Five years after the iPhone, carriers are the biggest threat to innovation

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Five years ago, the iPhone revolutionized the mobile business and kicked off a seismic shift in the technology industry that continues today. But the massive success of Apple's phone has overshadowed the grim reality of an American wireless marketplace that has become increasingly hostile to innovation — a market tightly controlled by carriers who capriciously pick winners and losers while raising prices and insisting that their use of valuable public spectrum remain free of any oversight. While the iPhone is a raging success, the wireless market is headed towards total failure.

The evidence is everywhere, starting with the iPhone itself: Verizon famously passed on the device at first, and if not for Steve Jobs personally convincing AT&T to sell his phone sight unseen, the iPhone may never have existed. Jobs was well aware that he couldn't reach the market of cellphone consumers without carrier support — at the D3 conference in 2005, he famously called the carriers "orifices" and offered this withering assessment of the industry as it then stood:

It's even worse. The carriers now have gained the upper hand in terms of the power of the relationship with the handset manufacturers. And they're starting to tell the handset manufacturers what to build. And if Nokia and Motorola don't listen to them, well, Samsung and LG will. So the handset manufacturers are really getting these big thick books from the carriers, telling them "here's what your phone's gonna be."

"We're not good at that," Steve added. Two years later, he would ship the iPhone, turning the industry on its head. Apple had succeeded in building the phone customers wanted instead of the phone carriers wanted, and things would never be the same.

And indeed, things are different — they've gotten dramatically worse. Instead of seeing the benefits of free competition at the consumer level, the carriers are now exerting more control than ever before as demand for mobile devices skyrockets. Getting a device on a major carrier can take up to 15 months and cost millions of dollars; carriers are notorious for demanding custom devices in order to create customer lock-in. "Exclusivity is the bane of my existence," says one source at a major phone manufacturer. "But it's the only way business gets done."

"Exclusivity is the bane of my existence," says one source. "But it's the only way business gets done."

It's even bad for Apple: one source close to the iPhone calls the carrier process "incredibly backward." But it's not just about frustrated manufacturers. Increased carrier control over customers and devices has stunted competition and stalled innovation — sometimes fatally so.

Just look at the tragic story of Palm, which went from darling of CES 2009 to legendary failure in just 31 short months. The company initially wanted to ship its Pre smartphone on Verizon, but the carrier backed out and Palm was forced to languish on Sprint, where it was unable to compete directly against the iPhone. When Verizon finally picked up the Pre Plus the next year, the carrier ordered millions of devices and then flippantly refused shipment and decided to focus on the Motorola Droid, leaving Palm sitting on millions of unsold units that couldn't be used on any other carrier in the world. The decision cost Palm hundreds of millions of dollars and led directly to the company selling itself to HP — and the once-promising webOS platform slowly dissipated into a puff of mismanaged open-source smoke.

"If we could have launched at Verizon prior to the Droid, I think we would have gotten the attention the Droid got. And since I believe we have a better product, I think we could have even done better," said Palm CEO Jon Rubinstein in 2010, trying to explain why his company was failing. But his exclusivity deal with Sprint means he was never given the chance to fairly compete.

Even Google and Microsoft are avoiding the carriers

Even powerful and established companies like Google and Microsoft are now avoiding the carriers as they scramble to compete with Apple. Microsoft is radically upending the entire PC market with its Surface tablets, but they're Wi-Fi-only for now, and Redmond refuses to discuss carrier partnerships. Same with Google, which just announced the Nexus 7 tablet; it's designed for on-the-go content consumption, but it lacks a mobile broadband connection.

Google won't comment about a 4G version of the Nexus 7 on the record, but it's fair to say relations between the search giant and carriers are strained: multiple sources say that Verizon purposefully delayed shipment on the LTE Galaxy Nexus after announcing the Motorola Droid RAZR, forcing Google to send US journalists unlocked HSPA+ review units to be used on AT&T when the phone launched internationally. And when Verizon did eventually release the Nexus, it was stripped of Google's Wallet functionality — forestalling the growth of Google's mobile payment system while Verizon works on its own solution.

And while the big companies are happy to sidestep the carriers in order to reach consumers, the real tragedy is that smaller companies are deciding that innovating in mobile just isn't worth the cost of dealing with the carriers. LA-based Vizio has found consistent success in the cutthroat HDTV business against huge competitors like Sony and Samsung, but after the company introduced a phone at CES 2011 it quickly realized that the carriers were too formidable an obstacle and canceled its plans.

"The cell phone market in the United States is not set up to encourage innovation."

"The cell phone market in the United States is not set up to encourage innovation," Vizio CTO Matt McRae says. "The inability to sell product directly to the consumer means that companies can't experiment and iterate quickly." After canceling its phone, Vizio instead decided to build its own PCs — products which it can sell directly to consumers without carrier interference. McRae says Vizio is still interested in developing a "small screen device," but adds that "there is definitely a big opportunity to make the process more efficient and fair across vendors."

But companies that depend on the carriers are forced to play along — and as a result, they're not allowed to compete on equal footing with giants like Apple and Samsung. The HTC One X is a high-end flagship device designed to compete squarely with the iPhone and Samsung's Galaxy S III, but Verizon and Sprint aren't carrying it: instead, Sprint offers a variant called the Evo 4G LTE, and Verizon is selling a downgraded device called the Droid Incredible 4G that simply doesn't match up to higher-end competition. How is HTC to compete for Verizon customers with a weaker device? Why should HTC depend on struggling Sprint to market and sell a custom phone when it could just leverage its existing One X campaigns to take on Apple directly?

And because success in the wireless marketplace can only come with carrier support, innovation is stunted as companies design their future products around what they think carriers might want, not where the market or consumer behavior is heading. "Companies build phones that the carriers ask for instead of taking risks and testing new concepts in the marketplace," says Vizio's McRae. "The result is a collection of handsets that are fairly homogenous from a small number of brands."

"The carriers have always been wary of ‘excessive' innovation in the mobile space."

And carriers rarely want what's best for their customers. "The carriers have always been wary of ‘excessive' innovation in the mobile space because of the danger that it might make mobile service cheaper," says Columbia Law School professor and The Master Switch author Tim Wu. If companies like HTC and Samsung were able to compete directly at the consumer level, the carriers would turn into dumb pipes — and AT&T and Verizon would be forced to raise their service levels and lower their monthly fees to effectively compete against each other.

That's good for consumers, but bad for carriers. "There's a business model that needs to be cared for," a Verizon spokesperson told us. But the wireless spectrum AT&T and Verizon use to build their networks is a scarce public resource literally leased from the people of the United States — shouldn't we have some say in how this market operates? Shouldn't the rules be set up to favor consumers instead of blocking innovation and increasing prices?

There is a long string of answers to these questions that favors the current system and makes it seem logical. Different cellular technologies and wildly mismatched spectrum among carriers makes creating universal devices extremely difficult. Patent licensing costs, especially for LTE devices, are enormous. Carrier subsidies allow cutting-edge technology to hit the mass market years ahead of schedule. "I have no idea how you can make a $199 product with embedded data without subsidies," says one source with years of experience in the industry.

"What you see with all this stuff is the rebuilding of the walled garden."

But spiralling down this string of answers is a form of consumer Stockholm syndrome. We are spending billions of dollars each year on mobile broadband. It is the most disruptive enabling technology in recent memory and will soon be the primary way millions of Americans connect to the internet. Understanding why the industry is cheating us out of innovation is great, but a look at the landscape makes it clear that it's time for the cheating to stop. "What you see with all this stuff is the rebuilding of the walled garden," says one industry source. "Carriers have had control for so long they want to continue to feel like they're in control."

The iPhone was a revolution five years ago because it was the first time an agile, consumer-focused company delivered the promise of mobile computing directly to its customers. But the success of the iPhone shouldn't cloud us from seeing the wireless market as it now stands: a market that is driving players big and small away from mobile broadband as the carriers tighten their grip.

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