The End of Smartphone Contracts

Anton Wahlman

Would you buy it?

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

Still, many U.S. consumers, who apparently don't know basic math, doexactly the opposite: They sign up to pay an extra $1,080 over twoyears in order to get a check worth anywhere from $200 to $450 today.

Normally, we call this a paycheck scam. Perhaps loan sharking. Nobodywould even lease a car on these terms.

So what am I talking about here?

I'm talking about the way the vast majority of U.S. consumers buy theirsmartphones, including well over 90% of iPhone buyers. The rates areprobably similar for Android, Microsoft (:MSFT) and BlackBerry consumers.

For reasons too long to explain in detail here -- credit scores andtechnology fragmentation of the past -- in the U.S. market most peoplebuy their smartphones on two-year contracts. The deal is basically asfollows: The carrier (Verizon (:VZ), AT&T (:T), T-Mobile, Sprint (:S), whatever)subsidizes the phone somewhere between $200 and $450 in exchange for atwo-year contract.

The latest iPhone receives the largest subsidy at $450, whereas otherdevices can be as low as around $200. That's the easy part. How muchare 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 -- plustaxes, of course. Yes, I know it gets granular here, with some optionsto "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 servicefor $45 per month, saving you $45 per month ($90 minus $45). Multiply by 24months (two-year contract) and you get $1,080 in savings. Then subtractthe subsidy you would be foregoing ($450 for an iPhone, perhaps $200for an Android) and you have a net profit of $630 or $880 over twoyears, not including the interest rate cost, which in today's interestrate environment is negligible.

There are other alternatives as well. You can trek over to Wal-Mart (:WMT),which resells T-Mobile service with a twist: If you don't make manycalls, opting to use your smartphone mostly for data, it offers anunlimited data plan for $30 per month. It also throws in unlimitedSMS and 100 minutes of circuit-switched calling per month.

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

You can buy unlocked smartphones from Google (:GOOG), Apple (:APPL) and Microsoft.

There are additional benefits as well. Buying an unlocked phone, youcan pop any SIM card into it when you travel abroad. This could saveyou 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 ofan unlocked phone could be even greater, even if you never travelabroad. Already SMS is free for whomever bothers signing upwith Google Voice. So you don't need to pay AT&T or Verizon $20 permonth for the privilege. The fact that the U.S. consumer hasn'tbothered to do this to a greater degree speaks to the laziness andignorance of the U.S. consumer.

More importantly, voice and video communications are also becomingessentially free with variants of VoIP (Voice over Internet Protocol). Applicationsranging from Skype to Google Voice to GoogleTalk to iMessage toFaceTime now do much of why you otherwise pay a carrier $50-$70 permonth to perform in terms of "unlimited domestic calling."

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

What does this mean over the next one to two years? Starting soon, you mightwant to buy data-only plans for perhaps $30 or less, per month, as youdon't need any calling plan or SMS plan. This way, you will mostlikely save even more than $1,080 over two years, compared to today'spricing 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 forthese "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 moreadvanced smartphones earlier and upgrade more often.

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

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

1. Google

2. Apple

3. Microsoft

4. Research In Motion (:RIMM) (if still alive by then)

The losers:

1. Verizon

2. AT&T

3. Sprint

4. Deutsche Telekom (:DT) (T-Mobile's parent)

The smartphone operating system (and ecosystem) players would be thebiggest winners because consumers would have more money to spend onmore frequent device upgrades. The consumer allegiance to the OS/ecosystems is also growing, in comparison to carrier/network allegiance.People think of themselves as an Apple/Google/etc. customer first, andas 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) thepayday-loan-shark-type interest rates that are currently baked intothe usury-style contract subsidies.

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

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.