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The Misguided Urge to Regulate Wireless

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.

That goes for the business models their entrepreneurial creators select. Neither Apple (AAPL) nor Research in Motion (RIMM), the Canadian company that invented the BlackBerry, runs the networks over which their devices operate. Their hardware and software are available via deals with wireless operators. These carriers invest heavily and bid fiercely to offer the most appealing devices and applications on their networks.

Consider the AT&T-Apple iPhone deal. It's exclusive, meaning that iPhones in the U.S. work only on AT&T's (T) network. The arrangement is controversial and has been called a restriction on customer choice. That view overlooks the dynamic process by which Apple creates its disruptive technology and provokes a heated competitive response.

Apple iPhone Stirs Fierce Competition Not only are myriad handsets available—including most, like BlackBerrys, that operate across multiple networks—but the exclusive deal rewards Apple, the innovator. The iPhone has brought the computer company an estimated $40 billion gain in market value.

This encourages more of what consumers—who bought 1 million 3GS phones in the handset's first weekend—love. RIM is fighting back with the Storm, while Samsung, Palm (PALM), Nokia (NOK), and a host of rivals—including the Google-backed Android operating system—are rushing out new models, many with the touchscreen that has been wildly popular since the iPhone's blockbuster debut in June 2007. The Consumer Electronics Assn. projects sales of 37 million smartphones in the U.S. this year. That's an astounding 14 million-unit gain, or 60% above pre-iPhone sales levels.

Customers are not hostage to subsidized handsets or to the two-year contracts typically attached. All U.S. networks offer prepaid cards at 10¢ or 20¢ per minute, allowing customers to bring their own phones. The flexibility isn't free: Contracts pencil out to about 5¢ per minute. This "volume discount" rewards users who commit to supporting the network—those $50 billion-and-up megastructures of spectrum, fiber, real estate, base stations, and millions of mobile radios.

Handset subsidies extend this rivalry. In South Korea, regulators have sponsored temporary bans on subsidies, explicitly increasing carrier profits by slashing subsidy costs and thereby cutting a line item that plagues financial results for wireless carriers everywhere. But the policy clearly harms customers.

Finland's Bundling Ban Choked Demand 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.
Thomas Hazlett is professor of law and economics at George Mason University.

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