Another blow for handset subsidies as UK regulator mulls price hike controls

The mobile phone subsidy model is already in trouble, what with devices such as the Nexus 4 threatening to bring smartphone pricing into the no-brainer pre-pay zone. But now carriers in the UK may have a new incentive to stop blending upfront device costs into their monthly fees: the telecoms regulator Ofcom has proposed allowing mobile (and landline and fixed broadband) customers to quit their contract sans penalty, if their operator hikes prices after they’ve signed up.

Ofcom’s move follows a great deal of pressure directly from consumers and from the consumer advice service Which?, which has run a campaign called Fixed Means Fixed since last July. On Thursday the regulator launched a consultation (PDF warning) on how to better protect people from price rises that are allowed under the small-print terms of their contracts, but that may not be obvious to most people when they sign up.

Why consumer protection could kill subsidies

Ofcom has proposed several options, which also include greater transparency of price terms and making it so that consumers must expressly opt into any variable-price contract. However, the regulator was clear that it favors changing the current rules so that “consumers are able to withdraw from a contract without penalty for any increase in the price for services applicable at the time the contract is entered into by the consumer.”

What does this have to do with handset subsidies? Everything.

Here’s how the current system works. Operators can raise their prices without letting customers bail out for free, as long as the hike falls short of causing ‘material detriment’ to the customer. What’s material detriment? Good question. It’s pretty much up to the operator to decide, and their measurements are wildly inconsistent – some set the barrier at inflation, some set it at 10 percent, and some mix those two up, depending on which ‘part’ of the overall charge we’re talking about.

You can hardly blame the average customer for not keeping up, and Ofcom says this situation is allowing a rather unhealthy trend. From the consultation document:

“With regards to the size and frequency of price rises in fixed term contracts, we consider there is a risk of these becoming a standard and regular practice in the communications sector. We note that some providers have increased prices more than once since 2011. Since most providers set a threshold… before they allow consumers to exit without penalty the incentive to raise prices once consumers have signed up to them will be large and any reputational damage to a provider will be diffused because competitors have pursued similar policies in the past.”

Which? itself recently pointed out that, in the last 15 months, all the major UK operators raised their prices at least once. The group’s campaign has garnered 37,000 signatures, and Ofcom has of course received many complaints about price hikes directly – it analyzed 1,644 of them in preparation for the new proposals.

Now, the operators have complained to Ofcom that “they are likely to review the way they currently subsidize handsets in order to reduce the risk to them if they have to let consumers exit the contract without penalty for any price rise”.

And what’s Ofcom’s response? A resounding “meh”:

“Our provisional view is that any disadvantages arising from changes in the way in that handsets are obtained by consumers would be outweighed by the protection offered by this option. This is on the basis in particular that handset manufacturers and handset/communications services retailers will continue to have a strong incentive to ensure that consumers are offered competitive and attractive deals for handsets.”

In other words, if Ofcom’s proposals go through, we may very well see a change in the way mobile phones are sold in the UK – currently a predominantly post-pay market, but maybe not for much longer.

In practice, this will probably mean that operators start charging a larger upfront fee for the handset in order to offset the risk of the customer quitting, or – as is already the case from where I sit here in Germany – splitting the contract in two, so that one part of the monthly charge is explicitly paying off the handset, and the other representing the service charge.

Either way, the actual cost of the handset would become much more apparent to the customer, making out-of-contract price a much more sensitive issue. Which is where the Nexus 4 comes in. Even less-savvy consumers can currently assess the low Google(s goog) Play price and realise that they’re paying more than necessary if they get it on contract. This will only accelerate that trend, particularly if the Google-phone pushes down smartphone pricing in the same way the Nexus 7 did for tablets.

Let’s see if Ofcom’s proposals go through. The consultation closes on 14 March, after which Ofcom will reveal the finalized rule-tweaks. Operators will then have three months to change their strategies accordingly, so we could very well be looking at a major shift in the UK mobile market before the end of this year.