Telecom

Setting the iPhone Free from AT&T


As the exclusive U.S. carrier for the Apple (AAPL) iPhone, AT&T has had a lot to celebrate. Rivals hope to crash the party.

A growing number of public interest groups want an end to the partnership that forces buyers of Apple's iPhone to buy their mobile-phone service only from AT&T (T). And they're taking their case to the highest levels of government.

Critics: Exclusivity Is Anticompetitive

The Consumers Union, the New America Foundation, and the Electronic Frontier Foundation, as well as software provider Mozilla and small wireless carriers MetroPCS (PCS) and Leap Wireless International (LEAP), are lining up in opposition not only to the Apple-AT&T partnership, but to all manner of arrangements whereby mobile phones are tethered exclusively to a single wireless service provider.

Consumer groups are reaching out to the Federal Communications Commission, the Copyright Office, the Federal Trade Commission, and congressional leaders, asking them to outlaw exclusive handset and software deals. Judging from the track record of Julius Genachowski, the newly nominated head of the FCC, petitioners may get a sympathetic hearing, at least at that agency.

Opponents also take issue with Apple's insistence that iPhone users download software only from the Apple iTunes App Store. The argument is that these and other "exclusivity" pairings are anticompetitive and limit consumer choice. "It is unthinkable that you could only use a Macintosh on an AT&T connection," says Michael Calabrese, vice-president at the New America Foundation, which is chaired by Google Chief Executive Officer Eric Schmidt. Google (GOOG) has helped develop phone software that competes with Apple's.

Apple and AT&T aren't the only tech companies under fire. Every major U.S. carrier including Verizon Wireless, Sprint Nextel (S), and T-Mobile USA has struck exclusive deals with cell-phone makers such as Samsung Electronics, HTC, and Research In Motion (RIMM). Companies such as RIM also have their own online application stores tied to particular devices.

Lots at Stake for AT&T

While any ruling would affect many industry players, AT&T and Apple may have the highest stakes in the battle. The iPhone is the No. 1 seller at AT&T, and the iPhone has been key to driving AT&T Mobility subscriber growth as it gets harder for carriers to add new customers. About 40% of the 4.3 million AT&T customers who activated the device in the second half of 2008 were new to AT&T, according to the company's latest quarterly filing.

Apple also benefits by extracting key concessions from its partner. For instance, Apple can sell music and applications to iPhone users without sharing revenue with AT&T, an arrangement AT&T doesn't allow with other devices.

AT&T would stand to lose big. Without an exclusive device, all the carriers may have to compete on service or handset price after subsidies. For Apple, "the [iPhone's] price might not drop very quickly, if at all, because the device itself still has great value—it's iconic," says Neil Strother, an analyst at consultant Forrester Research (FORR). The impact from opening up the phone to all software could be muted as well, as App Store revenue is minimal.

Friendly Ears at the FCC and FTC

The consumer advocacy groups are pinning their highest hopes on the FCC, which last year asked for comments on the exclusivity issue. Exclusive handset practices "result in a very direct and negative effect on the competitive positions of smaller carriers," wrote the Rural Cellular Association (RCA), which represents smaller carriers, in a Feb. 23 filing submitted in response to the FCC's request. "The large carriers use it as a vehicle to drive customers away from the smaller carriers," which end up getting popular phones years later, says Eric Peterson, executive director of the association.

The RCA hopes that as soon as a new, Democratic FCC chairman is in place, the agency will investigate the issue and rule on it. A former government official familiar with the FCC believes the new Democratic-majority commission will be sympathetic toward smaller carriers' interests. The FCC could prohibit exclusive handset deals outright, or it could impose limits on carriers' ability to restrict what networks a phone works on.

The RCA is also lobbying Congress to get involved and expects a bill that prohibits exclusive carrier deals to be introduced soon, Peterson says.

On Dec. 10, the New America Foundation met with law professor Phil Weiser and former FCC Commissioner Susan Ness from President Obama's transition team. The group asked that the Federal Trade Commission take up the issue of "wireless carrier anticompetitive practices"—namely, the practice of locking handsets to a particular network, and requiring users to buy software from a particular source, Calabrese says. A decision in the foundation's favor could make it illegal for AT&T and Apple to limit new iPhone users to AT&T's network or the App Store from the get-go. Former FTC Commissioner Jon Leibowitz, expected to be nominated for the FTC chairmanship position, is likely to be sympathetic to this view; in a February 2007 speech, he supported allowing any device to attach to any network.

Legalizing "Jail-Breaking"

The U.S. Copyright Office is getting involved as well. This year, it will review whether to extend a ruling that made unlocking cell phones—essentially, making them work on a network for which they are not intended—legal. Public interest groups and companies like Mozilla are trying to get that exemption renewed and get the Copyright Office to give a nod to a practice known as jail-breaking—essentially, allowing cell phones to run software of their owners' choosing vs. applications limited to offerings from, say, the Apple App Store. In comments filed in December, the Electronic Frontier Foundation claims that the current setups "disserve iPhone owners and suppress competition from independent iPhone application vendors."

The Copyright Office will hold hearings on this issue on May 1 in Palo Alto, Calif., and the following week in Washington, D.C. It will issue final rules in October. "[The issue arose] in large part because of the iPhone, because the iPhone did not exist in 2006," says the Electronic Frontier Foundation's senior intellectual property attorney, Fred von Lohmann.

Battles over these kinds of arrangements could be lengthy. But Apple could actually benefit from an end to exclusive carrier deals by dramatically increasing the iPhone's distribution. "They'd have sold five times more iPhones [without exclusive contracts]," estimates Trip Chowdhry, an analyst at Global Equities Research.

Exclusivity as Driver of Innovation

Apple declined to comment for this story, and has not submitted comments to the FCC. But on Feb. 20, RIM commented in a filing that exclusive handset deals have done nothing to restrict competition in the wireless marketplace. "There are at least 35 companies designing and manufacturing handsets today," the maker of the BlackBerry wrote in its filing. "As of March 20, 2008, there were more than 620 unique models of wireless devices available to American consumers. New manufacturers continue to enter the U.S. market …"

In its December comments to the Copyright Office, Apple said that jail-breaking phone software "will destroy the technological protection of Apple's key copyrighted computer programs in the iPhone device itself and of copyrighted content owned by Apple that plays on the iPhone, resulting in copyright infringement, potential damage to the device, and other potential harmful physical effects, adverse effects on the functioning of the device, and breach of contract."

AT&T believes that exclusive deals actually drive other carriers' innovation. "Exclusive arrangements are an important form of competition," AT&T said in a statement. "The popularity of the iPhone and its innovative features and applications have provoked a strong competitive response, accelerating not only handset innovation but also the pace of wireless broadband investment and applications development." Indeed, most carriers nowadays offer iPhone look-alikes. If consumer advocates have their way, rivals may eventually offer the iPhone itself.

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

Olga_kharif1
Kharif is a reporter for Bloomberg News and Bloomberg Businessweek in Portland, Ore.

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