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The iPhone 5 on display after its introduction during Apple Inc.'s iPhone media event in San Francisco, California September 12, 2012.  (Beck Diefenbach/Reuters)

The iPhone 5 on display after its introduction during Apple Inc.'s iPhone media event in San Francisco, California September 12, 2012. 

(Beck Diefenbach/Reuters)

Opinion

How U.S. carriers hose consumers with smartphone ‘subsidies’ Add to ...

Let’s say you could buy a stock today for anywhere from $200 to $450, and that I could promise you with 100 per cent certainty it would be worth $1,080 two years from now. Would you buy it?

Of course you would! The implied rate of return on a $200 to $450 investment turning into $1,080 over two years is a no-brainer, if you are capable of doing basic math.

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Still, many smartphone consumers, who apparently don’t know basic math, do exactly the opposite: They sign up to pay an extra $1,080 over two years in order to get a check worth anywhere from $200 to $450 today.

Normally, we call this a paycheck scam. Perhaps loan sharking. Nobody would even lease a car on these terms.

So what am I talking about here?

I’m talking about the way the vast majority of consumers buy their smartphones, including well over 90 per cent of U.S. iPhone buyers. The rates are probably similar for Android, Microsoft and BlackBerry consumers.

For reasons too long to explain in detail here – credit scores and technology fragmentation of the past – in the U.S. market most people buy their smartphones on two-year contracts. The deal is basically as follows: The carrier (In the U.S. Verizon, AT&T, T-Mobile, Sprint, whatever, and in Canada Rogers, Bell, Telus) subsidizes the phone somewhere between $200 and $450 in exchange for a two– or even three-year contract.

( Editor's note: we stick with the U.S. example for the rest of this piece)

The latest iPhone receives the largest subsidy at $450, whereas other devices can be as low as around $200. That’s the easy part. How much are you paying for this privilege?

If you want one to three gigs worth of data per month and mostly unlimited SMS and calls, you pay around $90 per month on AT&T and Verizon – plus taxes, of course. Yes, I know it gets granular here, with some options to “scale down” on some features you don’t use. But let’s start here.

An AT&T reseller such as StraightTalk resells unlimited AT&T service for $45 per month, saving you $45 per month ($90 minus $45). Multiply by 24 months (two-year contract) and buyers get $1,080 in savings. Then subtract the subsidy ($450 for an iPhone, perhaps $200 for an Android) and you have a net profit of $630 or $880 over two years, not including the interest rate cost, which in today’s interest rate environment is negligible.

There are other alternatives as well. U.S. consumers can trek over to Wal-Mart, which resells T-Mobile service with a twist: If you don’t make many calls, opting to use your smartphone mostly for data, it offers an unlimited data plan for $30 per month. It also throws in unlimited SMS and 100 minutes of circuit-switched calling per month.

It doesn’t take a mathematical genius to show that with this $30 unlimited data plan such a customer would be saving even more than the $1,080 example with StraightTalk above. Another reseller offering similar deals to StraightTalk is MySimpleMobile.

You can buy unlocked smartphones from Google, Apple and Microsoft.

Yes, they cost $200-$450 more than they would if you took the subsidy, but as I show in these examples you make that back in about a year, typically less.

There are additional benefits as well. Buying an unlocked phone, you can pop any SIM card into it when you travel abroad. This could save you literally hundreds of dollars per day when you’re on the road.

Starting sometime down the road even here in the U.S. the benefits of an unlocked phone could be even greater, even if you never travel abroad. Already SMS is free for whomever bothers signing up with Google Voice. So you don’t need to pay AT&T or Verizon $20 per month for the privilege. The fact that the U.S. consumer hasn’t bothered to do this to a greater degree speaks to laziness and ignorance.

More importantly, voice and video communications are also becoming essentially free with variants of VoIP (Voice over Internet Protocol). Applications ranging from Skype to Google Voice to GoogleTalk to iMessage to FaceTime now do much of why you otherwise pay a carrier $50-$70 per month to perform in terms of “unlimited domestic calling.”

The new VoIP alternatives are not limited to domestic calling. I don’t think I have paid a penny for an international call in five years using these various calling programs that are free.

What does this mean over the next one to two years? Starting soon, you might want to buy data-only plans for perhaps $30 or less, per month, as you don’t need any calling plan or SMS plan. This way, you will most likely save even more than $1,080 over two years, compared to today’s pricing of “all-in data/SMS/voice” plans from AT&T and Verizon.

What are the two conclusions from this trend – if U.S. consumers wake up and realize they are getting raped by signing up for these “contracts”? There are two:

1. The U.S. consumer will save close to $1,080, or over time even more, for each two-year period by just paying an extra $200 to $450 up front. This should be a boost to the U.S. consumer’s ability to buy more advanced smartphones earlier and upgrade more often.

2. The major cellphone carriers will see profit pressure. If they can only collect $30 to $45 per month instead of closer to $90, this will hurt.

Actually, it will hurt a lot more than those numbers imply. Why? If people are already not using their minutes of circuit-switched calling and aren’t using their SMS allocation and that’s what they would be giving up in the future, what the carriers lose is just pure profit. They will still have to supply the same data as they do today – except their revenue would be cut in half.

With these developments, who would be the winners and losers?

First, the winners:

  • Google
  • Apple
  • Microsoft
  • Research In Motion (if still alive by then)

The losers:

  • Verizon
  • AT&T
  • Sprint
  • Deutsche Telekom (T-Mobile’s parent)

The smartphone operating system (and ecosystem) players would be the biggest winners because consumers would have more money to spend on more frequent device upgrades. The consumer allegiance to the OS/eco systems is also growing, in comparison to carrier/network allegiance. People think of themselves as an Apple/Google/etc. customer first, and as a Verizon/AT&T customer second, if at all.

The carriers would be the big losers because they stand to lose (1) all SMS revenue, (2) all circuit-switched voice revenue and (3) the payday-loan-shark-type interest rates that are currently baked into the usury-style contract subsidies.

Americans should rejoice in these developments. They will be as positive as natural gas and oil finds in North Dakota and elsewhere will be for our energy needs in the future years.

Just like those will be at the expense of OPEC, carriers such as Verizon and AT&T will bear the burden of this shift in terms of getting people to a much cheaper smartphone world, without contracts and with no reason to pay for SMS or circuit-switched calls.

At the time of publication the author had positions in AAPL, GOOG and MSFT.

This article was written by an independent contributor, separate from TheStreet’s regular news coverage.

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