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Posted : 2013-01-06 16:06
Updated : 2013-01-06 16:06

Economics of handset subsidies

People walk by a mobile phone dealer near the Oksu Station, Seoul, Dec. 24. The dealer advertises on the glass wall massive discounts on handsets.
/ Yonhap

How phone prices are set and why that hurts consumers


By Kim Da-ye


From today, Korea's three wireless carriers will be banned from signing up new subscribers for up to 24 days as punishment for offering too many subsidies to mobile phone customers.

The marketing blitz of mobile operators based on excessive subsidies reached its peak in September when Samsung Electronics' Galaxy S III smartphones with a retail price of 994,000 won were sold with two-year contracts for as low as 170,000 won.

The regulator, the Korea Communications Commission (KCC), which has capped the amount of subsidies per handset to 270,000 won, stepped in, slapping fines on the three telcom companies and suspended parts of their businesses temporarily.

As wireless carriers give discounts on the monthly bill on top of subsidies on the phone, lucky purchasers of the 170,000-won Galaxy S IIIs ended up getting the handset for free plus extra cash.

Consumers thought the cutthroat competition among carriers was a boon to them, but the regulator argues that subsidized phones would eventually hurt them by increasing costs to carriers and forcing them to raise prices. Consumers are left confused over whom to blame for expensive phone bills ― carriers, phone manufacturers or the regulator.

How phones are subsidized

Until recently in Korea, the three wireless carriers ― SK Telecom, KT and LG Uplus ― completely controlled the distribution of mobile phones. They buy handsets from manufacturers such as Samsung Electronics, LG Electronics and Pantech, and supply the devices to dealers.

Most handsets are sold with 24-month contracts and subscribers usually pay for the handsets in installments until they end. A typical phone bill shows the monthly installment paid on a handset plus call/text/data charges minus discounts that vary depending on payment plans.

Discounts on the phone bills lessen the burden on consumers paying for their handsets, but they aren't categorized as "subsidies." The subsidies are direct discounts on handsets and are supposed to be paid by carriers via dealers. These subsidies appear as "marketing costs" on carriers' income statements.

But investigations by the country's anti-trust body revealed last year that the prices of handsets are decided in more complicated ways.

The Fair Trade Commission (FTC) concluded that both carriers and handset manufacturers overstated the cover prices of their mobile phones and pretended they were offering a lot of subsidies to consumers.

The FTC investigation found that the average gap between manufacturers' prices and carriers' prices for 44 handset models was 225,000 won.

Furthermore, the investigation found that Samsung, LG and Pantech hiked the prices of 209 handset models out of 253 sold between 2008 and 2010 with the purpose of paying a form of "rebate" back to carriers that can then be given to consumers as subsidies.

The FTC investigation said that the handset makers gave the carriers 234,000 won per phone on average, a whopping 40.3 percent of the total price of a phone.

One handset which the FTC identified as an "O" model made by an "A" manufacturer was sold for 568,000 won here but for 255,000 won abroad. The FTC said the 313,000-won difference has likely been paid as rebate to the carriers.

In the case of Apple's iPhone, the investigation found that its price was not overstated and that Apple did not offer any rebates to carriers.

A statement made by an official from a handset manufacturer released by the FTC succinctly sums up the complicated pricing system. The official said, "Consumers do not know how the price of a handset is decided. They do not know that incentives are included in the sales price and believe that carriers pay subsidies from their own profits.

"If carriers set the price high, including the incentives in it, the handset will appear expensive. And consumers think the more expensive a handset is, the better phone it is. So if the handset is subsidized, consumers are willing to buy it, believing they are getting a bargain for a good phone. That's why we do business this way."

Ultimately, dealers are left with a pool of money ― subsidies from carriers, rebates from manufacturers and even a portion of the dealers' own sales commission.

It's the dealers who make a final decision on how much profit they take and how much in subsidies to give, so tens of thousands dealers are likely to offer different prices, according to an official at the KCC.

Getting a good deal or a bad one depends on the research skills of consumers and the telecom regulator doesn't want discounts given to a minority of customers to become price hikes for the wider group.


"We calculated out that carriers make 270,000 won of profit per subscriber on average. That means subsidies exceeding 270,000 won for one consumer is a loss to another," a KCC official said.

In the meantime, the popularity of Apple's iPhones has brought an important change to the market ― no rebate from phone manufacturers. Samsung Electronics followed suit, vowing not to offer carriers "incentives" as its Galaxy series smartphones sell well without discounts.

Such moves can damage the profitability of carriers. Lee Suk-chae, the chairman of KT, criticized phone manufacturers last October for putting too high sales prices and forcing carriers to spend excessively on "marketing costs" rather than developing better designs and networks.

Even after the anti-trust body's investigation, all mobile phones remain more expensive in Korea than in other key markets. Samsung Electronics' Galaxy Note 2, for example, has a retail price of more than 1 million won although the phone maker no longer offers rebates, but it is sold for $649.99 plus tax without contracts in the U.S.

The phones distributed in Korea supports digital multimedia broadcasting (DMB) and other features for Korean users, but that shouldn't lead to a difference of hundreds of dollars, according to market observers.

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Subsidies or no subsidies?


Outside Korea, especially in the U.S. and in Europe, a minority of consumers are debating if buying phones at full prices without committing to contracts actually saves money.

The CEO of German-based mobile communication giant T-Mobile said in December that the carrier plans to end phone subsidies in 2013. According to PCmag.com, T-Mobile's chief marketing officer said last March that subsidies "distort what devices actually cost" and causes consumers to "devalue" their phones.

Last May, the KCC introduced a new policy that allows people to buy unlocked phones. Handsets had been locked to certain carriers via their own unique identity numbers, and carriers have now established the system that serves the phones that are not locked to them. Unlocked phones can be distributed to various outlets including electronics stores, supermarkets and online shops.

The regulator also negotiated with the three wireless carriers to come up with price plans appropriate for consumers with own phones. SK Telecom and LG Uplus decided to provide the same discounts on the phone bills enjoyed by subscribers to phone owners while KT came up with separate price plans.

Structural problems

Phone bills have been a key component of consumer price index, so the government, in the last couple of years, tried to keep the telecommunications companies from raising prices.

An association formed to develop an index for Korea's telecommunication charges said last April that compared to 10 other OECD countries, Korea's mobile communication charges was among the lowest when purchasing power parity was considered, after Australia's and Sweden's. The U.S, the U.K, and Japan were the top three countries with the most expensive mobile phone bills. The index did not consider relatively expensive 4G LTE price plans.

But nowadays costlier smartphones drive up mobile phone bills.

Expensive phones are, after all, a byproduct of the cozy relationship between manufacturers and carriers in the long-established market structure in which only carriers could distribute handsets.

Korea's mobile communication market is small, so amid tough competition, carriers cannot afford to lose its competitive edge coming from subsidies and the not-so-transparent pricing of mobile phones.

KT tried in 2011 a Fair Price policy by posting the regular price of its smartphone models at dealers' stores. The two other carriers did not join the move, and KT's efforts didn't last long.

Moreover, controlling prices has become increasingly difficult as businesses move online and dealers diversify. Excessive subsidies or extremely cheap handsets are mostly available online. Ppomppu, a community-like portal, became highly popular among those seeking massive discounts on handsets.

Online buyers often take risks because it is sometimes difficult for them to verify if the dealers are legitimate. Gusung Mobile, a big dealer at Ppomppu, was accused last week of pocketing some 15 billion by not executing "secretive subsidies" it allegedly promised to pay customers. Gusung has won customers by initially selling handsets at their full prices and giving back huge portions in cash after three months.

An official at the KCC said that based on the current rules, the regulator will continue closely monitoring illicit subsidies with the hope of them gradually decreasing while the anti-trust body will take care of handset prices.

However, the industry sees it differently. Local media reports said that carriers had been again dolling out a lot of subsidies before the ban came into effect. Because setting up telecommunication networks is a huge investment, the carriers are better off through signing up more new subscribers by giving out subsidies and getting slammed with fines than complying with the regulation but losing customers.

"The root cause of the problem is the overly heated competition among carriers. They should buy phones at the right prices from manufacturers and sell them without subsidies with the intention to compete with services alone. But differentiating from each other by services is difficult," an official at a local mobile operator said requesting anonymity.


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