Motorola, Nokia Set Cell Phones Free

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The implications for customers, carriers, and handset makers are mammoth. "This will fundamentally change the business," says Andrew Cole, president of management consultancy CSMG. In the next five years, 10% to 15% of U.S. wireless users could move to unlocked phones, figures Andrei Jezierski, partner at venture consultancy i2 Partners in New York. Given more than 227 million wireless users in the U.S. today, that translates to at least 22.7 million people.

Makers of unlocked phones stand to gain, particularly as early adopters spend big on unsubsidized models. A Nokia N80 sells for a hefty $499. And high price tags aren't deterring some buyers. At CompUSA, for example, unlocked phones have been "very successful," says Sammy Saloum, vice-president of merchandising. "It has gone beyond our initial expectations." Analysts believe unlocked phones will eventually grab 25% to 50% of the U.S. wireless market.

Phone Makers Stand to Profit

High price tags notwithstanding, unlocked phones may also bring lower-priced service plans. Up-and-coming carriers, such as Leap Wireless (LEAP) and Metro PCS, are expected to become more aggressive on plan prices for unlocked phones. Established wireless service providers could fight back by lowering service-plan prices for users of unlocked phones, which they didn't have to subsidize, by 12% to 15%, or around $7 a month, estimates Lin.

While customers benefit, carriers may feel the squeeze—in the form of higher subscriber turnover, increased customer acquisition costs, and narrower margins. Even though they'd pay less in handset subsidies, U.S. carriers' profit margins, excluding taxes, depreciation, and other charges, could plummet from as high as 40%-plus to the 30% range more common in Europe, believes Cole.

Some of those profits could end up in the coffers of handset makers, which have already begun treading on carriers' turf. Companies such as Nokia and Motorola have begun offering their own mobile music, radio, and gaming features—services now offered by service providers (see BusinessWeek.com, 8/9/06, "Nokia Goes Ear-to-Ear with Apple"). By unlocking the handset, device makers effectively weaken users' affinity with carriers.

Service Providers Retaliate?

Unlocked phones could also prove crucial for handset makers to fend off competition from iPod maker Apple (AAPL), expected to debut its own cell phone in early 2007. Many analysts predict the iPhone will be unlocked and sold in Apple's own stores. Established handset makers need to start distributing their products in a similar fashion to keep from losing market share.

As advantageous as unlocking phones may be for handset makers, it also carries risks. Carriers could fight back by cutting back on orders and bolstering ties with suppliers that don't sell unlocked versions. They could cut their subsidies of offending handset makers' phones. And they could refuse to sign up users who have unlocked phones. "We do not activate wireless devices that come from other carriers or directly from manufacturers," says a Sprint Nextel spokesperson, "because we can't guarantee the quality of service."

For now, handset makers don't appear worried. "I don't think the carriers will lash back because the volume is so insignificant," says Bruce Brda, a vice-president at Motorola who figures his company will have sold no more than 20,000 unlocked phones in the region this year. "And they don't care about the phone, they care about the service contract. I don't believe there's a huge conflict here."

At least not for now. "This is a long-term trend," Lin says. "Sooner or later, [unlocked phones] will become a more prevalent model here."

Kharif is a senior writer for BusinessWeek.com in Portland, Ore.