iPhone 5 and the dysfunction of 3-year contracts

The painful reality of Canadian cellphone service has once again come to the forefront this week. There was, of course, Apple’s big iPhone 5 announcement on Wednesday - more on that in a second - but there was also the report out of the Montreal Economic Institute that suggested Canada’s wireless market is “functioning well.”

According to the Globe and Mail story, the think tank believes that pricing in Canada is actually middle of the pack, contrary to conventionally held wisdom that the country indeed has some of the highest rates in the developed world. The Institute, which has been accused in the past of infusing right-wing ideology into its studies, suggests that wireless services are competitive globally, both in terms of pricing and innovation, so no additional regulation - as some are calling for - is needed.

Numbers and statistics can, of course, be interpreted in a myriad of different ways, so it’s somewhat pointless to argue against such conclusions. There is, however, one number that can’t be disputed that suggests Canada’s wireless market in fact isn’t “functioning well.” That number is three - as in three-year contracts.

When Apple chief executive officer Tim Cook unveiled the updated pricing for the company’s new lineup of iPhones on Wednesday, led by the iPhone 5, he pointed out that the suggested prices were on two-year contracts. The iPhone 5, for example, would cost consumers $199 on such a deal.

That’s the norm in most countries, but it’s of course not the case in Canada. Consumers here can expect to pay about the same, but on a three-year contract.

That extra year makes a big difference. For one thing, it takes negotiating power away from consumers for an additional 12 months. Many people who have been on contracts know that the only time they have any leverage with their existing provider in getting a better deal is at the end of that agreement. The provider has an incentive in keeping the customer from switching to a rival, so it may offer a better deal. A three-year agreement means this happens less frequently in Canada than in most other countries - exactly 33 per cent less frequently.

Secondly, three-year contracts discourage customers from upgrading phones more often. Most providers offer upgrade options two years in, but this usually ends up costing the consumer extra. Not only does this keep subscribers on older phones longer, but if iPhone sales really can boost the economy - as one analyst has suggested - then three-year contracts are actually hurting Canadian prosperity.

Wireless providers have said they need to have three-year contracts because the amount of subsidy they pay to phone manufacturers is high, and they ultimately sell fewer phones than a larger country like the U.S. That’s bunk, of course, because much smaller countries - those in Scandinavia, New Zealand, to name a few - pay the same subsidies and sell even smaller volumes, but don’t have three-year contracts.

Canadian carriers have also argued that they offer better monthly value, which again is not true. Studies from the Montreal Economic Institute aside, Canadian wireless providers have some of the highest per-user revenues in the world, in some cases making as much from one customer as some European carriers make from two.

That said, Apple is also at fault. The top-end iPhone 5 with 64 gigabytes of storage is selling for $899 in Canada without a contract. Fortunately, with cloud storage and the fact that the phone isn’t the ideal device for watching lots of videos on, not many will need that kind of space. Most buyers can probably settle for the cheaper 16 GB version at $699.

Still, the iPhone is believed to be Apple’s most profitable product, with a margin of 49 to 58 per cent, according to documents that came to light in the recent Samsung court case. The iPad, in comparison, has margins of only 23 to 32 per cent.

The iPhone price tag is out of whack with some of Apple’s other products, which means the company is extracting a good chunk of money from wireless carriers, who are its primary, direct customers. In Canada, those providers have just been better at passing that pain on to consumers.

Apple’s insistence on extracting a huge profit from the iPhone is therefore indirectly nailing consumers via wireless carriers. And it’s not just Apple. If anything, the company provides an aspirational example to other manufacturers; if they think their device is as good as the iPhone, they’ll charge carriers appropriately.

The question then becomes, who’s milking people more: carriers or manufacturers? Either way, the Canadian wireless market is not functioning well because in the end, consumers have none of the power in deciding prices.