Early Termination Fees Under Fire

Posted by Kallan Dahn Thursday, August 14, 2008

The great debate for this year in the wireless industry is going to be whether or not wireless companies are going to be forced to change their business model. Currently wireless carriers offer their phones at a deep discount below their cost on the handset, in exchange for a two year commitment to stay with the company. This is done in the form of a contract. Currently there is a hefty penalty for breaking such contracts. The National Associates of Regulatory Utility Commissioners (NARUC) is a cooperation between state and federal governments to protect wireless customers from "harsh" or "confusing" early termination fees. Verizon wireless has been a big supporter of pushing federal oversight of the termination fees instead of allowing individual states to enforce standards as proposed by NARUC. FCC Chairman Kevin Martin partially agrees with Verizon. He believes that here needs to be SOME federal regulation on early termination fees. Recently we have been seeing states like California condemning wireless carriers for imposing a penalty for breaking a contract. Wireless carriers such as Verizon are rightfully concerned about the fines being imposed on wireless carriers by such states. Recently California courts ordered Sprint to pay $73 Million in restitution stemming from early termination fees of contracts the judge deems against ethical business practices in California. The practice of early termination fees are being labeled such things as "Anti-Competitive". Can something really be anti-competitive if other carriers are imposing similar fees? This makes it a standard practice! Evidently, in California you can not impose any kind of penalty for breaking a contract.

Most subscribers of wireless companies pay between $50-$80 monthly for cellular phone service. Usually when one business sues another business for breaking a contract they sue for the worth of the contract. These phones are being sold with the understanding that they are received at a discounted rate, in exchange for an agreement to purchase products and services from the company for a certain number of years. The customer is given the amount of the penalty, and has agreed to it prior to purchase. Let's take for example numbers published by Alltel in their second quarter 08 Report. Cost of Unit (COU) per month to the company is $32.62. Average Revenue Per Subscriber (ARPU) $54.42. This tells us the company profits $21.80 for every month of service the customer has.($54.42 - $32.62 = $21.80) Now we look at a low end phone. Lets take their Motorola W315. Retails at $129.99, and is sold on two year agreement for free. The company has to have that customer as a subscriber for at least 6 months just to pay for the discount associated with the phone. This is based off of one single primary line. Taking into account two years of service, the company will profit $390. The termination fee ($200) is roughly half the amount of the profit to the carrier. Customer that break the contract after only one month of service profit the carrier only $15.59, after the cost of the phone is recovered, as well as their month of service.($200-$129.99-$32.62 =$37.39) The customer is paying for phone subsidy and 2 months of lost profit to the carrier!

I do think that early termination fees should be prorated based on the length of time that a subscriber has been a customer. My recommendation would be a $200 termination fee in month 1 and during months 2-12 the fee would drop $5 each month. During months 13-23 the fee will decrease $10 each month. This would put an early termination one month early at only $35. This is just a little more than the amount needed to just cover the carrier profit for the following month. See the ETF table for illustration.

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