Service Included

There is a bundle that most mobile operators offer but that rarely gets described as a bundle. The bundle is the combination of a service with a handset. The extent to which the handset is subsidized corresponds to the extent of the commitment the customer makes to pay for a service. Bundling is hardly a new business concept and it features widely in the media and telecoms sector. Bundling can also generate some fascinating blind spots for busy-body regulators. Whilst the EU feels compelled to stop the cost of local and national wireless calls being subsidized by roaming, they are strangely silent about the common practice of subsidizing handsets. This is because it is also very popular. The funny thing about subsidies is that subsidizing something is popular with customers but overcharging something else to pay for a subsidy is not ;) Popular though handset subsidies may be, they are still a distortion of the market. Customers with little or no interest in changing their handsets are made to subsidize, through higher usage and subscription costs, more fickle consumers prepared to churn to whichever provider offers the most fashionable handset.

The thing with subsidies that regulators usually get upset about is that it means people do not pay a fair price for what they get. They pay too much for some things and too little for others. The justification for business is that it all works out fair on average, but that is little comfort to the customers who do worse than average. The business rationale is even more straightforward: it influences people to buy more than they probably would otherwise. Think of switching mobile service provider to get a new handset and signing a new contract as entering a loan arrangement, but where the interest rates are not clearly explained. The aim is to present the price in a way that looks more attractive to a customer, whilst actually being more expensive, or in such a way that as to encourage the making of a purchase or commitment they otherwise would not. Sometimes, though, selling things cheaply may be an inappropriate strategy. Charging a lot may reinforce the impression of quality. This is true of Apple’s iPhone. The last thing Apple wanted is a subsidy from service providers. Much better that the customer pays the full price and Apple’s iPhone retains the cachet associated with that price. Even better still that the product is guaranteed to sell well despite being much more expensive than competitors. So Apple have used their unique market position to reverse the normal economic principles governing the relationship between handset manufacturer and service provider. Instead of wanting the service provider to subsidize the handset, Apple has insisted on receiving 10% of ongoing revenues in its recent deals to provide iPhones to European providers. The upside for the service providers is they do not have to pay a fixed amount for each handset. This eliminates some of the risk associated with subsidized handsets; customers may not make enough calls to generate the revenues needed to compensate the provider’s initial outlay. Think what Apple’s revenue share means for the customer. They do not know it, but they pay for their mobile phone not once but over and over. As well as the price of the handset, 10% of every call charge will go to Apple. What is Apple really doing to earn this money? It is not as if they are bearing any of the costs associated with connecting the call. Not that I expect this pricing oddity will generate any interest amongst the regulators either – they have no chance of beating Apple in a popularity battle if the implication is that the iPhone’s price would be even higher. That is the implication. The true cost of an iPhone = the price people think they pay for the handset + 10% of the cost of usage. So buying an iPhone is just another kind of loan arrangement, where the initial price is held low but the customer has to pay more in the long run.

The moral of the story here is that, in a free market, you can charge whatever you like, and however you like, if people are happy to pay for it. And what people think they are paying for, and what they actually pay for, may be quite different. And that there is no such thing as a free market, which is why businesses do exclusivity deals like those being made between Apple and service providers in each country. So there are lots of morals to this story ;) Some people are so keen to get an iPhone they simply do not care who provides the network and hence what their phone service is like. Apple knows this and is exploiting it. Service providers will happily pay the extra to Apple if it secures them revenues from otherwise unattainable customers. They will try to enforce the exclusivity element of their deal, as demonstrated by AT&T’s robust response to a Belfast firm offering to unlock iPhones. If regulators really cared about ensuring free markets work correctly, they would question the purpose of exclusivity deals between handset manufacturers and service providers. But regulators rarely pick a fight they think they will lose and this fight is not likely to make them more popular either.

Because some people will suffer any network service to get Apple’s handset, one question is when, not if, Apple will enter the market as a virtual network. If Apple’s brand continues to be so much stronger than the brands of the networks it deals with, it might as well spin the Apple brand into the virtual supply of the service as well as selling the consumer electronics. This would fit perfectly with the Apple mantra of exercising control over the complete customer experience through proprietary rights over all the elements of the products and services that contribute to the experience. All they need to do is to build up market share and when they reach the critical point, just port all their customers to the new Apple service provider. They have already begun down this path, as demonstrated by Apple taking over the ownership of service activation. Instead of this being done by AT&T, new iPhone users initiate their service through Apple’s iTunes portal. If Apple were to become a service provider, an even more intriguing question would follow. All and sundry, including Arun Sarin, have pointed out over the last few years that usage charging will eventually be eliminated in favour of eat-all-you-want subscription charges. If customers are not paying for usage, and are keen to have their handset upgraded at regular intervals, it also follows that Apple would not need to levy a subscription fee either. They could simply offer a contract where the customer pays for the handset and is given a year’s worth of service inclusive in the charge. Then, when the year is up, if not sooner, the customer would be encouraged to buy the latest model of handset. By getting all its charges paid up-front, Apple would have a huge cashflow advantage over other providers. The worst that could happen would be that people unlock their iPhone and take it to another network, but this would be of little concern to Apple who would already have banked all the revenue they were expecting to earn from that customer. Apple would also be safe in the knowledge that the customer who churns will incur extra service charges to be on another service provider, and that the churning customer will not be able to get a new Apple phone without once again paying a full, service inclusive, charge. In addition, some of the features would only be supported on Apple’s network. So customers who buy the phone and integrated service can be expected to stay loyal to Apple so long as the phones continue to be more desirable than those offered by rivals.

It is possible to continue this thought process a few steps further still. So far, we have envisaged a world where the service for your calls and data is included in the cost of a new telephone. As we can see in the evolution of television and other entertainment services, everything could be supplied down the same bitpipe. Apple, with good reason, are aware of this and already sell a television product. If the cost of a telephone service were bundled into the one-off charge for a handset, why not apply the same model to all forms of entertainment? Many television providers already charge for both the customer’s choice of channels and for rental of a personal video recorder. By the same logic, why not bundle the cost of the channels into the charge for the recorder or whatever the device employed to manage the download and replay of content? The industry will simply have returned to the same business rationale as when Japanese hi-tech firms went on a spree of buying Hollywood movie studios: make money from the hardware, and treat the content as the way of enticing sales. If the content is free because it is user-generated, like YouTube, all the better for making fat profits. So in future I expect you may see something that would currently be unimaginable. Interactive television would encourage viewers to make a voluntary payment to the makers of a television show they particularly enjoy. They would just need to press a button and call up a donation screen during or after the show. This approach to raising funds would not be that different to the way PBS public service television in the US depends on donations. Leaving a tip would be the viewer’s way of showing appreciation, like paying for service at a restaurant. Such tips would be voluntary, but it would be the one way to really show viewers appreciate the creativity of the artists, or the objectivity of the reporters, that made the program. Otherwise the typical customer will note that their bills for hardware state that service, including artistic creativity, is included.

What would this mean for revenue assurance? Well, it would make retail billing very very simple, so the risks of leakage at that end would fall. However, it may also lead to more complicated revenue sharing arrangements, with lots and lots of risks for everybody either paying or receiving a share. Do I really think this will happen? Yes and no. I doubt this exact series of events will happen, but I do think that pricing and revenue sharing arrangements will get more varied. Traditional assumptions about who pays who for what will be overturned at least sometimes if not most of the time. A lot will come down to bargaining power – which is why Apple is able to get unique deals. That bargaining power is inextricably linked to the customer’s perception of what they are paying for. To increase their influence, service providers will need to do a better job of selling their service, rather than relying upon handsets to do it for them. So far they are losing the battle. Paying mega-bucks to Apple may help win more customers, especially useful with a flagging brand like T-Mobile in Germany, but it reinforces the idea that customers should be indifferent to who provides the service. That will suit the handset manufacturers fine. They in turn will continue to branch out to be seen as an element in the supply of content, as in the case of Apple’s iTunes and Nokia’s new online music service. The big manufacturers are levering their brand loyalty in order to force networks into a secondary role in terms of managing the relationship to customers, and so far it looks like the networks are struggling to respond and build more loyalty. Even the Taiwanese handset manufacturer HTC, little-known to consumers but makers of extremely popular devices that are typically supplied under the service provider’s brand, has changed its business model in response. Now HTC has reorganized its business in order to make and promote HTC-branded handsets. I can personally sympathize with their business logic. Why make a great little device and put the service provider’s logo on it, when customers who contact the provider about the device just get informed that they should contact the manufacturer instead? In my case I contacted T-Mobile UK about unlocking the HTC-manufactured, T-Mobile branded handset known as the MDA. T-Mobile UK responded by sending me a letter with a pin number and stating I should contact the manufacturer for instructions on what to do with it. That is pretty poor brand management in itself, but what made it hilarious was that they even directed me to the wrong manufacturer – for some reason they mistakenly told me that Sony Ericsson made the device! Luckily I knew better so wasted no time because of T-Mobile’s incompetence.

Who will win this struggle with brands to get the greatest bargaining power? In my opinion, the handset manufacturers have already won and Apple’s revenue share deal is only the first sign that the war is over. On the Interbrand index of the top 100 global brands in 2007, Nokia ranks 5, Apple is at 33, and even LG makes it to the list in 97th place. There is not a single service provider on the list. The only businesses that can realistically compete with the manufacturers are the other big players in the software/internet/technology world – the Microsofts and Googles – and the makers and owners of content. Given how Apple is currently bashing the music industry into submission, it looks like the content makers are faring little better than service providers, although if Apple lost share in the download market to rivals like Microsoft and Nokia that might help the content companies get on a more even footing. Even so, this struggle between hardware, software and content is where the real action is. Communications service providers have turned themselves into the technology world’s equivalent of airlines – unloved and only able to compete on price. Which only leaves one question in my mind: now that they get a share of service usage, who assures the revenues of Apple?

Eric Priezkalns
Eric Priezkalns
Eric is the Editor of Commsrisk. Look here for more about the history of Commsrisk and the role played by Eric.

Eric is also the Chief Executive of the Risk & Assurance Group (RAG), a global association of professionals working in risk management and business assurance for communications providers.

Previously Eric was Director of Risk Management for Qatar Telecom and he has worked with Cable & Wireless, T‑Mobile, Sky, Worldcom and other telcos. He was lead author of Revenue Assurance: Expert Opinions for Communications Providers, published by CRC Press. He is a qualified chartered accountant, with degrees in information systems, and in mathematics and philosophy.