Mobile Phone Madness

If you bought any generation of iPhone in the U.S., a federal judge just decided you can now join a class action challenging the exclusive marketing agreement between Apple and AT&T. It’s just not evident why you would want to. It’s not at all clear you are getting a bad deal and, if history holds true, changes in the market will deliver attractive new options long before a court case does.

Some consumers have long complained about Apple’s practice of locking iPhones so that they could only work on AT&T’s network, and Apple’s practice of deciding what applications could and could not be installed on the phone. They argue that the arrangement minimizes competition and limits their choices. But, as Bob Hahn and Hal Singer documented in a study published last fall [Download Here], the exclusivity agreement has likely spurred others to accelerate their own innovations and provided consumers with a wide range of smartphone alternatives, some of which are arguably superior to the iPhone.

If we’ve learned anything from the technology marketplace of recent years–change happens overnight and apparent dominance ends fast. Or, perhaps you’ve forgotten that AOL once seemed to have an iron grip on Internet access, Microsoft was the favorite target of antitrust zealots, Google was once just a mathematical expression, and Apple was a struggling afterthought in a computer market dominated by the Wintel partnership.

As Hahn and Singer wrote in September 2009: “Although casual observers have often claimed that a particular innovation was here to stay, they commonly are proven wrong by unforeseen developments in this fast-changing marketplace. We argue that exclusive agreements can play an important role in helping to ensure that another must-have device will soon come along that will supplant the iPhone, and generate large benefits for consumers.”

And, from personal experience in the U.K. where the iPhone is sold by multiple carriers, we can tell you that having a choice in carriers does not deliver iPhone nirvana. There is something of an iPhone price war that makes the phone more affordable, but the user experience once you own the phone is not all that rosy. Reception is quite spotty in the countryside when traveling on trains, and dropped calls from London to Manchester are the rule rather than the exception. And that’s with a provider that’s reputed to have a very good network.

Still, our personal experience is not the key issue. What counts for decision makers is the relative benefits and costs of exclusive agreements. The primary benefits of banning an exclusive iPhone-type agreement would be greater price and non-price competition in the mobile device market. But competition in this market is already intense. From BlackBerry to Droid, new smartphones are coming out all the time. Even Google has produced its own branded phone. Are consumers better off with identical iPhones from every carrier or from a wide variety of smartphone models competing to distinguish themselves with an expanding array of capabilities, applications and designs?

Barring exclusive agreements carries significant costs. Carriers would have weaker incentives to aggressively promote new devices and ensure network quality. They would also have fewer incentives to innovate, such as developing new and better networks, like the “4G” networks that are coming online now to handle exploding data demands by consumers and businesses.

The real question for policymakers and the courts is the underlying structure of the market and whether a dominant player forecloses competitive choice or new entrants. In the smart phone market, it is hardly the case that the iPhone is dominant. Apple is a major player, but Research in Motion (BlackBerry) and Nokia outsell it. A long view of this market shows that competitors have risen and fallen over time–exactly what one would expect in a market that is changing rapidly. And the available choices are enough to make your head spin.

The mobile device marketplace in the U.S. is remarkably robust. That dynamism makes it easy for regulators to pick the right economic policy: namely, a light-touch regulatory approach that allows device makers and networks to innovate. Consumers will be better off if the courts appreciate the fundamental economics of the market and follow regulators’ lead. If they want continued innovation and expanding choices, this class action against Apple and AT&T is one that consumers should pray that they lose.

(This blog post was published earlier on Forbes.com.)