Friday, July 31, 2009

The Misguided Urge to Regulate Wireless

Thomas Hazlett:

Senator John Kerry (D-Mass.) has called for an inquiry into the Apple iPhone and BlackBerry Storm, the Senate Commerce Committee has held hearings, and the U.S. Justice Dept. has opened an investigation. Their concern? Wireless carriers market these expensive, cutting-edge smartphones by subsidizing the handsets and requiring two-year service agreements. What they lose on the phones they make back in monthly fees.

To some, this seems unfair and anticompetitive. But calls for regulation are perverse. Indeed, Senator Kerry performs a great favor by singling out the iPhone and the Storm—iconic examples of dynamic, productivity-fueling innovation—as the root of the problem. These products are precisely the disruptive technologies that policymakers should herald. Yes, we need to investigate them—to figure out how to encourage more of the same...

Restricting subsidies also hurts technology adoption. In Belgium—the sole European Union country to ban phone subsidies (under a 1935 statute banning sales tying a product to a service)—the iPhone went on sale for $1,000, its highest price in the world. The EU recently struck down the subsidy prohibition as anticompetitive in a case brought by Belgian gas stations that objected to a rival offering customers free towing service if they bought so many liters of gas. The EU (correctly) upheld the discount and tossed the law. Now Belgian iPhone buyers will benefit via lower prices. Perhaps they'll also get free towing.

Finland banned handset bundling until 2006. The rule was scrapped by the Finnish government because individual customers were not buying new, expensive 3G phones. This gave application developers little incentive to design useful add-ons, further reducing 3G handset demand in a vicious circle of stagnation. When the ban was dropped, new technology adoption took off, courtesy of network subsidies—and customer contracts.

In the U.S., AT&T similarly seeds iPhone apps by reducing handset prices. The 65,000 Apple App Store programs now available make the exclusive iPhone network more valuable to consumers.

In this deep recession it is curious that iconic innovations demonstrating robust growth are inspiring regulatory attention. In truth, the key policy issues here involve little more than how to control crowds on iPhone model release days and how to discipline State Dept. officials whose "Crackberry" habits disrupt high-level government meetings. When Washington turns its regulatory gaze on the very killer apps we should be celebrating, we've found what needs fixing.



thinking said...

There is no doubt that the govt needs to be very careful about regulating this or any other industry.

However, for an alternative view, consider the work of Tim Wu, a law professor at Columbia University and the one who first popularized the term net neutrality, and the landmark 1968 Carterfone ruling.

Wu offers an interesting analogy with the situation that existed in wire line telephony, where "for much of the 20th century until the 1970s, the AT&T monopoly barred consumers from attaching anything but a Bell telephone to their network….That rule, unsurprisingly, suppressed all competition and most innovation in the making of telephones."
AT&T argued "that control over all equipment on the network was necessary for the telephone system to function properly." One AT&T ad stated: "It takes a totally unified system to make it all work. One system. AT&T." If that sounds familiar, it should: it is exactly the same argument made by wireless carriers today in largely locking out other phones and/or applications from their network.

The situation changed in a landmark 1968 case referred to as the Carterfone case. AT&T wanted to prohibit the use of the "Carterfone," a device that facilitated communication between a mobile radio and a telephone.
The FCC in Carterfone struck down AT&T’s rule as "unduly discriminatory" and rejected arguments made by AT&T that suggested control over all equipment on the network was necessary for the telephone system to function properly.
What were the results? Professor Wu explains:

The 1968 Carterfone right to attach devices to home networks is perhaps the fundamental consumer right in telecom, and indeed its consequences have been historic. The attachment right is broadly celebrated by policy analysts of every ideological persuasion, who recognize the Carterfone principle as a central tenet of a competitive telecommunications policy. However, AT&T’s wireless descendants have shown an interest in resurrecting, one way or another, the pre-Carterfone rule.
The Carterfone principle has had enormous consequences not only in telecommunications policy, but for the economic prosperity of the United States. The ability to build a device to a standardized network interface (the phone plug, known as an RJ-11) gave birth to a new market in home and business telecommunications equipment. That led, predictably, to competition in the phone market. But it also led, unpredictably, to other innovations. Those have included mass consumer versions of the fax machine, the answering machine, and, perhaps most importantly, the modem. Arguably, the FCC’s rules on network attachments—now known as the Part 68 rules—have been the most successful in its history. The freedom to buy and attach a modem became the anchor of the mass popularization of the Internet in the 1990s. As one observer put it, without Carterfone, "the development and broad popularization of the Internet also would not have occurred as it did. The key point of Carterfone is that it eliminated an innovation bottleneck in the form of the phone company."

Professor Wu recommends that the industry or the FCC should define a cellular Carterfone principle: "a basic interface to which any equipment manufacturer could build a mobile device and sell to consumers."

I should add to Prof. Wu's work, that one reason why the iPhone has been so successful is that, ironically, Apple has taken away much of ATT's power to dictate the features and application of the phone. So while the iPhone is exclusive, for now, to ATT in the US, Apple has given us a model of how a more open system can flourish.

Without that, much of the recent spate of innovation in smart phones would not have happened.

So sure the regulators need to tread carefully. But I'm willing to bet that in 1968 the same arguments were made in defending ATT and against the Carterfone ruling. Thank goodness that the FCC still decided to act.

thinking said...

As to those phone subsidies, Prof. Wu explains that carriers sell telephones on a "buy-now-pay-later" basis, like an installment plan, as opposed to a lump sum purchase. There are some problems with that.

In essence, it's a loan where the interest is concealed in the price of the plans. But we have no idea how much the carriers jack up their rates to justify the cost of this subsidy. This is one form of loan where there's no truth in lending disclosure.

And for consumers who choose to keep their phones longer than their contract, they end up paying for this subsidy regardless. So why, for instance, after a customer's 2 yr contract is up, ostensibly to pay for the subsidy, shouldn't their monthly rates go down?

Walk into any cell phone shop and you will see 2 prices: one with contract subsidy, the other without. But why not also show 2 monthly plan prices, one paying for the subsidy, the other lower because you pay full price for the phone.

The bottom line is this: In the cell phone business consumers are forced to pay an installment loan on all or a portion of the price of their phone, with no disclosure as to what interest rate are effectively being charged. There is no way to opt out of paying for this loan as long as one wants cellular service, even if the customer brings their own equipment or keeps their phone long after the price subsidy has been paid off.

Shawn said...

thinking; that's a great point about the 'why aren't there two prices for rate plans'...but wouldn't you think that that differentiation (or something else) would just happen eventually, as carriers compete for customers?

Seems like rates have come down a good bit, and seem to be poised to be continuing to do so with the ubiquity of carriers such as cricket and metropcs (unlimited calling/texting for a monthly fee of typically around $30-$35, I believe...never looked at them very hard).

Why worry about trying to force the issue with government action, and get inevitable stifling and perverse incentives? Maybe you're not calling for that, and I'm basing my comments on previous ones of yours...

And, as to cell phones and 'cell neutrality,' GSM carriers everywhere are virtually wide open: bring in a GSM phone that has one of our frequencies on it, and you get service with us; just pick up one of these pre-paid sim cards, and you're out the door. Unfortunately, apple/att will not allow for the unlocking of the iphone in most countries, though there are a few where you can buy it unlocked, and the iPhone is *quite* expensive there.

With that said, two US companies, Sprint and Verizon, are CDMA (not GSM) technology companies, and I have heard many problems of trying to get sprint onto verizon, and vice-versa. I heard that they'd 'opened up' their networks a while ago, but I have no idea how well that's working; anyone have input on that?