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Wednesday, June 11, 2008

Pay Me Now Or Pay Me Later
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One should avoid clichés like the plague. But there is little in ecclesiastical wisdom that can match the old saw about there being no such thing as a free lunch. Goods and services come at a price. If a consumer wants to impress her friends with her high-end mobile phone, she had better be willing to part with cash sufficient to compensate the maker of that phone. A football fan with dreams of sampling all of the different games available each Sunday on DIRECTV should not be surprised to find that a good deal of equipment must be installed before he will ever see the first kickoff – equipment that DIRECT does not provide gratia placenti. Consumers must pay for what they would consume.

This simple truth appears to have been lost on a few “consumer advocates” who object to the imposition of early termination fees, or “ETFs,” when consumers cancel service contracts without having fulfilled the terms of their bargain. For, in fact, the use of service contracts and associated ETFs is merely a mechanism for spreading costs over an extended period rather than requiring consumers to bear them in the form of a one-time fee.

To extend the examples above, smartphone and DBS service both require consumers to have fairly sophisticated end-user equipment. If one were simply to purchase a high-end mobile device, the retail price would run into the several hundreds of dollars. Similarly, the need for a parabolic antenna, set-top box, and the labor for installation required to receive DBS service suggest a substantial upfront consumer investment before any actual service can be received.

Service contracts and ETFs provide an alternative. A smartphone that may have cost our hypothetical consumer $500 had she purchased it as a stand-alone device might be provided for only a few dollars in conjunction with a one-year commitment to a particular carrier’s service – allowing the carrier to recover the full cost of that smartphone over the period of the contract. Rather than pay DIRECTV an initial equipment and installation charge of several hundred dollars, our football fan can instead amortize those costs over a year or more in conjunction with a service contract. Naturally, however, to the extent a consumer wants to opt out of any such contract, he or she should reasonably expect the affected service provider to demand recompense for the upfront investment necessary to provide service.

Now none of the above strikes one as particularly controversial or difficult to understand. Indeed, ETFs are not uncommon in other industries in which the provision of service requires a substantial investment that may be lost if a customer ultimately elects not to purchase service (e.g., automobile leases, apartment rentals, air travel, etc.). So why the gnashing of teeth and rending of cloth over ETFs in the media and communications markets?

I can only surmise that the most recent political angst over ETFs in contracts for voice and video services results from a lingering suspicion that competition isn’t working and that these markets, in particular, are failing. Of course, there is an odd sort-of upside down logic to the view that vulpine megalomaniacs running communications and media companies are, in fact, not using ETFs legitimately to spread the costs of service over time, but rather are using them to prevent consumers from switching to competing service providers. If these markets actually were failing and there was not in fact fierce competition among and between various service providers, there would be little need for companies to use ETFs to “lock in” their customers. To the contrary, it is precisely because there is such vibrant competition in these markets, and because consumers can otherwise move so readily between various service providers, that ETFs are necessary when large upfront investments are made in each customer.

Now, of course, even in the most competitive markets practices sometimes emerge that are not wholly consumer friendly; these practices even sometimes take hold for a period of time. But markets ultimately deal with such practices, and they do so with a flexibility and sensitivity that can never be matched by regulatory or judicial action.

In the case of ETFs, service providers surely can do more to dispel the notion that ETFs are being used to frustrate competition rather than because of it. One simple step, for instance, is to allow consumers a choice when they initiate service to pay all upfront equipment and installation costs in one lump sum or have those costs spread over the life of a contract (with an appropriate ETF). Similarly, because the investment necessary to provide service to any particular customer will be recovered over the life of a service contract, any ETF should be pro-rated to reflect the actual economic cost of early termination to the service provider. Finally, service providers should include in their ETF policies exceptions for cases of demonstrable hardship where termination results from events unforeseen.

With these caveats, ETFs are not to be feared, like some genus of firedrake, but are instead legitimate business tools that facilitate commerce and trade, and which provide consumers increased choice and flexibility. Indeed, if the extent of federal intervention in this area were limited to the establishment of guidelines consistent with this framework and the preemption of diverse action in the fifty states and twelve federal appellate circuits, it might actually facilitate market competition and enhance consumer choice.

If, on the other hand, the federal government is intent upon limiting the use of ETFs for voice and video services, “pay me now or pay me later” may become simply “pay me now,” and the price for communications equipment is likely to be higher than most expect.

posted by W. Kenneth Ferree @ 2:28 PM | Communications , Wireless

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