Telecommunications, Media, and Technology Economics

In many countries, including the US, most mobile handsets (or phones) are “locked” to work only on the network of the provider that originally sold the phone. For instance, an AT&T Mobility handset is designed to only work on Verizon’s wireless network and cannot be used on another wireless provider’s network. Some parties (mainly regulators, consumers, and consumer advocates) have claimed that this locking prevents consumers from switching carriers, which reduces competition and leads to higher prices and less innovation. In the US, several consumer class action lawsuits have been filed seeking an injunction of this practice and compensatory damages from the wireless industry providers. The complaints about handset locking are not exclusive to the US and stretch from here to Europe, the Middle East, and Asia.

However, the issues are not easily resolved. First, networks often rely on different wireless technology platforms. In the US, for instance, Verizon Wireless and Sprint rely on CDMA technology, while AT&T and T‑Mobile use GSM technology. Sprint Nextel uses yet another standard called iDen. Consequently, even if there were no software locks, customers might not be able to switch due to technological incompatibility. Second, switching from one network to another even if they both use the same wireless platform can lead to a reduction in handset functionality. For instance, video mail, ring tone downloads, and wireless Internet access might no longer function. Worse, your phone might lose its roaming capability and only work in your home area. Third, many networks refuse to activate unlocked phones that were sold for a different network because of network security and integrity issues.

Finally, notwithstanding all of the above, the mere existence of handset locking, or other provider-switching barriers, does not mean that consumers have been harmed. If the mobile retail market is competitive, handset locking can benefit consumers because mobile competitors will be induced to offer “bargains” to acquire new customers. In wireless, this usually means free or heavily subsidized handsets. Thus, in determining whether switching barriers are present and what their impact is on consumer welfare, it is important to recognize that if they do exist they should be evaluated in the context of the overall level of competition.

In some of the EU countries, regulators have ruled on the practice of handset locking. For instance, UK regulator Ofcom ruled that handset (or SIM) locking was a barrier to consumers switching suppliers and that the removal of locking, or easing of its terms, would benefit competition in a number of respects, including price, consumer choice, and entry barriers. Despite this finding, the UK regulator found that “is inappropriate to use more formal regulatory power to reduce SIM-locking or change the terms for unlocking, certainly in the absence of a clearer understanding of how far SIM-locking matters to consumers.” Instead, Ofcom stressed that consumers are best served by improved awareness. Consequently, it allowed SIM locking. Currently, most UK wireless providers offer to unlock handsets for a fee at the beginning of the contract or after a subscriber has had service for a certain number of months.

In the US, some consumer action lawsuits have been settled. For instance, Sprint has offered to unlock subscriber handset once its phones are deactivated and the customers’ bills are paid. The company has also agreed to add information about the locking software and how to obtain the unlocking code in the list of terms and conditions of its subscriber contract. Furthermore, Sprint has offered to allow non-Sprint phones to be connected to the Sprint network. Verizon followed suit in late November 2007 and opened its network to any compatible mobile handset. Verizon also allowed open access to the Internet and third-party applications. This last move is quite significant, as I discuss in more detail below with respect to the iPhone, the Skype motion, and the Carterfone rule.

As in the case of handset network locking, similar complaints and allegations have been filed against handset manufacturers and wireless operators with respect to handset software locking. This appears to be mainly a US issue. Consumers and third-party software vendors claim that disabling handsets to download and run third-party software prevents price competition and harms consumers. Leading this charge is Skype and Google. The topic has become particularly hot in recent weeks due to Apple and AT&T Mobility’s policy not to allow third-party software on the iPhone.

Google has founded the Open Handset Alliance, which is developing “the first, complete, open, and free mobile platform,” Android. The Open Handset Alliance has lobbied the US government (the House Subcommittee on Telecommunications and the Internet) to require wireless carriers and handset providers to allow third-party software on their handsets. The Alliance also argued that early termination fees (discussed below) make competition among wireless carriers virtually nonexistent. Specifically, with respect to the iPhone, the Alliance argued that there is no subsidy on the phone. However, there was still a two-year term contract.

Any government or regulatory intervention in the design and functionality of mobile handsets should be rooted in economics. Specifically, as long as the relevant market that encompasses mobile handsets is competitive, it is hard to imagine a credible case for intervention. The US Federal Communications Commission has repeatedly found the wireless industry to be effectively competitive. Therefore, it is unlikely that the alliance’s arguments will find economic support. Furthermore, the existence of Android, a completely open mobile platform, appears to be a competitive alternative to locked handsets, such as the iPhone. Thus, if a consumer wishes not to purchase a locked phone, then he can opt for a phone based on Android. Finally, a number of US wireless carriers, including Sprint Nextel, T‑Mobile, and Verizon have already agreed to allow open access to the Internet and third-party applications, further providing consumers with competitive choices to locked handsets.

Like network and software handset locks, term contracts have been the focus of regulatory and legal debate in a number of countries. Term contracts require customers to remain with a particular carrier for a certain period, typically (but not always) in exchange for a substantial handset subsidy and/or lower airtime prices. Terms usually are 12, 24, or 36 months. In the US, most contracts require a term of 24 months. In Israel, on the other hand, all terms are 36 months. Should a subscriber breach the term contract, he is liable to pay an early termination fee (ETF). ETFs range anywhere from $150 to the sum of the remaining monthly recurring charges or higher. US wireless carriers typically charge $150–200. ETFs have been subject to consumer action lawsuits and regulatory reviews. Consumers and consumer advocate groups argue that ETFs are unjust penalties and result in switching barriers. They also claim that these barriers reduce competition and lead to higher prices and less innovation. In the US, some opponents have even argued that ETFs are to blame for the relatively low wireless penetration rate.

In addition, in the US, term contracts with ETFs have been not found to be an illegal business practice. Rather, the courts have found them to be liquidated damages compensating the carriers for the harm caused by subscribers who terminate their contracts early. The only question that remains is whether (a) customers have been sufficiently informed about their obligations and the ETF, and (b) whether the ETF amount is economically justified.

In other countries, such as France, regulators require that mobile handsets offered as part of a term contract also be offered in a “naked” version; that is, unlocked without a contract. For instance, when Orange introduced the iPhone in France in November 2007, it was required to also offer the phone on a nonsubscription, unlocked basis. Similarly, when T‑Mobile introduced the iPhone in Germany, rival Vodafone filed a lawsuit against T‑Mobile, claiming that the exclusive deal violated German competition laws. To avoid further legal headaches, T‑Mobile consequently offered a contract-free version of the iPhone for Euro 999 ($1,480). With a two-year contract, T‑Mobile charges Euro 399. Subsequently, however, T-Mobile withdrew its offer to sell an unlocked version of the iPhone.

Just as the other switching barriers that allegedly reduce competition and lead to higher prices must be thoroughly examined, ETFs must be carefully analyzed before any conclusion is drawn as to whether they are indeed anticompetitive. The mere existence of ETFs does not prove anything, and, in competitive mobile markets, such as the US, it is unlikely that they are anticompetitive. Conversely, things are less clear when all wireless carriers in a country offer exceedingly long term contracts. For instance, as mentioned above, Israel’s wireless network operators all offer 36-month contracts only. With the average shelf life of a handset being about 18 months, subscribers are likely remaining with the same carrier for a very long time, unless they are willing to use an outdated handset for the second half of their term.

With competition and technological innovation thriving, wireless operators and equipment manufacturers fiercely protect their intellectual property rights (patents, trademarks, and copyrights). Take, for instance, mobile handsets whose battery lives, screen size, and resolution are key determinants for competitive success. Not surprisingly, equipment manufacturers frequently are sued for allegedly infringing on another party’s intellectual property. Similarly, the wireless telecommunications industry is characterized by many industry standards, such as CDMA, WCDMA, GSM, CDMA2000, and so on. These standards are set by international standards setting organizations (SSOs). When deciding on a standard, SSOs frequently require the owners of patents that are essential to the standard to make them available at fair, reasonable, and nondiscriminatory (FRAND or RAND) terms. FRAND and RAND, however, are difficult to implement, leading to antitrust lawsuits and infringement countersuits. There are a number of such battles currently raging, involving companies such as Qualcom, Nokia, Broadcom, and Texas Instruments.

To read about these types of cases, please see: http://www.nera.com/PracticeArea.asp?pa_ID=31&more=ClientExp&c_ID=483

Mobile virtual network operators (MVNOs) are one of my favorite topics because they present a number of interesting aspects in terms of strategy and regulation. MVNOs are a relatively recent development in wireless telecommunications. Unlike facilities-based mobile network operators (MNOs), most MVNOs do not own network facilities. Rather, they operate as resellers by purchasing airtime at wholesale rates from MNOs and reselling it to customers at retail prices. However, unlike simple resellers of fixed or mobile telecommunications services, MVNOs typically rely on their brand appeal and reputation acquired in nontelecommunications lines of business to sell mobile services (i.e., they often bundle telecommunications services with their other products). MVNOs also add distribution channels and other bonus items when reselling mobile services.

MVNOs are a worldwide phenomenon and regulators in countries where there are no MVNOs frequently seek to encourage their entry through regulation. Regulators expect that MVNOs bring competition and with it lower prices and more innovation. Unfortunately, it is not that simple. By far, most MVNOs are strategic tools for MNOs rather than independent mobile competitors. Given the widespread interest in MVNOs and the extensive work I have done in this area, I have dedicated an entire page to this topic. Also, check out the book on MVNOs that I coauthored as well as a number of articles.

MVNO book: http://www.nera.com/Publication.asp?p_ID=2924

MVNO Still a Go: http://www.nera.com/newsletter/COV_IP_Business_MVNO_COM1490.pdf

MVNO 2006 Market Report: http://www.prepaid-press.com/news_detail.php?t=paper&id=1528

Is the MVNO Model Doomed?: http://www.nera.com/Publication.asp?p_ID=3014

The Economics of MVNOs: http://telecomeconomics.com/wireless/admin/preview

As mobile operators are attempting to offer triple play (voice, video, and data), mobile Internet access has repeatedly become the focus of regulatory, strategy, and technological debate.

Skype offers a relatively cheap (and sometimes free) alternative to landline and mobile telephony. While Skype is available for download to most PCs and Mac computers, Skype claims that wireless operators and handset manufacturers block the download of Skype Mobile to US handsets. Seeking assistance from regulators, Skype has filed a motion with the US Federal Communications Commission (FCC) demanding that the FCC more stringently apply the famous 1968 Carterfone decision that allows consumers to hook any device up to the telephone network, as long as it does not harm the network. In Skype’s eyes, that means allowing any software or application to run on any device that can access the network.

The Skype Carterfone motion has created much interest in Congress, the media, and the public. However, the motion does not find much support with economists. The fundamental problem is that is that Carterfone-like rules and corresponding FCC interconnection/attachment mandates have been put into place for noncompetitive markets, thus they are completely inappropriate for competitive markets. For this reason, unless Skype can demonstrate that the US wireless sector is not competitive, it will be difficult to find any economic support for its quest.

Regulators in many countries regularly analyze their wireless markets for market failure (that is, where market forces cannot work properly) and the general level of competition. The findings of these analyses are far reaching and used by regulators when making rulings, by antitrust authorities when analyzing claims of alleged anticompetitive behavior, and by courts when reviewing the merits of legal proceedings against the wireless industry. Given the importance of these reviews, it is crucial that competition reviews be conducted properly. For instance, relying on the number of players in a market or the market share of the different players is simply not enough information to allow for an informed decision. Rather, a comprehensive analysis consists of a number of assessments, such as price levels, pricing trends, profitability (EBITDA, ROCE, etc.), profitability trends, the likelihood of collusion, and so on. Calculating a Hirschman-Herfindahl index is not enough.

In a number of countries, including the US, a call from a mobile network to a fixed network is more expensive than the same call (all other things being equal) when it originates from the fixed network. Part of the reason for this difference is the fact that terminating a call on a fixed network is more expensive than terminating a call on a mobile network. The historical justification for these asymmetric interconnection rates was the uneven call flow between fixed and mobile—mobile used to generate significantly more calls to fixed. However, as mobile telephony becomes increasingly more popular, any reason for asymmetric interconnection rates has becomes even less economically justifiable. For that reason, in a number of countries, mobile termination rates or more generally mobile interconnection is being reviewed.

Typically associated with landline telephony, triple play is a bundled service consisting of voice, data, and video. Quadruple play offers two types of voice, fixed and mobile. Triple play is a leading strategy employed by landline operators to counterbalance fixed-to-mobile substitution, in terms of both lines and minutes of use. However, as technology improves, mobile operators are also seeking to offer bundles (albeit a bit different than landline carriers). In order to offer Internet (data) and TV (video), mobile operators need to obtain sufficient bandwidth and invest heavily in mobile broadband networks.

Mobile TV is a hot, hot topic in a number of countries as regulators, and interested parties are reviewing the business case for mobile TV, deciding on mobile TV standards and regulations. Given the importance of this trend, I have dedicated a separate page for this interesting topic.

With the increased need for bandwidth comes an increased demand for spectrum. Much like the crazy days of the third generation or 3G spectrum allocations, regulators, again, are looking at allocating mobile TV and broadband spectrum using beauty contests and auctions.

With portfolio competition becoming the norm, carriers that cannot readily offer two or three services are wide open to takeover attempts. For instance, T‑Mobile currently offers “only” mobile services (in addition to a Wi-Fi network). While this is not necessarily a bad thing, it does make it more prone to acquisition by other parties. Check out my blog for the recent rumors of who is being acquired by whom.

With the roll out of new services and service bundles, the wireless industry conducts a significant amount of market research. What do consumers want? When do they use their minutes? Where do they call? What do they download? Who will use mobile TV? What demand will mobile TV meet? These and other many interesting questions are topics for market research.

Market research has been heavily impacted by the increasing popularity of mobile phone service. On one hand, the increasing popularity of mobile phones provides market researchers a new tool to monitor consumer behavior. On the other hand, mobile telephony has lead to a decrease in fixed lines, which for a very long time were the primary link between market researchers and consumers.

Fame does not come cheap. As mobile telephone service becomes a commodity, consumer class action lawsuits are on the rise. Mostly a US phenomenon, lawsuits have been filed by consumers on early termination fees, software locking, network locking, and even mobile phone prices.

Investors are happy when wireless carriers bet on a new technology or service. However, they sue when the wireless operators fail to meet their targets. Hence, shareholder class action lawsuits remain a staple in the wireless sector.

Mobile Number Portability (MNP) allows mobile subscribers to retain their phone number when they switch networks. While many countries have implemented MNP, others have yet to implement it. Thus, MNP and its expected benefits remain a popular topic of discussion.

Check out my blog for the latest mobile debates!