Google’s Nexus One Sales Model Isn’t Quite the Barrier Buster

Nexus One In Portrait Mode

Nice phone. But does it really shake up the cell phone business model?

In the days preceding the release of the Google Nexus One (a.k.a. The long awaited gPhone or what Google calls the first superphone), the talk of the web was that Google was going to break down some sort of Berlin Wall in the way the mobile phones are sold. Whereas most phones are sold by the wireless carriers in conjunction with a 2 Year jail sentence and are locked to that carrier’s network, Google was going to usher in a new paradigm and sell the phone both direct to customers, unlocked to a particular carrier, and without the need to put handcuffs on.

Q. But did it really accomplish that result?
A. Sort of.

Q. Did it shake things up and change the way wireless phones are (and will be) sold?
A. Hopefully, but probably not.

Q. Did the company that pledges to “Do No Evil” really free customers from the tyranny of the wireless carrier oligopoly?
A. Maybe, but doesn’t seem that way.

Let’s take a look at Google’s cell phone math and see how things really turned out …

2007 and Apple’s Impact on the Industry
Prior to the release of the iPhone in 2007, WiFi was a virtually unheard of feature on handsets. The bulk of wireless phones were sold to customers by the Big Four wireless carriers in conjunction with a phone and a dreaded 2 year contract. That means that carriers were (and still are) the real customers of phone manufacturers. Manufacturers had to design a phone that appeals to both customers and the carrier whose network they were trying to make the phone for. Since the carrier is therefore the first customer, you the consumer, could only select from phones that were first chosen by the carrier.

Carriers saw technologies such as WiFi as a threat that could be used by thieving customers to bypass the carrier and route voice and data traffic over zero-revenue WiFi networks. Therefore, carriers wouldn’t buy and resell phones with unfettered WiFi access.

But then came Apple. For year before there was an iPhone, rumors were circulating that Apple would release their own phone based on the iPod. The demand was so pent up, that carriers vying to put the iPhone on their network were no longer in the phone feature driver’s seat. Apple got to dictate what features it would put on the iPhone. And Apple was able to make WiFi a standard feature – at least for data. (It took another 2.5 years until just this past week for Apple and AT&T to come to an agreement allowing VoIP applications to run on the iPhone – mostly thanks to some glaring eyes from the FCC.)

Once Apple broke through that barrier, other phones makers were able to benefit and put WiFi on their phones.

Unfortunately for consumers, other iPhone rumors failed to materialize – particularly that Apple would sell the phone unlocked.

Fast Forward to 2010 and Google’s Chance to Move Things Forward
Once again, Google, like Apple had the benefit of pent up demand on their side to be able to dictate terms with carriers. Instead of technical progress, it was expected that Google would use their market power to break the wireless carriers’ lock on handset sales, sell directly to customers, and end the dreaded 2 year contract that Apple failed to achieve.

Even Google loaded on the hype proclaiming their sales model to be “Our new approach to buying a mobile phone” Well, Google did sell the phone direct (if you gloss over the fact that HTC is actually manufacturing the phone). But they kind of came up short in the revolution department.

First (and this may be a bit nit picky), selling an unlocked and unsubsidized phone is nothing new:

In the United States it seems somewhat novel. But even here it’s been done before. For years online stores like Amazon.com have had a wide selection of unlocked phones.

However, the frequent complaint about the unlocked phones involves selection and price. Often times, the latest and greatest phones weren’t available in an unlocked variant. And when they were, they were often times imported from the EU and carried a very high price. For instance, take a look at the nearly $750 price tag on the Motorola Milestone – the EU/Asia/Canada GSM version of the Motorola Droid. That’s almost a $200 premium over the $559 unsubsidized price that Verizon charges for the Droid (which itself is probably a tad inflated).

And, as we just stated using Verizon as an example – while they may not be sold unlocked, even the major carriers will sell unsubsidized phones to customers without the 2 year contract. T-Mobile offers the same.

Second, while the Nexus One can be called a latest and greatest phone, the unlocked feature kind of unsells itself when you look at its radio frequency support:

In the US, we have two nationwide GSM network providers: AT&T and T-Mobile. The phone supports T-Mobile’s 1700/2100 MHz 3G frequencies, but not AT&T’s 850/1900 MHz 3G frequencies. So, while it is unlocked and you can use an AT&T SIM card to register it onto the AT&T network, you’ll be limited to 2G speeds. So, unless you are moving out of the country, you are effectively still locked to T-Mobile!

Now, there is news that Google has been approved by the FCC to introduce a new Nexus One that will work on AT&T’s 3G network, this new phone will drop support for T-Mobile’s 3G frequencies!

But if you do plan on leaving the country, you’ll be happy to know that both the T-Mobile and AT&T versions of the Nexus one do support the 3G frequencies used in Europe!

Third, the pricing options again work to unsell the appeal of an unlocked, unsubsidized phone:

What’s with all the strikethroughs here? See the new article for information on the corrections!

In Google’s self proclaimed “new approach to buying a mobile phone”, the price is $529 for the unsubsidized phone. According to iSuppli, the marginal cost of the Nexus One is approximately $174.15. So the sales price is triple the manufacturing cost. So much for buying direct and escaping some of the carrier’s markup. This is an iPhone grade markup!

Now here’s where it gets very interesting. Google is still offering the same old-fashioned locked in sales paradigm by selling the phone locked and subsidized for $179.

$350 is a price difference so tantalizing, that even those who love the principle of being contract-free would be hard pressed to pass it up – especially if you do the math. It’s just too good. Or, maybe, bad…

It turns out that T-Mobile has a pretty predictable pricing model for their subsidized pricing. Take the T-Mobile myTouch 3G Android phone. It’s pretty much the most expensive Android phone from T-Mobile (not counting the gimmicky Fender edition of the myTouch). It sells for $149.99 with a two year contract and $399.99 without a contract. That’s a premium of $250 to escape the contract. That $250 price differential holds up pretty well. On pretty much all Android phones T-Mobile sells the price difference is between $250 and $270 between subsidized and unsubsidized – no matter who the manufacturer is.

So with the Nexus One from Google, you are actually paying about $100 extra in premium to avoid the contract ($350 vs. $250). If Google wanted to be in-line with T-Mobile’s own markups, the unsubsidized price should be no more than $429.

But it gets even more interesting. Unlike their competitors, T-Mobile was nice enough to start giving unsubsidized phone buyers a $10/month $20/month discount off their phone bill as of last October. So, instead of paying $89.99/month $99.99/month for unlimited voice/text/data, it’s $79.99 without a contract. (That almost makes total sense since a buying a subsidized phone really entails making a down payment and paying off the rest of the “discount” in monthly installments over the course of the two year contract.)

This means that an unsubsidized phone from T-Mobile will save you $240 $480 over the course of two years if you stay with T-Mobile. So you get back almost all of the price premium you’ll pay for the unsubsidized phone. Yes, that still means you’re overpaying up to $30 for the unsubsidized phone (not even factoring in interest) – money you don’t get back for paying extra at the time of purchase. Clearly, as nice as this sounds compared to T-Mobile’s competitors, they still want to lock you in.

This also means that with the Nexus One, purchasing the unsubsidized phone means that you are overpaying by $110 in money you do not get back for paying full price (versus only about $30 or less when getting a phone from T-Mobile). Yikes! You have to really hate contracts to pay the full price on this one!

Then again you don’t really win with the subsidized Nexus One if there’s a chance that you may cancel your contract early. If you cancel service after 2 weeks and before 4 months of starting service you will get hit with $550 in early termination fees. Only recently Verizon made headlines when they upped ETFs for smartphone customers to $350. In this case, T-Mobile will charge their usual $200 ETF. But on top of that, Google will charge an additional $350.

The $350 that Google charges reflects the difference between the $529 and $179 prices for the phone. That would indicate that Google would lose out on their kick back from T-Mobile if you cancel service early. It doesn’t quite explain the $200 from T-Mobile – other than perhaps that the contract is a standard contract that would have been kind of awkward to modify for Google without giving away any business secrets regarding how subsidies work.

Fourth, a mysterious subsidy treads on evil ground for a company that says “Don’t Be Evil”:

So one can assume that a price tag over $500 would be off putting to a lot of potential customers. Hence, the $179 subsidized price. But there is a simpler alternative that’s been in use for ages – financing.

Instead of using the “old approach” of getting in bed with T-Mobile (and presumably soon AT&T and Verizon) to lock customers in, Google could have offered a financing plan. It’s nothing novel. Just take a look at Sears, Best Buy and other retailers. It’s how many folks have been buying large appliances, cars, and televisions for years. And then there’s always credit cards. If your credit limit can cover the up front costs then you get an instant loan without needing to apply for more credit.

This is pretty interesting too in that, of all companies, T-Mobile is now offering financing for phone purchases. T-Mobile’s new financing plan is not the same as purchasing a subsidized phone – You don’t have to sign a two year contract. It’s totally separate – and frankly, close to the way phones ought to be sold. If you don’t want to sign a two year contract, but can’t afford the high price of a smartphone, T-Mobile offers their Equipment Installment Plan which is essentially a 20 month loan at 0% interest.

And if up front affordability is an issue, T-Mobile’s EIP is actually more attractive than purchasing a subsidized phone. Take the myTouch example again. It’s $399.99 without a contract. With a subsidy and 2-year contract, it’s still $149 up front. But with the EIP, it’s even lower – just $20 up front and $20 per month. Since there’s no contract, you still get the $10/month $20/month discount on service. Unfortunately, as mentioned earlier, over time this will still result in an overpayment of $30 after two years of service.

The fact that the unsubsidized Nexus One price is so incredibly unattractive, it makes you wonder if Google really wanted to charge $529 for the unsubsidized phone. As part of the deal to offer the T-Mobile subsidized price, does T-Mobile perhaps require some sort of unattractive price for the unsubsidized option in order to make the two year contract look appealing? Does T-Mobile really pay Google a full $350 for Nexus One subsidized subscribers? If so, this would be more than the estimated $200 subsidy for a typical phone. It would put the Nexus One clearly in JesusPhone territory.

So if Google truly doesn’t want to do evil, how do they fix this? New phones always drop in price after some time. Even Apple slashed $200 off the price of iPhones only two months after the original iPhone’s introduction. Google could pull the same trick after the Google fanboy rush period is over. If they wanted to, the solutions are simple:

  1. Eliminate the $110 unsubsidized purchase penalty. In most business getting all of the money up front is considered a good thing. So make it a good thing and chop the unsubsidized price down to $419. Done!
  2. Get rid of the subsidy and replace it with a more honest financing plan – similar to T-Mobile’s own EIP.
  3. Come out with a new phone (Nexus Two?) that’s a true 3G world phone and works on both AT&T and T-Mobile in the US. (It’s funny how we forgot about “world phones” which were popular in the voice driven 1G days.)

If Google does these things, then (and only then) can we say that Google has pioneered a “new approach to buying a mobile phone.”