, but its track record is pretty solid. Wal-Mart rapidly became the largest grocery store in the United States after all, and it has more locations than other pre-paid wireless companies. I’m guessing it’ll do well.

You better believe it. Have you seen the stacks of prepaid calling cards that adorn the shelves in every Wal-Mart checkout line?  Do you think they just have those there for decoration?  That’s a huge business, folks. While some of us haven’t touched a prepaid calling card since our college days decades ago, millions of people buy and use such cards every day.  As Worthington notes, prepaid plans mean you don’t have to pay for more than you’ll think you need and for many folks that’s about all they want to hear.  Esoteric inside-the-Beltway debates about tethering, Net neutrality, app stores, etc., are meaningless to most people.  They just want a phone that works at the right price — namely, cheap!

Finally, this development certainly calls into question the asinine theories being bandied about in Washington these days about the mobile marketplace lacking competition and innovation, something recent studies have shown to be complete bunk.  I’m not saying that Wal-Mart’s entry into this sector is going to turn cell phones into the equivalent of the toothpick or napkin market; there will always be room for differentiated phones and plans, especially at the higher end of the market. But as the retailing giant expands its reach in this sector, it’s bound to have an impact — especially for the entry-level devices and plans that low-income consumers might want.  Somehow I doubt this will let the regulation-happy gang over at our current FCC sleep any easier at night, but it should.