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01-06-2015 | Research Article

Wireless Carriers’ Exclusive Handset Arrangements: an Empirical Look at the iPhone

Authors: Ting Zhu, Hongju Liu, Pradeep K. Chintagunta

Published in: Customer Needs and Solutions | Issue 2/2015

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Abstract

Since the Apple iPhone’s launch in 2007 in an exclusive arrangement with AT&T, it has garnered overwhelmingly positive responses from consumers and from the media. With its success, exclusive contracts between handset makers and wireless carriers have come under increasing scrutiny by regulators and lawmakers. Such practices have been criticized by regulators, by the media, and by “locked-out” consumers, due to the fact that a consumer has to subscribe to a particular service provider if he or she strongly prefers one handset to others. In this paper, we empirically examine the impact of handset exclusivity arrangements on consumer welfare. First we study consumers’ purchase decisions for mobile services that include the choice of a handset and of a service provider. We do so by combining panel data on consumers’ purchase decisions with supplemented data on prices and features of common handsets. Next, assuming a Stackelberg leader-follower relationship between the handset manufacturers and the service providers, and using our demand estimates, we recover the markups for the players in the market. We then simulate what would have happened in the counterfactual scenario when the iPhone is available from all carriers. Our results suggest that, if we take into account adjustments in handset prices from handset manufacturers and service providers in response to the change in market structure, consumer welfare will increase by $326 million without the exclusive arrangement. We view our analysis as a starting point to a more complete characterization of consumer behavior and the complex relationships among players in this industry.

previous article Implementing Retail Category Management: a Model-Based Approach to Setting Optimal Markups

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“Verizon Unwraps iPhone,” by Shayndi Raice and Yukari Iwatani Kane, Wall Street Journal, January 12, 2011.

“FCC to Review Exclusive Deals that Lock up Hot Cellphones,” by Amy Schatz, Wall Street Journal, June 19, 2009, page B3.

This regulation is viewed by many as a watershed event that eventually led to the breakup of AT&T.

According to Global Wireless Matrix 2007Q4, a study conducted by Merrill Lynch, the wireless penetration rate in the U.S was 84.4 %, including 16.1 % prepaid customers and the rest on long term contracts. In our data 70 % of consumers chose a two-year service contract.

“Is Handset Exclusivity Really the Wireless Issue of the Day?” by Roger Entner, Nielsen Wire, August 27, 2009.

See the written statement of Mr. John E. Rooney, President and CEO, U.S. Cellular Corporation, before the U.S. Senate Committee on Commerce, Science and Transportation, June 17, 2009.

See Rural Cellular Association’s “Petition for Rulemaking Regarding Exclusivity Arrangements between Commercial Wireless Carriers and Handset Manufacturers” before the Federal Communications Commission.

Thus our analysis ignores the behavior of contract “breakers” and the role of the early termination fee. According to Sinkinson[21], less than 1.4 % wireless subscribers report paying termination fees.

Even in those markets, researchers have often assumed myopic consumers (e.g., Berry, Levinsohn and Pakes [34], Petrin [24], Sudhir [35]).

“Wireless, Cellular & RFID Industry Trends,” by Plunkett Research, LTD.

An early example of a smartphone was the IBM Simon introduced in 1993. It was hailed as “the first time a company had placed a computer in a cellular phone” (Mobile Phone News, November 8, 1993).

“Cellphone Politics,” Wall Street Journal, July 7, 2009, page A14.

“Telecoms Face Antitrust Threat,” by Amol Sharma, Wall Street Journal, July 7, 2009, page A1[36].

Other studies have looked at the representativeness of such a panel derived from repeated cross-sections of overlapping data (e.g., Liu et al. [20]).

Potentially we are able to estimate a model with two separate outside goods – a prepaid plan and no wireless service. Given the limited information about the prepaid plans in the data, we choose to combine these two options as one alternative in the choice set.

Alternatively we can estimate a single price coefficient, but add up the handset price and the discounted flow of monthly service fees, with the discount factor to be estimated as well. In other words, $ {\beta_i}^H{p}_{jkt}^H+{\beta_i}^S{p}_{jkt}^S={\beta}_i\kern0.62em \left({p}_{jkt}^H+{\displaystyle \sum_{\tau =t}^{t+24}{\rho}_i^{\tau -t}{p}_{jk\tau}^S}\right) $ to a scaling factor and so none of the other parameter estimates will change.

The specific terms of vertical contracts between handset manufacturers and service providers are complex and unobserved. Alternatively, a bargaining model between the contracting parties might be a reasonable approximation, e.g., Sinkinson [21] assumes that the joint surplus of the contracting parties is a determinant of market structure.

The details on the calculation of these matrices are provided by Villas-Boas[25].

While not reported here, the regression of prices on exogenous and instrumental variables yielded an R ² of 0.72.

Scott Cunningham from CoreEconomics used a different approach to calculate elasticity of demand for the iPhone, and found an elasticity of −3.37 for the iPhone.

Dedrick et al. [37] also finds that carriers capture higher gross profits from each handset than the handset makers.

Since we do not have the marginal costs of iPhone from other carriers, we assume that their marginal costs are the same as AT&T’s, which has been recovered from the supply side model.

Verizon launched the iPhone 4 at a starting price of $199 in February 2011. According to Localytics, a mobile app analytics firm, Verizon had 32 percent of the iPhone 4 market in July 2011 (http://www.localytics.com/blog/2011/verizon-powering-32-of-all-us-iphone-4s/).

The price drops $0.41 on average.

The 95 % confidence interval for the annual welfare gain is ($314 million, $338 million).

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Hahn R, Singer HJ (2010) Why the iPhone Won't Last Forever and What the Government Should Do to Promote its Successor. J Telecomm High Tech 8:313–350

Subramanian U, Raju JS, and Zhang ZJ (2008) “Exclusive Tie-Ups for Handsets in the Cellular Industry,” working paper

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Baker CA. (2007) “Breaking Up Is Hard to Do:Consumer Switching Costs in the U.S.Marketplace for Wireless Telephone Service,” working paper

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Title: Wireless Carriers’ Exclusive Handset Arrangements: an Empirical Look at the iPhone
Authors: Ting Zhu
Hongju Liu
Pradeep K. Chintagunta
Publication date: 01-06-2015
Publisher: Springer US
Published in: Customer Needs and Solutions / Issue 2/2015
Print ISSN: 2196-291X
Electronic ISSN: 2196-2928
DOI: https://doi.org/10.1007/s40547-015-0036-1

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