HERE’S a consolation prize to the millions who recoil in bafflement from cellphone companies’ labyrinthine price plans, with their ever more intricate arrays of minutes, messages and megabytes: Economists don’t understand them, either.
Hal Mayforth
In many parts of the world, the pricing of cellphone calling is simple. But in the United States, carriers offer multitiered plans.
“The whole pricing thing is weird,” said Barry Nalebuff, an economics professor at the Yale School of Management. “You pay $60 to make your first phone call. Your next 1,000 minutes are free. Then the minute after that costs 35 cents.”
To economists, it simply doesn’t make sense to make chatterboxes pay that penalty. After all, most businesses tend to give discounts to customers who buy more.
It would be easy to see the cellphone companies simply as avaricious oligopolists trying to gouge consumers for every penny they can. And in some senses they are aiming to maximize revenue, at least as much as the market will let them.
But understanding the psychological nuances of how a price plan affects customers’ behavior is at least as important to running a cellphone company today as knowing how radio waves spread over a city. Those high charges for going over your allotted minutes, for example, are designed to cause you enough pain that you will switch to a plan with a higher regular fee.
“You give people a really good bargain on this bucket of minutes,” explained Roger Entner, a senior vice president for telecommunications research at Nielsen. “People are risk averse, so you have a relatively high overage charge, which gets people to overbuy. You also get really predictable revenue out of it, which Wall Street loves.”
Neither the cellphone companies nor their customers, as it turns out, always act in the rational way that economists might predict. Consumers often put immediate gratification and the avoidance of unpleasant surprises above their long-term interests. The companies, meanwhile, are trying to meet the sometimes irrational expectations of investors, who want growth without too much nasty volatility, even if their profits suffer.
Here are a few other examples of how the dance between cellphone companies and their customers is, to use Professor Nalebuff’s term, “weird”:
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When Apple and AT&T started offering the iPhone for $199, plus $30 a month for Internet access, sales shot up, even though the previous deal — $399 for the phone and $20 a month — cost less over a two-year contract.
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Phone companies have doubled the price for text messages, to 20 cents each, in recent years, even though they cost almost nothing to deliver.
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When companies introduce certain discounts — like Sprint’s recent offer of free calling to any mobile number — the effect is that customers often switch to more expensive plans.
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One thing that is costing cellphone companies a lot of money to provide is the one thing they offer for a flat rate with no limits: surfing the Web on gadgets like the iPhone.
There is nothing obvious or necessary about this approach to pricing. In many parts of the world, you simply buy a phone from a store, then buy a card that entitles you to talk for a set number of minutes. Use up the card and buy more minutes. No contracts. No surprising charges. No confused economists.
But for all the complexity, cellphones American-style do have a certain supersized logic. Americans spend more money each month on their wireless bills than people in any other country. But the money we spend buys a whole lot more talk time and text messages than it does elsewhere. On average, we effectively spend about 5 cents per minute of talk time and about a penny a text message, lower than anywhere else in the developed world.
This year, the deals are becoming even better. For people who want to surf the Web on their phones, wireless companies are willing to sell them iPhones, BlackBerrys and other sleek gadgets for hundreds of dollars less than they cost. The catch, of course, is that customers need to pay $30 or so extra each month for Internet access. For those who just want to talk and text without a fancy phone, there is hot competition to offer lower- price, unlimited phone plans that don’t require contracts.
In many ways, however, the least important factor in setting prices is the actual cost of providing cellular service. Cellphone companies resemble airlines, that other industry whose oblique prices exasperate consumers. Think of a cellphone network as one giant airplane that costs tens of billions of dollars to build. The cellphone companies don’t really know how much it costs to handle a call to Aunt Suzy in Syracuse, any more than an airline can calculate a specific cost for Seat 12B.
“Service providers don’t have a good measure of their costs,” said Philip Marshall, an analyst for the Yankee Group. “They don’t have the ability to say if they are going to make money” on any particular plan.
PUT simply, all a phone company wants is to get as much money as possible each month from its customers. Then it hopes that this total is more than its costs.
That’s why the carriers put great stock in a measure called average revenue per user, or ARPU (pronounced “ARE-poo.”) A climbing ARPU makes for happy phone companies and happy investors.
But in fact, over the last decade, total ARPU has been declining slightly, a result of competition. But unlike the airlines, the two largest cellphone carriers — Verizon Wireless and AT&T — have healthy profit margins. The distant third and fourth — Sprint and T-Mobile — have had a harder time keeping up.
Every few years, the companies adopt new technology that expands their networks’ capacity. For a while, they passed the benefit of these improvements to customers by periodically increasing the number of minutes in pricing plans. But since 2004, the basic rate for the lowest-priced plan at the largest carriers has stayed constant, at $39.99 for 450 prime-time minutes.
The cellphone companies wanted to avoid the sort of price wars that occurred a decade earlier in the long-distance market. So they decided to compete by offering distinctive goodies that cost little, yet had a lot of customer appeal.
Verizon Wireless focused, for example, on offering free calls to other Verizon customers. In response, T-Mobile, the smallest of the major carriers, concocted the My Faves plan, which gave users free calling to any five numbers, whatever carrier they used.
In 2004, Cingular Wireless (now AT&T) introduced what it called rollover minutes, with plans that allow unused minutes of talk time to be used in the following months.
An economist would see Cingular’s move as a price cut. After all, why buy a big plan as a cushion against what might be an occasional month of high use when you can accumulate your minutes from low-use months? In fact, it worked the other way around, encouraging people to buy larger plans. It turned out that people were happy to buy extra minutes if they knew they could keep them, rather than having them expire.
In May 2004, Sprint answered the growing complexity of cellphone plans with a much more straightforward approach. Its Fair and Flexible plan offered 300 minutes for $35, and each additional block of 50 minutes for $2.50. It was a plan that an economist could love.
Unfortunately for Sprint, customers hated it because their bills varied a great deal from month to month. ”Nobody thinks about getting the lowest cost per minute,” said a former pricing executive for Sprint who asked that his name not be used to avoid offending his former employer.
Sprint dropped the plan in early 2007, and reintroduced plans with big buckets of minutes and higher fees for going over the allotted time.
Despite all the carriers’ efforts to lure people to buy ever more expensive voice plans, the average revenue per user from voice service has been falling since 2003, according to statistics from CTIA, the wireless trade group.
MORE recently, the carriers have confronted another problem: People are talking less on their mobile phones, and texting instead. In the first half of this year, the average wireless customer sent 518 texts a month and made 220 phone calls, according to CTIA figures. (That average, of course, is driven up by the furious texting of teenagers.)
Revenue from voice plans has fallen 31 percent since peaking in 2003. To fill that hole, the carriers raised the price of a text message from 10 cents to 15 cents, and later to 20 cents. These fees provided nice cash, but as with the voice charges, the main purpose was to persuade customers to subscribe to text-message plans that cost up to $20 a month for unlimited texting on AT&T and Verizon and $10 a month on Sprint and T-Mobile.
“It really makes sense, if you are texting at all, to buy an unlimited text plan and not have to worry about it,” said Will Souder, a vice president for pricing at Sprint. Fewer people are running up big bills from 20-cent text messages, but the company’s ARPU has gone up anyway because so many customers signed up for unlimited text plans.
THE biggest boon to the wireless carriers has been Apple’s iPhone, which increased interest in using a mobile phone to surf the Web.
When it entered the smartphone business in 2007, Apple tried to turn upside down the traditional model in which carriers subsidized the cost of handsets. It initially wanted customers to pay $599 — later cut to $399 — for their handsets, but they would pay AT&T, its exclusive carrier, only $20 a month for the Internet access, a portion of which would go to Apple.
Consumers balked at the high upfront cost. By the second generation of the iPhone, Apple reverted to a traditional subsidy model. The iPhone that now costs consumers $199 actually costs AT&T about $550, according to analysts’ estimates. To cover the subsidy, the Internet price increased to $30 a month.
Yes, consumers come out behind on that deal, to the tune of $40 over two years, but it was only when the opening price dropped to $199 that iPhone sales started to skyrocket.
Now all the carriers are selling heavily subsidized smartphones. They hate this state of affairs — and wish that American consumers would just pay full price for the phones, the way people do in Europe. T-Mobile recently introduced an option for customers to pay a lower monthly bill if they buy their own phones, and even offered to spread the handset cost over two years with no interest charges.
“They are trying to break the model and get away from the big subsidies that are going into these phones,” said John Hodulik, an analyst at UBS Securities. “There is something to that, but I’m not sure it will work because people want their brand-new shiny phones.”
The growth of smartphones has especially benefited AT&T, which has the iPhone, and Verizon, which is seen as having the best network. Sprint, at No. 3, has been losing customers for several years. In addition to trying to improve its customer service, Sprint has started several pricing changes to try to stem the losses.
Sprint’s boldest move has been to offer a $50 flat-rate plan, including unlimited voice, text and Internet, through its prepaid Boost brand. In prepaid plans, like those popularized by MetroPCS and Leap Wireless, you don’t have to sign a contract, but you also have to buy a handset without a subsidy. Boost has garnered a net 2.1 million new accounts since introducing the unlimited offer early this year. T-Mobile and AT&T have responded in recent months by offering $60 unlimited plans.
Boost was successful, said Matt Carter, its president, because its plan stood out from the multitiered offerings of traditional wireless carriers — including its parent, Sprint. “There is a lot of complexity out there in the marketplace,” he said. “What we are is a force for simplicity.”
Lower prices that are predictable and easy to understand. Maybe an economist won’t find that weird. But will the consumer?
