Retail and Consumer

Bundled handsets: how did we get here?

Published on 23rd Nov 2018


There has been considerable growth over the past few years in the number and types of services, considered essential to modern life. Many are accessed or delivered via some kind of device or hardware; whether that is a box, a router, a smart phone or another IoT device. Increasingly, the hardware becomes outdated within a comparatively short period of time, so providers and consumers alike want payment packages that offer good value services whilst allowing for upgrades.

Nowhere is this more evident than in the smartphone market. Unlike routers and set-top boxes, consumers can (and do) buy smartphones as standalone items – the hardware has its own intrinsic value to the consumer (depending on brand, camera quality etc), and that value can be considerable, running into many hundreds of pounds. The hardware is as important to the consumer as the service provided through it, so consumers are as interested in finding a way of spreading the cost of the phone as they are in receiving the data and minutes under the subscription services.

Bundled handset packages offer consumers a way to get a new handset with their service; approximately two-thirds of pay-monthly customers are on one of these tariffs, representing more than 20 million customers. Depending on the provider, consumers can either receive a mobile handset as part of an airtime contract, or they can have separate contracts for the handset and airtime elements (split contracts).

On 26 September 2018, Ofcom launched a Consultation on helping consumers to get better deals on mobile handsets, in which it expressed disappointment that providers have not addressed issues in the market on a quick, voluntary basis without the need for formal consultation and regulation. It is currently consulting on achieving greater transparency beyond end-of-contract notifications; and introducing fairer default tariffs that would apply at the end of minimum contract periods.

What are the issues identified?

Ofcom has identified two key issues:

  • Transparency: The underlying principle is that consumers should clearly be able to identify the goods and services that are offered to them and at what price, in order to evaluate what is on offer and make an informed decision about what to buy. When a mobile customer signs up for a bundled handset and airtime contract, providers are not transparent with customers about what proportion of the price they pay is for the handset and how much is for the airtime. It is therefore not easy for customers to compare the price of a handset under a bundled package with the price of a handset under a split contract, or with its cash price coupled with a SIM-only deal.
  • Loyalty penalty: If mobile customers on bundled handset and airtime deals do not take action at the end of their minimum contract period, their contract rolls forward and they continue to pay the same price. Ofcom's concern is that, for bundled packages, this includes the cost of the handset, which the customer will have already paid off. Ofcom thinks that this is unfair.

The Citizens Advice super-complaint

In the same week that Ofcom published its consultation, Citizens Advice made a super-complaint to the Competition and Markets Authority (CMA) about 'loyalty penalties' across a range of consumer markets, including the market for mobile handsets. As a result, we now have a situation where the CMA must review price discrimination, Ofcom is already consulting on it and the FCA is also looking at price discrimination in the financial services market (see our Insight on Price Discrimination – a regulatory hot topic).

In its review of bundled handsets that accompanies the super-complaint, Citizens Advice finds that 43% of adults in Great Britain have a 'handset-inclusive contract', which it describes as 'uniquely involving high value hardware bundled with a service contract'. Citizens Advice acknowledges that it is a benefit of bundling that consumers are able to spread the cost over time, but, echoing the Ofcom consultation, it takes the view that there are two major drawbacks:

  • Transparency: By blurring the cost of the phone and data allowances, handset-inclusive contracts make it hard to know what the best deal is. Citizens Advice research shows that in 73% of cases it is cheaper to buy a handset and data separately, but 55% of consumers who have bought their phone as part of a bundled contract thought that their route was usually cheaper.
  • Loyalty penalty: Consumers who do nothing continue to pay the same original price, despite no longer benefitting from a new handset. One in three bundled contract consumers go beyond their minimum contract period, and, on average, they spend six months beyond their minimum contract and face a loyalty penalty of £22 a month. This means that consumers overpaid by £490 million on their last mobile phone contracts.

Financing handsets is tricky

If a provider allows a customer to have use of the hardware but does not transfer ownership of that hardware, it will be carrying on the FCA regulated activity of consumer hire. If it transfers ownership of the hardware to the customers and then recovers the cost of the hanset over the period of the subscription, it will be carrying on the FCA regulated activity of consumer lending.

Some markets have been able to swim in these waters comfortably from the get-go. For example, an electric vehicle manufacturer might sell a vehicle to the consumer, but retain ownership over the battery. This allows the manufacturer to require the return of the outdated battery for disposal and the replacement with an up-to-date improved version. It will provide the battery under a regulated hire agreement for a monthly fee. This is nothing new for vehicle manufacturers, who have long provided leasing, hire purchase and lending as ways of financing their goods.

This is, however, less appealing in the telecoms industry, which is already highly regulated by Ofcom. The prospect of also becoming part of the highly regulated financial services industry is unattractive, a point which appears to at least have been acknowledged by Citizens Advice in terms of both the cost and practicalities of having dual regulation. Becoming FCA-regulated can change the economics of a product launch: not only does a regulatory application take time and money; once authorised, there are ongoing compliance costs for the firm, reporting considerations, an alternative complaints process, senior management personal responsibilities, and extensive customer disclosure requirements to be complied with, both pre- and post-contract, which often need specialist legal input. Even introducing customers to third party finance providers involves (for the introducer) seeking FCA authorisation and a great deal more friction in the customer journey and (for the lender) increased regulatory and control risk.

We have seen a couple of different ways that subscription service providers in general have sought to avoid carrying on FCA-regulated lending or leasing activity. Firstly we have seen providers 'lending' the hardware to the customer free of charge, taking the approach that the 'commercial purpose' of the arrangement is the provision of the service, which can only be accessed or properly used via the hardware, rather than a hire arrangement. This is most likely to work where the value of the hardware is a very small proportion of the overall service cost and is generally not available as a standalone piece of kit.

More usual in the smartphone market, however, has been the practice of either 'giving' the handset to the customer at the outset of the service contract free of charge or 'selling' it for a comparatively small upfront fee, and then not mentioning the handset (or who owns it) in the service contract. In this scenario, the economic model that sits behind the service contract will be designed to ensure that the provider recovers the cost of the handset over the minimum service contract term. Furthermore, it is possible to argue that no credit is provided because, from an English law perspective, the customer's contract does not contain a deferred obligation to pay for the hardware. Similarly, any termination fee will usually be presented as a sum which is calculated to compensate the provider for the loss of the future income stream represented by the monthly subscription fees over the remaining term of the contract. There is no question of accelerated payment for the hardware.

What does Citizens Advice want?

Citizens Advice wants all telecoms providers to be required to offer split contracts. It believes this will increase transparency and enable customers to shop around more easily to ensure that they are getting the best deal for their handsets and airtime contracts. In other words, it thinks that all providers should become dual authorised by both Ofcom and the FCA. It argues that dual regulation can only serve to increase consumer protections. It would appear that it also wants bundled packages to be banned, as it says that if all providers move to split contracts, there will be no more charging for handsets at the end of the minimum term.

Osborne Clarke comment

In our view, the remedies that the CMA is most likely to favour will follow the principles set out in the recent UKCN Review, published jointly by the CMA and the FCA in October 2018, and the examples set in the financial services sector, where demand-side remedies of prompts and increases in transparency have not produced adequate results. In its recently published Discussion Paper 18/9 on the fairness of certain pricing practices in financial services, the FCA focusses on loyalty penalties and price discrimination and looks at more radical supply-side remedies. Examples are banning auto-renewals, breaking up product packaging, simplifying tariffs and even price capping (for example by introducing a price collar – restricting the difference between highest and lowest pricing; or introducing price discrimination bans).

Although Citizens Advice acknowledges that if the entire market started offering split contracts, there is no guarantee that handset finance would stay at 0%, it appears to think that any cost increase would be a price worth paying to avoid loyalty penalties and obfuscation. It is worth saying that while transparency might be increased through display of an APR that comes with a split contract, equally, it might not – a disclosure-heavy two-contract approach can increase the risk of confusion at point of sale, which may explain why split contracts are currently only available direct from providers and not via resellers. It should also be noted that regulated credit can only be provided if the relevant customer passes creditworthiness and affordability tests, so those at the more vulnerable end of the market or with limited credit history may be unable to obtain their handsets via this route.

On a more legalistic note, what Citizens Advice sees as the 'commercial reality' of the situation: that customers are continuing to pay the same subscription price after the hardware has been 'paid off', is not the legal reality. In bundled contracts, the economics of providing the hardware, taking into account the macro-impact and cost of early termination, are baked into the subscription fees. In other words, legally, it is not necessarily the case that customers are continuing to pay for handsets after the end of the minimum period, because they were never paying a specific amount for the handsets under the contract in the first place. Where other subscription providers install hardware as part of a service, installation and hardware costs are often baked into the subscription in the same way. What opens the bundled handset model to criticism is the fact that handsets are also available to buy and finance in other ways and there is no easy way to compare handset prices. Hence the argument that having a consistent approach across the market as to how handsets are advertised and sold would better serve consumers. However, given the volume of customers who are attracted to these bundled packages and who have sufficient engagement to switch at the end of their minimum subscription periods (but for whom a split contract or a cash purchase and SIM only deal might be cheaper), cost may not be the only factor in why they choose this route. They may like the service they receive from a particular provider or have loyalty to a particular brand.

Understandably, Citizens Advice is most concerned with the impact on the most vulnerable consumers. As we progress through the digital revolution, where comparison services are encouraged to assist customers in shopping around to encourage competition, it is the vulnerable, the less financially engaged, the elderly and the less well-educated who do not benefit from that competition. The concern here is that it is almost impossible to separate a vulnerable customer from a non-vulnerable customer, particularly given the FCA's view that everyone is likely to go through a period of vulnerability in their lives, whether through bereavement, redundancy, disability or age. It follows that the most likely remedies to be deployed will be at product level, potentially having a significant impact on consumer markets and raising the prospect of unintended consequences for the market as a whole, such as increased pricing and a more convoluted sales process.

Interested in hearing more from Osborne Clarke?

* This article is current as of the date of its publication and does not necessarily reflect the present state of the law or relevant regulation.

Connect with one of our experts

Interested in hearing more from Osborne Clarke?

Related articles