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Verizon: Termination Fees Are for Marketing, Sales, Equipment

Quick, why do wireless carriers have termination fees? Obviously to cover the cost of the handsets whose costs they subsidize, right? Wellll ... that's part of it. Earlier this month, the FCC, reacting to reports of how Verizon Wireless was doubling termination fees for "advanced devices," sent a letter with detailed questions. The company's response gives a lot of insight into how it views early termination fees. The answer also suggests how it is now juggling rationalizations on why it sets the fees so high -- and in how much carriers might have to change the way they do business if Google is successful with its unlocked device.

The important facts to keep in mind is that Verizon now charges a $350 early termination fee (ETF) for users who get "advanced devices" like a Droid and that the fee drops by $10 a month during the life of the contract because some of the expense has been recaptured by the company. And that lead to an extremely insightful and ultimately telling question from the FCC:

It appears that if a customer cancels a two-year contract after 23 months, the customer would still owe an ETF of $120. Is this correct? If the ETF is meant to recoup the wholesale cost of the phone over the life of the contract, why does a $120 ETF apply?
What made this question so smart was that the FCC pickup on the fact that 23 months at $10 reduction a month still left $120 on the early termination fee. In its answer, Verizon Wireless said the following:
  • Customers who terminate early on the average do so with more than 12 months left on their contract. Even at the 12 month point, according to the company's estimates, it sees a financial loss typically more than double the $230 remaining applicable ETF.
  • Verizon Wireless argues that to have the ETF go to zero by the end of the term, it would have to start the amount higher than $350. And then Verizon says that the current scheme is good for customers "because early terminations occur disproportionately in the early part of the contract term and relatively few customers terminate near the end of the contract term."
  • And if someone is close to the end of a contract, they should just wait it out, says Verizon Wireless, because they get to walk away with a device that still has value -- oh, except that it's locked to work with only the Verizon network, so unless the person is willing to pay to have it unlocked, it's value is, oh, WORTHLESS. Other than as an ineffectual paperweight. (Of course, it could use a non-linear reduction schedule and give that to people, but maybe it would make consumers think twice when the number is so much higher than the ETF of its competitors.)
  • Are the devices really that expensive? Absolutely not. In that estimate, Verizon Wireless includes partial compensation "for all the costs and risks of providing service, which include advertising, commission, store costs, and network costs." Ah, yes, all those many sunk costs that are undertake whether that consumer starts an account or not.
Now add one more thing. I just called Verizon Wireless sales and asked what happens if I bring my own unlocked device. Answer: no ETF and a month-to-month contract at exactly the same rate that the two-year contract requires.In other words, the person with the unlocked device is treated as a chump because he or she represents that much extra money in the Verizon coffers, because clearly some significant portion of the monthly rates are normally going to pay for the hardware. Second, if you can quit after a month without any penalty, then maybe all that talk about recouping those onerous marketing and sales costs is just so much hot air.

That's why a Google phone, if it became popular, represents such a danger to the carriers. If there were a significant number of unlocked phones (and remember that Google can sell at a loss if it can lock in ad revenue, to say nothing of all the user information it gains), then eventually one of the carriers would start offering a discount because a) it would be possible, and b) eventually one of the marketing organizations would default to price competition because it couldn't think of anything else. At that point, the pressure increases on all the carriers. Given the interest of the FCC and that Congress has shown, we might even see regulation forcing the limitation or end of termination fees when someone isn't getting the hardware from the carrier. And that would be the last nail in the coffin of consumer-entrapment-business-as-usual.

Image via Flickr user Reuben Whitehouse, CC 2.0.

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