Hanging Up on Early-Exit Fees

(page 2 of 2)

To preempt state court rulings, T-Mobile and Sprint Nextel have already announced they will start reducing early termination fees as the time remaining on a contract declines. Exact details haven't been disclosed, though the changes are expected to take effect this year. Just two days before the Supreme Court decision, AT&T (T) announced it would reduce its $175 early termination fee by $5 per month through the life of a new contract. That matched a policy implemented last year by Verizon Wireless, which has also introduced a 30-day risk-free service trial and now allows customers to switch calling plans without starting a new contract.

Sprint's Vulnerability

The industry would rather make the changes on its own. "Early termination fees are changing based on consumer demand," says Joe Farren, spokesperson for CTIA, The Wireless Industry Association, noting that consumers can always opt for pre-paid wireless services that don't require contractual commitments.

But carriers' moves may prove too little too late. Lawsuits alone could result in billions of dollars in costs and settlements, and may prompt providers to axe early termination fees altogether. "Pandora's box is going to open up,” says Jessica Zufolo, senior policy director for telecommunications, media, and technology at Medley Global Advisors.

For an industry that has long used contracts to keep subscribers on board, elimination of termination fees could spell massive changes, such as higher churn and slimmer margins. A satellite TV company typically spends around $700 to recruit a consumer. For wireless companies, the cost of acquiring customers, including marketing and handset subsidies, is closer to $400, and it typically takes more than a year to recoup. Higher rates of switching could be especially nettlesome for Sprint Nextel, which regularly finishes near the bottom of customer satisfaction rankings. "The biggest loser, unfortunately, in this space is Sprint," says Serge Matta, senior vice-president at ComScore (SCOR).

A Dash of Kindness

An industrywide, free 30-day trial period would provide cold comfort to wireless providers. The provision would make it easier for a certain percentage of subscribers to start hopping from one provider to another to get free service. Back when long-distance companies abolished contracts, a material percentage of consumers began switching without paying their last bill, says Rich Nespola, CEO of consultancy TMNG (TMNG).

To keep subscribers, more wireless carriers might follow Verizon Wireless's lead and begin allowing subscribers to switch to lower-priced plans without having to extend contracts. A recent survey of more than 2,000 users by ComScore showed that 19% of Americans switched to their current carrier for a better price. Carriers may also offer users more free content and other incentives to encourage them to stay. "They'd do sweet things instead of barbs," says Richard Doherty, director at consultancy Envisioneering Group. But these treats are likely to eat into revenue and margins.

One potential beneficiary of lower termination costs: equipment manufacturers. Today, an average American replaces a cell phone every 17.7 months, vs. every 16.6 months in 2006, according to consultancy J.D. Power. That lengthening replacement cycle spells trouble for handset makers Nokia (NOK), LG, and Motorola (MOT). If early termination fees go away completely, handset sales could jump 25% in the first six months, Doherty estimates.

A downside: To preserve their margins, service providers may not subsidize the equipment as much as they do today. Sure, subsidies are becoming less common, and less of a draw for consumers willing to splash out upwards of $500 for a razzle-dazzle smart phone. But, unable to charge termination penalties, service providers may simply pass the cost to consumers as other fees.

Kharif is a senior writer for BusinessWeek.com in Portland, Ore. With Jennifer Schenker in Paris.