In Defense of Early Termination Fees
Cell phones have really
come into their own in the last few years. Even relatively Spartan
phones can now take pictures, send text messages, and ease the pain of
commuting with a game of Brickbreaker. These technological marvels can
even send and receive telephone calls.
It gets better. Smart
phones, such as BlackBerries and Treos, can browse the Internet, send
email, juggle your schedule, and even warn of upcoming traffic jams
with Google Maps. Apple’s iPhone adds a sense of style to the mix.
Every year new features come out that make people’s lives easier.
They’re affordable, too. There are now more than 3.3 billion cell phones in use around the world.
That’s
amazing. But what would it take for all this progress to come
screeching to a halt? Alameda County Superior Court Judge Bonnie Sabraw
has one answer: abolish early termination fees.
Consumers and
consumer advocates alike have hailed her recent decision, which
declares the fees to be in violation of California state law. Sprint
now has to pay $73 million to former customers.
Of course, Judge Sabraw’s precedent could have unintended consequences. They would not be pretty.
BUT FIRST, what are early termination fees, anyway? And why do people hate them so much?
People
probably hate early termination fees for the simple fact that they are
fees. Perfectly understandable. Less forgivable is the tendency for
many people to not read the contracts they sign. Some people get a rude
surprise when they switch carriers before their contract is up.
Early termination fees must accomplish something
for companies to continue to wield them in the face of widespread
public resentment — not to mention judges pretending to be legislators.
As
it turns out, early termination fees help more people afford better
phones. They are a democratizer of technology. They also give phone
companies more incentive to innovate and add new features.
It
works like this: phones are expensive. They can cost several hundred
dollars. A lot of people can’t afford that kind of upfront cost. But
spreading that cost out over time can help people of limited means
afford quality phones, just as mortgages make home ownership possible
for people who don’t happen to have $200,000 lying around.
Service
providers will typically sell their phones at a loss, then make their
money back by charging more for monthly service. It’s a little bit like
Gillette’s famous strategy of selling razors cheaply and making their
money back on the blades.
Since it takes time for phone
companies to recoup their initial losses, they’ll often require
customers to commit to, say, two years of service.
Customers
can opt out early if they like. But they’ll have to pay an early
termination fee to do it, which can be upwards of $200. That’s pretty
steep. But it does make sure that customers pay back the subsidy they
received for their cheap phones, one way or another.
Put
another way, early termination fees reduce risk. As long as the risk is
low, service providers will continue to make their products as
affordable as they can. That’s good for business and consumers alike.
STILL,
CRITICS allege that early termination fees are anti-competitive,
because they make it harder to switch carriers. That ignores the
intense competitive effects that the fees have on innovation.
When
something is cheap, people buy more of it. By making the upfront cost
of phones as inexpensive as possible, early termination fees vastly
increase sales.
That’s why companies are racing furiously
against each other to come out with new and better phones. A new widget
that your competitor doesn’t have can bring in millions of dollars of
new contracts.
If early termination fees reduce competition in the cell phone marketplace, then why is there so much of it?
Don’t expect to see an answer in Judge Sabraw’s next verdict.
The
next time someone grumbles about early termination fees, tell them what
the fees do to make phones affordable and to ensure a competitive,
innovative marketplace. And remind them to read that contract before
signing it.