What's the Deal With Contracts?

So if there is one area of cell phones that I have found myself explaining most often, it's how cell phone contracts work. It's a confusing system, some would say intentionally so, to keep customers in the dark so carriers can make additional money. In order to explain how cell phone contracts work in the United States, I should first explain how they work in Europe.

Cell phones cost money. I know, I was surprised too. To clarify, cell phones cost a lot of money. So much that most people would be unwilling to ever spend so much on a device they expect to change every couple years. In order to make cell phones more affordable, carriers often offer huge discounts on handsets, under the understanding that you will sign a contract for two years during which they can make up the difference by increasing the cost of your service. This is called a subsidized phone plan.

Now, back to Europe. In Europe, while you're under contract on a subsidized phone plan, you will pay an extra 5-10$/month for the duration of your contract. Once you finish the terms of that contract, the additional subsidy charge falls off your bill, and you save 5-10$/month until you decide to upgrade your phone.

This differs from the U.S. carriers, in that around here, when you finish the terms of your contract, you continue paying a subsidy charge. This is because the cost of the subsidy is built into their normal service costs, so there is no "extra charge" to take away. The only benefit an American gets at the end of their contract is the privilege to purchase a new phone at a discounted price (with another two year contract). This is interesting, because it means that whether you choose to upgrade or not, you are paying for a new phone, as the subsidy is built into their normal operating costs.

Now, there is never any requirement to sign a contract, as you can always pay full price for your phone. Without a contract though, you will end up paying something like 200$ more for the simplest phone on the shelf, or up to 600$ more for a smartphone (the subsidy on smartphones is much higher, because they can make it up via the data plan, part of the reason why they require a data plan on any smartphone). And after you've paid immense amounts for your new phone, you'll end up paying for it again, due to the presumed subsidy built into your bill.

When I said the only benefit was getting a new phone, that wasn't quite true. You also then have the right to change carriers, a fact that is useful as a bargaining chip, but depending on where you live, this option may not be viable. Often, there is a particular carrier most people will prefer, due to the handsets they offer, or the level of service they provide in their area. Once you find the best carrier for your area, there are often few reasons to reconsider down the road.

All this comes together to a simple recommendation I used to offer all of my customers who were eligible for upgrade, use it. You're going to pay for a new phone either way, you might as well get one.