Despite the complaints, some customers prefer subsidies and ETFs

By Tammy Parker

For those in the US who oppose early-termination fees, I have two words: iPhone 2.0.

The retail price of the 3G version of the iPhone will start at $199 thanks to a subsidy of several hundred dollars by AT&T, which was not allowed by Apple to subsidize the first version of the device. The reason for the new subsidy: AT&T and Apple see this as a necessity to drive mass-market adoption of the device because US mobile customers have shown repeatedly that they would prefer to pay less for a device even if that means signing up for a two-year postpay contract with a costly fee for early cancellation.

Despite the obvious preference shown by mobile phone buyers for subsidized pricing, one aspect of the subsidization practice, early-termination fees, has repeatedly come under fire in class-action lawsuits and public laments by self-described consumer-advocacy groups. The FCC has received more than 3,700 complaints about the fees during the past two years. For that reason, the commission is now pondering taking action to regulate ETFs on a federal level.

During an FCC-sponsored public meeting on June 12, consumers, public-policy wonks, mobile operators and others were allowed to speak their peace regarding the application of ETFs to customers who break service contracts. ETFs go hand in hand with US mobile operators’ subsidization of handsets as an inducement to get customers to sign long-term contracts. Customers who break those contracts are charged ETFs of about $200, more or less,, though the two largest operators, AT&T Mobility and Verizon Wireless, now prorate their ETFs over the length of contract.

Alan Plutzik, attorney with Bransom, Plutzik, Mahler & Birkhaeuser, and counsel of record for the Wireless Consumers Alliance, testified that in a class-action lawsuit against Sprint Nextel, the numbers revealed that some 2 million Californian mobile customers have been charged ETFs, meaning by extrapolation that 40-50 million people nationwide have been charged ETFs.

Consumer advocate Pamela Gilbert, an attorney with Partner, Cuneo Gilbert & LaDuca, contended that ETFs “force consumers to choose between staying with a carrier that doesn’t meet their needs” or paying a penalty to end their existing contract in order to get service from another network that can meet their needs.

I agree that there were issues in the past when people signed up for mobile service only to find that it would not work in their neighborhood. I suffered that fate when I agreed to move from AT&T Wireless’ TDMA network to its GSM network, which was so full of coverage gaps and traffic issues that I hardly made a mobile phone call for a year (and I eventually switched operators because of the problems). But with major operators offering 30-day trial periods for new users, people who sign up for mobile service in the US these days should be able to get a pretty good idea of whether their mobile will work where and when they need it to before they commit to a long-term deal.

“I sincerely feel actually that we do not need early-termination fee contracts. As a country, these are not as common as the normal way of doing business. Normally you purchase a product and then you pay for service,” testified Anne Boyle, chair of the Nebraska Public Service Commission.

“What?” I said out loud when I heard Ms. Boyle’s comment (fortunately, I was watching the proceedings from my home via the Internet). Installment contracts and early-termination fee arrangements are rampant in US consumer-goods marketing. I have satellite TV service from DirecTV, and it has an early-termination fee attached to it. I think I’d have to cough up $200 if I were to cancel the service before I’ve used it for two years. Similarly, the health club contract that I signed up for a couple of years ago and, regrettably, never actually leveraged by working out, had an ETF attached to it. Even though I only worked out once in 12 months, I knew I’d be nailed with an ETF if I canceled the contract before a year was up (and I kept wishfully thinking that I’d actually make it to the gym sometime during those 365 days).

The Competitive Enterprise Institute, a non-partisan public policy group that backs free enterprise, has come up with more examples of ETF use in other industries, including apartment rentals and automobile leases. “In all of those cases, we expect consumers to figure out for themselves what is and what is not part of the contract they’re signing. As long as any potential fees are disclosed at the time of the agreement, they’re simply part of the deal,” said CEI in a press release.

So, it’s pretty clear that ETFs are not unique to the mobile industry. But that’s not to say that some of the industry’s related practices haven’t been downright sneaky. I had been off contract with my current mobile provider for a couple of years, when, in May 2007 I decided to alter my rate plan. I had the same old phone and same old phone number, I just wanted a different airtime package. Imagine my surprise when I discovered that simply changing the service plan resulted in me suddenly being on a new two-year contract. Had the salesperson at the store explained this to me? No. Not a peep was uttered. I didn’t bother to complain because I hadn’t planned on switching networks anyway, and because I had been on the network for so long, I qualified for a substantial subsidy on a new handset. So, I subsequently went ahead and bought a new subsidized handset since I’d already unknowingly locked myself into a two-year contract anyway.

However, operators are now starting to let customers change their rate plans without causing their contract terms to be extended. So, again, that problem appears to be resolved.

Speaking at the FCC meeting, Christopher Guttman-McCabe, vice president of Regulatory Affairs for mobile industry trade group CTIA, contended that removing ETFs from industry practice would also remove options for lower priced service and devices. In the absence of subsidies and related ETFs, “customers’ out-of-pocket costs are higher,” he said.

Similarly, CEI contends that long-term mobile contracts with cancellation fees “help more people afford a higher quality range of products.”

Yet Chris Murray, senior counsel, Consumers Union, argued that subsidies and ETFs don’t’ save consumer’s money. Instead, he said, they “rob consumers of the benefits” that an open marketplace would bring.

According to Murray, the average handset subsidy is only $14.33, but ETFs are more than 12 times that subsidy. Further, Murray termed the ETFs “junk penalties,” because operators bury expenses such as costs-of-acquisition, marketing costs and more in them, meaning the fees are not calculated based on the actual cost recovery related to a customer’s breach of contract.

On that note, I would argue that however ETFs are calculated or assessed, from a customer’s perspective, they’re usually cheaper than the full value of a service contract.

If ETFs are eliminated, then mobile operators in the US will probably reduce handset subsidization but continue to sign postpay customers to contracts. However, when a customer breaks such a contract, rather than making that person pay a $200 ETF, the operator would have to go after him or her for the value of the full remaining term of the contract. Let’s say Jane Doe decides to end her $50-per-month mobile service one year before her contract is up. That’s 12 times $50, or $600, that she owes the operator for the term of service. Hmmm…maybe a $200 ETF–or better yet, an even smaller prorated ETF–doesn’t look so bad after all.

Maybe it’s just me, but as a consumer, I’d rather pay $50 for a $400 handset and risk being charged a $200 ETF if I break my service contract than pay $400 for the same phone and then be hit with an even larger bill for the full term of my contract if I cancel it early.