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Cellular Walls Come Tumbling Down

At the Consumer Electronics (CES) show earlier this year, cellular devices got a lot of attention; probably more than ever before. But it isn't all good news for the mobile carriers. It seems the walls protecting their playground are crumbing at an accelerating rate.

The U.S. telephone network built by AT&T Bell Labs enjoyed significant protection as a regulated national utility; all the way up until the Government broke it up. A system of subsidies created national "universal" service. It was an impressive accomplishment. Starting in the 1960s, the protective walls began to fall. As recently as the 1970s, customers were only allowed to rent Western Electric phones from the phone company. Those forms of protection were torn down by various court cases and technology breakthroughs (remember the extra fee for touch-tone dialing?).

Probably the first chink in the armor was number portability. Prior to November 2003, changing carriers meant changing numbers. The advent of number portability opened up competition among the mobile carriers in a new way, but the industry model remained unchanged.

The big change came in 2007 from Apple. None of the major carriers actually produce their own phones (though do brand them); instead they imposed oversight into phone design with partner manufacturers. The mobile carriers--not the end users--were the hardware makers' customers. The carriers balanced customer needs, network capabilities, and market economics in design considerations. All the carriers were working the same knobs and none of the equipment vendors could risk alienating the carriers. This lasted until 2007, when Apple offered some new knobs.

Since it had no incumbent market share, Apple had nothing to lose, and so demanded engineering control. Apple had a proven track record in product design and a loyal customer base, and sweetened the deal with product exclusivity. In the U.S., AT&T agreed and all of the carriers soon learned from the iPhone's phenomenal success that the market was actually willing to pay much higher prices for a much better solution. The carriers have since ceded their control over hardware. RIM, Motorola, HTC, and Palm now design products for the end user rather than the carrier.

Meet the New Boss, Same as the Old Boss
So while Apple successfully tore down the arbitrary barriers on hardware design, the protective walls simply moved to Apple. Apple retained full control of the source code, user interface, and hardware. Apple didn't manage the network, but did pick the network carrier with exclusive arrangements (possibly without performance guarantees). Apple also created and controlled the Appstore with exclusive authority over which apps were acceptable and which were denied. No apps can be legally loaded without going through the Appstore. For all this, Apple takes a hefty sales commission from the carrier on new subscribers and 30% of all products sold through the Appstore. It was an impressive shift that met little resistance. To the contrary, the iPhone is a huge success by any measure, thanks to its extraordinary user experience.

It appears Apple's own successful walled model is now under threat. Google made headlines with the new Nexus phone which uses a very different model: An open unlocked phone, an open unlocked Appstore, and the ability to completely bypass the Appstore (Android Marketplace). Google also separated the sale of the phone from the selection of the carrier--at least in theory.

The new category of smartphones downplays voice capabilities. The carriers built subscription models based on voice minutes and offer "unlimited" data services for a lower monthly cost. VoIP makes voice possible over the data stream, so the logical desire to run voice over 3G came next.

At first the carriers blocked voice over data both technically and via user agreement, but pressure mounted and this barrier dropped. Between Wi-Fi and 3G, many smartphones are quite capable without voice minutes. The outcome of this isn't clear yet, but it clearly threatens "unlimited" data plans and AT&T was the first to announce limits on data. One area where use of data (3G or Wi-Fi) for voice is very attractive is on international calls. The carriers don't allow alternative carriers, and international dialing from a mobile is comparatively quite high. TruPhone, Google Voice, and Skype offer alternative (less expensive) methods for international dialing (see Long Distance Choice is Back).

The cell phone industry continues to unravel. Consider these current trends:

Awareness of the cost of "free" Voice Mail: Take Back the Beep and other public campaigns drew attention to why carriers make "free" voice mail a painfully slow endeavor. Long pauses, too many options and menus keep users connected to voice mail systems (callers and retrievers) much longer than necessary, increasing consumed billable minutes. Google relaunched its Google Voice service specifically as a voice mail only service aimed at cell phone users. Google Voice can send an SMS notification to the phone as a means to get around proprietary voice mail alerting on the handset.

Femotcell: Femtocell technology is a micro-cell solution that could allow a user to increase wireless coverage with a mini tower connected to a wired network. The technology is a logical way for carriers and customers to increase coverage inside the walls of offices or work areas where coverage is insufficient. For the most part, it was thought to be a carrier based solution, but YMax Corp. (the makers of MagicJack) demonstrated a femtocell that allows GSM phones to bypass the wireless carrier much as its MagicJack bypasses the local carrier. The cellular carriers may well challenge this new product, on the grounds that it encroaches on their spectrum licenses. However, if the product winds up being introduced successfully, you can bet on a new wave of similar products.

Appstore Model: When the personal computer was still new, most shopping malls had software stores. It was a nice place to browse for new applications. But as the software options increased and moved away from physical packaging, the software stores disappeared. The Appstore may follow a similar path. Today, the Appstore provides two key functions: a place to browse and an installation tool. The next generation of browsers will enable stronger webapps--potentially threatening the current app model. As with the desktop computer, more and more applications run in the browser either natively or with plugins. The line is already blurred: the difference between Google Mail in a browser and the Google Mail application on Android or iPhone is not that significant. Most vendors are seeking to emulate Apple's Appstore model of control, but it may prove to be difficult for even Apple to retain it. Google recently launched a webapplet version of Google Voice for the iPhone, specifically because Apple blocked the app from the Appstore.

Contracts: Carriers are willing to subsidize the cost of new phones with term contracts, but most don't decrease network charges after the subsidy is recovered. Users that don't utilize the subsidy (i.e., provide their own phone) don't pay lower rates either. This model has not changed yet, but the writing is on the wall as more companies introduce and sell unlocked phones. Carriers will need to compete for these users by offering lower prices. Additionally, the prepaid model, relatively new in the US, is gaining acceptance and market share without any contracts. Sprint's Boost now offers a Blackberry with unlimited voice and data for $60/mo without a contract. The current model is analogous to getting a free car from a gasoline company with a contract to purchase x/gallons per month--but still paying the same price per gallon as everyone else. The goal really is to keep the per-month rates high. Most likely, subsidized phones will last for some time, but the contracts will move toward repayment of the phone (as in car payments), with separate terms for phone service emerging at decreasing prices.

Unlocked Phones: An unlocked phone means it can be used with any service provider, not just the one that sold it. This is less important in the US since most of our carriers use incompatible air interface technology anyway (i.e., a GSM phone won't work on a CDMA carrier's network). The basic idea of the new model is that the phone and the phone service are two separate consumer decisions. Phones can be sold as other consumer electronics--and after it is purchased the carrier can be selected.

MVNOs (Mobile Virtual Network Operators): In the past few weeks, both Mitel and TruPhone announced themselves as mobile carriers. MVNOs are good for wireless carriers in that they increase overall marketing and bundling of wireless services. But a mobile virtual network operator does effectively turn the big carriers into their worst nightmare--just pipes. MVNO offerings are expected to significantly increase this year, as other equipment and service vendors are discovering the power of bundling services.

Ebooks: Ebooks such as the Kindle and Nook use wireless services as an important part of their solution, but effectively hide the wireless carrier. The Amazon Kindle was initially released with delivery enabled via Sprint, but newer models are now using AT&T. Most customers won't notice or care--the millions each carrier spends on advertising has no value as wireless enabled appliances hide the provider.

It is hard to feel sorry for mobile carriers. Their revenues continue to grow as mobility becomes increasingly important to our everyday lives. However, it is clear the model and definition of the customer is undergoing rapid change. With increased mindshare, comes increased oversight. The FCC is rapidly engaged in carrier policing (or investigating so far). The FCC requested additional information on why Apple blocks certain apps and how the carriers are determining early termination fees. Congress is asking questions about the increasing costs of SMS.

The reality is the wireless industry is expanding into many facets of our lives. Either the cell phone or the wireless network is impacting, disrupting, even replacing industry after industry--payphones, call boxes, pagers, PDAs, CB Radios, FRS radios, answering machines, land lines, portable game players, music players, and so on.

Dave Michels is a frequent contributor and regularly writes about telecom at his blog PinDropSoup.