Locked In a Cell: How Cell Phone Early Termination Fees Hurt Consumers

2005-08-11

Executive Summary

By almost any measure, the cell phone industry is one of the real market-expansion success stories of the digital age. As of the end of 2004, there were 182 million wireless phones and related devices operating in the United States, up from 24 million in 1994.

Yet, at the same time, the number of giant companies controlling the industry has been shrinking. In mid 2004, six companies – AT&T, Nextel, Sprint, Cingular, Verizon and T-Mobile – controlled approximately 80% of the market. Since then, four of the six – Cingular and AT&T, and Sprint and Nextel– have merged. Now, just four firms will control 80% of the market.

Such a high level of concentration in a major industry can be accompanied by excessive market power, which in turn can reduce competition to the detriment of consumers.

Numerous studies have documented rising complaints about low service quality in the industry. For example, a recent MASSPIRG report, Can You Hear Us Now, surveyed 874 Massachusetts cell phone customers and found general dissatisfaction, with 42% of consumers having a billing problem with their provider and 68% reporting dropped calls and other quality problems.1

This report, Locked In A Cell: How Cell Phone Early Termination Fees Hurt Consumers, is based on a national survey of 1000 consumers and their attitudes on early termination fees (ETFs), which are penalties of $150-$240 per phone designed to lock consumers into a contract with an existing provider – often for periods extending beyond the initial two-year contract – and prevent them from shopping for a new provider with better service or better terms.

In response to consumer lawsuits in several states challenging ETFs as unfair, the cell phone industry has petitioned the Federal Communications Commission (FCC) to treat ETFs not as penalties designed to restrict consumer choice but as a part of the rates that the companies charge their customers for cell phone services.

This report analyzes the industry’s efforts to immunize itself from state consumer protection efforts against this unfair practice that effectively makes consumers captive customers.

Key Findings

Between July 12, 2005 and July 14, 2005, the polling firm IPSOS North America called 1000 U.S. households and asked a series of questions about cell phone service and early termination fees. We found:

Cell phone customers are discouraged by the fees from switching to a new cell phone company that would provide lower rates and better service. Thirtysix percent of the respondents replied that the fees had prevented them from switching.

Cell phone customers disagree with the cell phone industry that the termination fees are part of their rate structure – they view the fees as penalties designed to prevent consumer choice. Nearly 9 out of 10 consumers (89%) agreed that the early termination fee is “a penalty to discourage switching cell phone companies.”

Early termination fees cost cell phone users more than $4.6 billion from 2002 to 2004. By combining the actual costs incurred by the 10% of consumers who switched in the past three years ($2.5 billion) with the benefits lost by consumers who couldn’t afford to switch ($1.2 billion) and benefits lost by consumers who felt the benefits weren’t enough to offset the fees ($929 million), cell phone early termination fees cost consumers more than $4.6 billion from 2002 to 2004.

Roughly half of consumers would consider switching companies if early termination fees were eliminated. The survey found that nearly half or 47% of cell phone customers would “switch cell phone companies as soon as possible” or “consider switching cell phone companies” if early termination fees were eliminated.

Primary Conclusions

• Cell phone companies’ early termination fees work and, as a result, create captive customers unable to exercise their right to choose the bestquality service and lowest rates. Customers that are dissatisfied with cell phone service and want to choose a better service provider are saddled with two highly unsatisfactory options: either pay an expensive penalty or continue enduring poor quality service. In most cases, given the high cost of the fees, they are stuck with the latter option.

• The fees inhibit competition in the cell phone industry. Because consumer choice is restricted, companies can avoid providing the highest quality service and lowest-possible rates that would otherwise prevail in a highly competitive industry. This represents both an enormous loss for America’s cell phone users and a reduction in the efficiency and fairness of the nation’s economy.

• The FCC should not be fooled by the clever but fatally flawed arguments in the industry’s recent petition to the Commission. The industry’s arguments distort economic reality, hide the negative impacts of the fees, and represent little more than a desperate attempt to get the federal government to unjustifiably protect the industry from well-deserved legal challenges, on behalf of customers, at the state level. As the economic arguments and empirical research in this report show, the industry’s claims that the fees are rates designed to recoup their costs rather than penalties imposed on customers are neither credible nor valid.

• There is little public support for the FCC to grant the industry’s petition. The public is neither buying the industry’s fees nor being fooled by its arguments to the FCC. Cell phone users overwhelmingly want the fees to be eliminated and believe that the fees are penalties rather than rates. Even most of those cell phone users who do not want to switch companies or have not paid the fees support elimination of the fees and reject the industry’s claim that the fees are rates.

Major Recommendations

First, the FCC should reject the cell phone industry’s petition requesting that the Commission define early termination fees as rates rather than penalties and preempt legal challenges to the fees at the state level.

Second, the FCC, the rest of the Bush administration, and Congress should not take any other steps requested at a later date by cell phone companies or industry representatives that are designed to prevent cell phone companies from being held legally accountable for the impacts of early termination fees at the local, state or federal levels.

Third, all cell phone service providing companies should quickly eliminate the use of early termination fees (or other mechanisms with similar adverse impacts on consumer choice).

Fourth, the Government Accountability Office of the U.S. Congress should conduct an independent review of the impacts (on consumers, competition and the overall economy) of high concentration and market power in the cell phone service provider industry.