MONEYBOX

COMMENTARY ABOUT BUSINESS AND FINANCE.

DEC. 11 2012 12:50 PM

Its Crazy To Pay $200 for Your Next iPhone. You

Should Pay $600!
T-Mobile wants to make you pay full price for your phone, and you should
thank them for it.
By Matthew Yglesias

With the help of the iPhone, T-Mobile is trying to upend the way wireless companies
charge you
Photo by Sean Gallup/Getty Images.

Mobile phones have changed enormously over the past six years, but the mobile phone business
model has not. You buy a magical device for practically nothing, then nd yourself locked into a
two-year contract with a baing, shockingly expensive monthly bill. Not coincidentally, the
companies that have led the smartphone revolutionApple and Googleare consistently
among the most admired in America while everybody hates Verizon and AT&T, the leading
cellphone operators. The gadgets are great, the billing process is a nightmare.

Now T-Mobile, the longtime also-ran of the U.S. mobile phone market wants to shake things up
by oering mobile service thats not a horrible scam. But will people be smart enough to gure
out that they can get a genuinely better deal?
The key to understanding the mobile phone economy is that it features extremely high barriers
to entry. Given the diculty and cost of buying broadband spectrum and constructing a
network, it is basically impossible to launch a new nationwide cellphone company. That means
potentially staggering prots for incumbents.
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On the other hand, the huge costs involved in upgrading a network to state-ofthe-art infrastructure mean that xed costs are much bigger than the marginal cost of serving an
additional customer. So once youve built the network, you need to scramble like crazy to sign up
as many people as possible. So far, operators have done that primarily with a bait-and-switch.
Rather than tempt you in the door with low monthly bills, they induce you to switch by oering a
discounted price for the latest and greatest phones, with the iPhone being the biggest prize of
all. The customer walks out thrilled with the deal he got on his phone. Only later, when his
ridiculous, complicated, and obscenely high bill comes, does he realize he has been eeced.

This games been working great for Verizon and AT&T, but much less so for T-Mobile. The
subsidiary of Germanys Deutsche Telekom has failed to achieve the scale to compete with the
big two, and its corporate masters decided they didnt want to make a risky investment by
growing the company. Plan A to sell T-Mobile to AT&T was blocked by the Justice Department
and the FCC, who wanted to preserve competition in the marketplace.
Now T-Mobiles gearing up to try to compete by changing the game. Theyve nally secured a
deal to put the iPhone on their network. They have made the radical and perhaps brilliant
decision to sell it and other smartphones without subsidy. Thatll make the devices a lot more
expensive. Consumers will be surprised to learn that the $199 iPhone 5 actually retails for $649.
AT&T and Verizon essentially pay Apple the full price, sell it to you for the low price, and make it
up by charging you more every month.
But that subsidy is quite costly for customers. If you buy a subsidized iPhone 5 from AT&T, the
cheapest plan available costs $85 per month and only comes with 1 GB of data, a minimum of
$2,040 over the two years of the contract. A basic T-Mobile unlimited voice plan with 2 GB of
data costs $59.99 per month, $1,440 over the two years. In order to get that $450 iPhone
discount, you would end up paying $600 more to AT&T over the life of the contract, and get less
data.

A plan with a subsidized phone is a bit like a house with a mortgage. Your upfront costs are
lower, but total costs go up because you have to pay o the loan. The dierence is that there are
actually good reasons to nance houses with loans. One, the interest is tax deductible, which
limits the total cost. Two, houses are incredibly expensive and saving up to buy one in cash could
take decades, not months. And three, the underlying house is an extremely durable asset, so it
makes sense for banks to extend credit on generous terms.
Smartphones, by contrast, suer from rapid depreciation because of technological
obsolescence. Paying the full up-front cost, saving on a cheaper cellphone bill, and then
assessing your desire to buy a new model down the road based on the actual merits of the
upgrade rather than your wireless providers upgrade cycle makes much more sense.
Until recently, its been extremely dicult for customers to do this sensible thing. The big two
havent oered discounted data plans to people who are willing to buy an unsubsidized phone.
T-Mobile has oered this, but it wasnt the emphasis of their marketing, and the latest and
greatest phones typically havent been designed to work optimally with their network.
Thats why last weeks announcement is such a game-changer. By dropping the subsidy model
entirely, T-Mobile is committing itself to marketing the virtues of honest billing practices. And by
securing ocial Apple support for its network, T-Mobile will be able to compete head-to-head
with the other players in terms of handset functionality. If high-end consumers realize what a
better deal you can get with the nonsubsidized model, then ultimately AT&T and Verizon will
have to start oering that option to compete.
Of course, customers have to actually recognize that the new deal is better. The subsidy model is
basically a scam, but it only arose thanks to our own collective mental failings. A phone-buying
public used to getting high-end devices for $200 or $300 may simply balk at the discovery that a
pocket-sized computers actual price is twice that or more. Until now, limited competition in the
industry has let us optimistically believe that the American phone-buying public is the victim of
unscrupulous business practices. But if T-Mobile cant make this work, the lesson will be that the
real fault lies with ourselves.
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