Experts question Google phone business model

When Google Inc. introduced its Nexus One phone in January, it unveiled a whole new business model in the mobile phone market.

But it has become clear that the business model is based on a vision that isn’t currently possible in the U.S., experts say.

“Google was initially saying it wanted the Nexus One not to be tied to an operator, to be open and free for anyone to buy it and use it,” said Allen Nogee, an analyst with In-Stat. “It seems like a great philosophy. The problem is in the U.S. the operators have built a web in such a way that’s impossible to do.”

Google’s recent response to the U.S. Federal Communications Commissions’ questions about early termination fees points to the disconnect between Google’s vision for its phone business and the current reality of the mobile business, Nogee and other experts say.

In a letter to the FCC, Google describes its new business model.

“Simply put, empowering consumers to pair a mobile device such as the Nexus One – and additional devices in the future – with the users’ choice of operator and service options is a new model for selling mobile devices in the United States, one that we believe will maximize consumer benefits,” Google wrote in the filing.

But unless Google plans to offer essentially a universal phone, it will be doing nothing different than the many third party phone retailers in the U.S. that already sell a variety of phones that are tied to a specific operator.

The issue that Google faces is that operators in the U.S. use different technologies and frequencies. Phones are typically built to run on one particular network in the U.S. In order to let users pick a phone and then a network, Google could try design a phone that runs on all the relevant frequency bands and technologies, “but it would cost $2,000,” Nogee said. Google is likely unable to do such a volume business in that kind of universal phone that it could drive the cost down, he said. That means Google is in the same position as any other third party retailer: it must sell phones that are purpose-built for individual carriers in the U.S.

A Google spokeswoman declined to comment on whether Google planned to sell a universal phone or simply sell different models compatible with different networks.

It is now offering a Nexus One built for T-Mobile’s network and has said it is working on one for Verizon Wireless. That means “they’re not really doing anything new and innovative,” said Andy Castonguay, an analyst with the Yankee Group.

Many other companies sell phones online, including Walmart. Some, like Wirefly, let people choose a phone and then choose an operator that has already approved the device.

People can buy an unlocked version of the current Nexus One phone and use it on T-Mobile’s network or AT&T’s network but not AT&T’s 3G network.

“The claim that it’s an unlocked device is not untrue, but it’s not particularly reflective of reality” because using the unlocked phone on AT&T’s network without being able to use 3G is not a very attractive proposition, said Castonguay.

Analysts also say it’s a stretch to say that Google’s model is better for customers.

“I’m not sure that new in this context means better. In fact, in many ways they’ve taken a step backwards,” said Castonguay.

That’s because buyers of Google’s Nexus One phone will pay more if they change their minds about the phone.

Nexus One users who cancel their contract with T-Mobile in under four months must pay T-Mobile a US$200 cancellation fee and they must pay Google an additional $150 fee. That gives the Nexus One the most expensive cancellation fee for any T-Mobile phone.

“It is the highest ETF because in most cases people with a T-Mobile phone only pay $200, not an additional $150 to Google,” said Chris Hazelton, an analyst with the 451 Group.

Google charges customers that fee because T-Mobile pays it a commission for each Nexus One subscriber and asks Google to return that commission should the customer cancel their contract within four months, Google said in the filing.

Most retailers, like Best Buy, also get commissions from operators for selling wireless services and must repay an operator for that commission if a customer cancels service within a specified time period, Castonguay noted. However, retailers absorb that repayment rather than charge the customer for it, he said.

“Google is doing something unusual in offloading their risk in that equation,” Castonguay said. “They are doing this in a way that is highly risk averse. They are in a position where the risk of cancellation is born almost entirely by the customer.”

Some retailers construct their contracts in such a way that they don’t get paid a commission unless a customer sticks with the contract for a certain period of time, thus eliminating the potential issue of having to return a commission, Nogee said. He finds it unusual that Google would have to repay a commission.

A Google spokeswoman did not explain why Google passes that charge on to consumers while other retailers don’t.

Another unusual move from Google is its decision to use a new term for its cancellation fee.

“Google is not a wireless network operator, does not enter into contracts for mobile service plans with customers, and does not charge an ‘early termination fee’ (ETF) to consumers based on contractual terms in a mobile service plan related to early cancellation,” it wrote in the filing.

It’s a matter of syntax for Google to say that its fee is not an ETF, Castonguay said.

To the customer, Google’s “equipment recovery fee” looks identical to the typical ETF fee operators charge for canceling before the end of their contract. “That’s not legitimate [to give it a different name] because they haven’t changed the model,” said Hazelton.

Google might be able to get away with calling its fee something different if it came up with a totally different business model, such as offering a subsidized phone even for customers who don’t contract with a mobile operator, Hazelton noted.

The search giant isn’t yet in a position to do that because it hasn’t figured out how to monetize the services, like Google Maps and Gmail, that it offers to its mobile users, Hazelton said. If it does begin to earn money from services that run on Android phones, it might be able to subsidize phones using that income. “That would be a real value,” he said.

Google’s filing has another interesting tidbit of information: the search giant says it has yet to collect any fees from Nexus One users for canceling their service. The analysts were surprised by that, given that churn rates are usually around 2 percent and smartphone return rates are typically upwards of 20 percent.

When asked for comment on how its cancellation rate could be so low, the Google spokeswoman said she had nothing more to add beyond what’s in the filing.

Observers can interpret the lack of returns in a couple of ways. It could be that customers are so satisfied that they haven’t wanted to return the phone. Or “it tells you the ERF and ETF are working,” Hazelton said, meaning the fees are expensive enough to discourage people from canceling their contracts.

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Jim Love, Chief Content Officer, IT World Canada

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