Forcing Mobile Carriers to Prorate ETFs

Today Senator Amy Klobuchar (D., Minn.) sent a letter to Sprint Nextel Corp., AT&T Mobility, and T-Mobile, asking the carriers to make good on their previous announcements to prorate their early termination fee (ETF). Currently, the carriers charge the same amount of ETF, regardless whether a subscriber breaches his contract two months into the contract or two months prior to the end of the contract. Senator Klobuchar and other members of congress have demanded, among others, that these fees are prorated. See my blog entry for February 27, 2008. In her letter, the senator states that the thus far empty promises to prorate ETFs “underscore the need for Congress to act and to pass the Cell Phone Consumer Empowerment Act.” A few comments and thoughts on Ms. Klobuchar’s demands are in order:

1.      As I have repeatedly stated, when properly analyzed, ETFs (ranging typically between $150-$200) are actually a very cheap way out of a contract, relative to the economic harm caused by the breach.

2.      When accounting for the fact that most ETFs are never collected, ETFs, on average, are always cheaper than paying the remaining contractual monthly recurring cost.

3.      About 2/3 for all ETFs are charged because subscribers fail to pay their bills.

So, why prorating an ETF that is already lower at almost any point in the contract than the economic harm caused by the breach? Demanding prorating ETFs would only make sense if they were set in direct relationship with the economic harm inflicted on the mobile carrier as a result of the breach. Simplified, this would mean that at any point in the contract, the ETF equals the product of the monthly recurring cost and the month remaining on the contract minus the cost the carrier avoid from having no longer to serve a customer who breaches. For instance, assume an AT&T Mobility subscriber has a monthly recurring cost of $50 and breaches three months into his 24 months contract. As a result of his breach, AT&T Mobility forgoes 21*50=$1,050 in revenue. Since AT&T no longer has to service the customer, it also avoids some cost. Mobile network costs, however, are typically incurred in large increments (that is, high fixed costs, low variable costs), thus resulting in an avoided cost of approximately 20 percent. Hence, in this admittedly simplified model, AT&T Mobility’s economic loss due to the subscriber’s breach of contract is $1050-$210=$840. Thus, the ETF for this example would be $840. Only if ETFs were set in direct relation to the harm caused is it justifiable to demand the prorating of ETFs. Sure, mobile carriers can elect to voluntarily prorate ETFs – something which Verizon Wireless has already done and other carriers are likely to follow suit.