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Progress on Point
Release 15.8 June 2008 Periodic Commentaries on the Policy Debate
Exclusive Handset Prohibitions:Should the FCC Kill the Goose thatLaid the Golden iPhone?
by Barbara Esbin and Berin Szoka
Since the Apple iPhone first went on sale in June, 2007, the company has sold atleast 5.4 million of the high-end devices and hopes to reach the 10 million mark laterthis year.
These impressive sales figures testify to the demand that has been buildingfor years for a smart phone that offers a truly “converged” media experience: richInternet browsing, music and video together with email and voice telephony. Yet fewremember that the iPhone’s success follows the failure of Apple’s first attempt to bringiTunes to the mobile phone: the Motorola ROKR™, launched in September 2005. Itwas ROKR’s failure to meet Apple’s expectations that caused the trendsetting companyto realize that, if they wanted to build a phone worthy of iTunes, iPod, and Apple’s highlypolished brand of innovation, they’d just have to do it themselves. Nearly eighteenmonths and $150 million later, the iPhone was born.
Today, as millions more Americans eagerly await the release of the 3G high-speed, second-generation iPhone, one might think that everyone would celebrate theproduct as a breakthrough stimulus to innovation in the handset market as well as to thebusiness relationships between carriers and equipment manufacturers. Yet, on May 20,2008, the Rural Cellular Association (RCA) petitioned the Federal CommunicationsCommission (FCC) to investigate whether the agency should prohibit as anticompetitivethe business model that made the iPhone possible: exclusive arrangements betweenwireless carriers and handset manufacturers.RCA argues that such arrangements harm rural consumers (and, of course,RCA’s members) because only the “Big 5” (Verizon, AT&T, T-Mobile, Sprint Nextel and
*
Barbara Esbin is a senior fellow and director of the Center for Communications and Competition Policyat The Progress & Freedom Foundation. Berin Szoka is a visiting fellow at The Progress & FreedomFoundation. The views expressed in this report are their own, and are not necessarily the views of thePFF board, fellows or staff.
1
Eric Zeman,
Analysts Rain On Apple's iPhone Parade
, The Information Week, May 28, 2008, availableathttp://www.informationweek.com/blog/main/archives/2008/05/analysts_rain_o.html.
2
Amol Sharma, Nick Wingfield and Li Yuan,
Apple Coup: How Steve Jobs Played Hardball In iPhone Birth; In Deal With Cingular; He Called The Shots; Flirting With Verizon
, The Wall Street Journal, Feb.17, 2007, available athttp://online.wsj.com/public/article/SB117168001288511981-euxzmjNFZTZhA_2z8OBtD6GK900_20070224.html?mod=blogs(“
Apple Coup
”).
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Progress on Point 15.8 Page 2
Alltel) are “able to command these exclusive arrangements,”
leaving small ruralwireless carriers and their customers without access to the most innovative handsetsand services, such as Apple’s iPhone and the competitors whose development theiPhone’s success has spurred. (The combination of Apple’s exclusive U.S. deal withAT&T and AT&T’s policy of barring its users from spending more than 40% of their timeroaming off-network effectively renders the iPhone “off limits” to many RCA membersubscribers.
) One must ask whether the iPhone or its competitor devices would havebeen developed as well and as quickly without such exclusive deals—and ask the samequestion about
future
devices. In other words, would banning such arrangementseffectively spite
all
consumers by ensuring that, if some customers can’t have the fruitsof device innovation immediately, then none should?RCA insists that these deals are driven by the market power of the “Big 5”wireless carriers, who use exclusive arrangements as a weapon against theircompetitors, including rural carriers. (Never mind the fact that, if the iPhone isunavailable in certain rural areas, that’s because AT&T
does not compete
in that area.)Yet the hard truth for RCA is that it was
Apple
While some carriers had reached exclusive arrangements prior to the 2005Apple/Cingular iPhone deal, most of those deals concerned mobile virtual networkoperators (MVNOs), whose business model as resellers required that distinguishthemselves from the underlying carriers whose services they resold by offering uniquedevices and service features. These early exclusive arrangements largely failed in themarketplace. But today other smart phone manufacturers are following Apple’s leadand demanding exclusive deals with sharing of revenue from customer data plansrather than the traditional model of simply try to sell as many units as possible.
Thereason? Such devices can attract huge numbers of new customers to a carrier—witheach new customer paying for data as well as voice service. In an industry with highfixed costs and low marginal costs, this translates into large potential profits for a carrierwith an attractive new device.
This dynamic gives companies like Apple the leverage
3
Rural Cellular Association,
Petition For Rulemaking Regarding Exclusivity Arrangements Between Commercial Wireless Carriers and Handset Manufacturers
(filed May 20, 2008), at 3 (“RCA Petition”),available athttp://gullfoss2.fcc.gov/prod/ecfs/retrieve.cgi?native_or_pdf=pdf&id_document=6520010759. Since thefiling of the RCA Petition, Verizon has announced its intention to acquire Alltel.
See
Amol Sharma,Dennis K. Berman and Serena Ng,
Verizon in Talks To Acquire Rival Alltel
, The Wall Street Journal,June 5, 2008, available athttp://online.wsj.com/article/SB121260855426646057.html.
4
RCA Petition
at 6-7.
5
Apple Coup
,
supra
note 2.
6
See, e.g.,
Thomas Ricker,
Nokia, Like Apple, Will Seek Its Slice of the Revenue Sharing Pie
, Engadget,Dec. 11, 2007, available athttp://www.engadget.com/2007/12/11/nokia-like-apple-will-seek-its-slice-of-the-revenue-sharing-pi/ .
7
“The big financial leverage [for AT&T] is on the people who switch carriers. It’s not like you have to addnew cell towers for them; they’re almost all profit. And those people are hard to come by, because youhave to switch them off somebody else’s network.” Alex Mindlin,
iPhone’s Hold on Users Not Exclusive
, May 19, 2008, available athttp://www.nytimes.com/2008/05/19/business/19drill.html?_r=1&oref=slogin.
Page 3 Progress on Point 15.8
Exclusive distribution arrangements with a carrier also provide the equipmentmanufacturer the freedom to innovate. Motorola’s ROKR failed, in part, becauseMotorola insisted on loading the phone with its standard software. Apple’s initial effortsto cut a deal with Verizon failed for a similar reason—Verizon’s reluctance to give upuse of its proprietary VCast service to sell music
—while AT&T recognized that only byletting Apple take the lead on technological development could a truly revolutionarydevice be created. The resulting partnership allowed the two companies to makesignificant investments to develop a radically innovative device while
ensuring that thephone and its new features (such as visual voicemail) would function properly onAT&T’s network.Other exclusive handset arrangements that have followed the iPhone’s successinclude LG’s Voyager (offered exclusively by Verizon Wireless), Samsung’s Ace™(offered exclusively by Sprint Nextel), Samsung’s Katalyst (offered exclusively by T-Mobile), LG’s AX565 (offered exclusively by Alltel Wireless), the soon-to-be-launchedRIM Thunder (the long-awaited touchscreen BlackBerry that will be offered exclusivelyby Verizon Wireless) and the Samsung Instinct (also to be offered exclusively by SprintNextel). All are targeted by RCA as significantly and unfairly diminishing the ability ofsmaller carriers to effectively compete “due to their limited handset selection, therebyfurther enhancing the market power of the ‘Big5’” and “essentially creating another‘digital divide’ between urban and rural America.”
Whether the so-called “Big 5” carriers have market power in the geographicareas served by RCA members is far from evident, as discussed below. However, onething is painfully clear: Now that the market has demonstrated the value of exclusivedistribution arrangements as partnerships that make possible the development of newdevices, RCA is seeking the government’s help to ensure that its members may reapthe competitive rewards of others’ investments. RCA’s petition casts the nations’ fivelargest carriers (AT&T Mobility, Verizon Wireless, Sprint Nextel, T-Mobile and AlltelWireless) variously as “monopolistic,” “dominant,” and “oligopsonistic”
villains who usetheir market power to “command” exclusive arrangement’s like that between AT&T and
8
The iPhone was not only a revolutionary product in terms of design and features. The business modelstruck between Apple and AT&T was revolutionary as well: It appears to be the first time a handsetmanufacturer was able to obtain a share of the monthly subscriber revenues generated by its product.Apple’s revenue-sharing is certainly unprecedented in its scale: Apple has not disclosed how much itreceives per iPhone customer per month and estimates vary, but at least one analyst has put theestimate at $18/month—or $432 over the term of AT&T’s required two-year contract.
See
Tom Krazit,
Piper Jaffray: AT&T paying Apple $18 per iPhone, per month
9
Apple Coup
,
supra
note 2 (“Verizon wouldn't give up its ability to sell content like music and videosthrough its proprietary V Cast service,” instead of directly through iTunes, as iPhone users can do fromtheir phones.).
10
RCA Petition
at ii, 3, 8.
11
In this case, the alleged “oligopsony” is a small group of carriers who, as handset
buyers
, supposedlyexercise market power over handset
suppliers
.
See
id
. at 3 n. 5.
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