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TheStreet Open House

The End of Smartphone Contracts

NEW YORK ( TheStreet) -- Let's say you could buy a stock today for anywhere from $200 to $450, and that I could promise you with 100% 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.

Still, many U.S. 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 U.S. consumers buy their smartphones, including well over 90% of iPhone buyers. The rates are probably similar for Android, Microsoft (MSFT) 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 ( Verizon (VZ), AT&T (T), T-Mobile, Sprint (S), whatever) subsidizes the phone somewhere between $200 and $450 in exchange for a two-year contract.

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 you get $1,080 in savings. Then subtract the subsidy you would be foregoing ($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.

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