Out of Control

Skype’s business problem is that most wireless companies offer consumers a wireless service plan and the phone in a bundle. This usually takes the form of a contract under which the customer, in exchange for a significant discount on the cost of a phone (sometimes the phone comes free), agrees to commit to a specific term of service from the service provider, say 12 to 24 months. The downside is that breaking the contract means incurring a hefty penalty fee--$100 or more.

Skype and its supporters have seized in this. True, the size of the penalties have drawn complaints. Yet state and local consumer protection agencies on one side and legislators on the other have been loath to ban them because the “bundle-by-contract” business model keeps the cost of cell phones within reach of most consumers. In short, regulators see the penalty fees as protecting bundling’s benefit of providing wider, cheaper access to wireless service. The practice has never been found to be monopolistic nor exploitive. Consumers still have an enormous choice of service providers, phones and plans.

But since Skype’s plan hinges on non-bundling, bundled phone services present a competitive problem. So, rather than solve what amounts to a business challenge, Skype is looking to the government to end the bundling-via-contract idea through misapplication of Carterfone and by capitalizing on (and further obfuscating) the current debate over network neutrality.

Carterfone applied to AT&T’s exclusive relationship with its Western Electric subsidiary. Although no “smoking gun” memo was ever found dictating procurement policy, it was generally understood that, despite AT&T’s claims that it welcomed all bidders, Western Electric got just about 100 percent of its business. The only equipment that AT&T bought from outside vendors were the few components Western Electric didn’t make.

When Carterfone, a small Texas manufacturer of a device that could connect mobile radios to the public switched network, challenged AT&T’s rule that equipment had to be certified by AT&T to connect to the network, the FCC ruled in its favor.

Today, no carrier enjoys legal protection as to the equipment that it can attach to its network. Carriers, nonetheless have the right to certify phones to assure they will perform well on their networks, and co-brand with manufacturers who submit to certification. They have the right to enter into marketing partnerships with content and applications providers, such as ESPN, Yahoo! and CNN. However, even today, you can purchase a cell phone independent of a service plan. Of course to use it, you still have to register with one of the wireless service providers that serve your community (98 percent of the U.S. population lives in counties where there’s a choice of three), and you have to set up an account to pay for service. It’s this last point that I’m not sure Skype understands.

The Internet opens up many new and innovative business models. Some, however, are built around the free use of resources owned by others. Skype’s peer-to-peer phone network is a great example and organizations no less than CERN, one of the major international Internet development centers, has resisted its use. Policymakers should be wary of allowing Internet companies to invoke terms like “innovative” and “outside-the-box” to finagle a free ride at another’s expense.

Of course, the free ride motive seems to be often at the heart of Google’s arguments about network neutrality. So no surprise that Skype has found use for the issue, too. But say what you will about the past history of Internet neutrality, network neutrality never existed in wireless. Service and applications were always tightly bundled. This didn’t mean a closed market or a monopoly, but what the trade calls a vigorous “OEM” (for original equipment manufacturer) business.

Companies you’ve likely never heard of, like Atreus Networks, Jamdat and Kabira Technologies compete to provide the best of breed components, software and applications to phone manufacturers and carrier buyers. At the 2007 3GSM World Congress in Barcelona in February, more than 1,300 vendors showed up to court wireless service providers worldwide. This is a healthy competitive market with a healthy competitive supply chain--much of it due to bundling.

Skype thinks consumers will be better served if they were forced to purchase wireless a la carte: a phone from one vendor, service from another, and each voice and data application from yet others. It’s like suggesting that new car buyers would be better served if they were required to buy tires, batteries and sound systems separately from the rest of the vehicle. Note that this is possible: there are plenty of car, battery and car audio shops in business to meet the needs of the more demanding consumer. But law recognizes there is no inherent consumer harm when the car company includes these items with the car itself. Nor does the law balk at any company that has an OEM certification program.

The same is true for wireless and that’s how it should be. There are 161 million wireless customers in the U.S. Wireless providers invested more than $20 billion in capital expeditures each year between 2001 and 2005. Minutes of use grow while cost-per-minute declines. This is what current business models, allowed to develop free of regulation, have accomplished in the wireless market. Americans would be better off if Skype made an effort to work within this framework, rather than attempting to persuade Congress and the FCC to change the rules on its behalf.