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Why all smartphones are $199

smartphones_199.gi.top.jpg By David Goldman, staff writer

NEW YORK (CNNMoney.com) -- A hot new smartphone can be Incredible, Vibrant, Epic or just "eh," but no matter how it stacks up, it's a safe bet that it will start selling at $199.

On the four major wireless networks -- Verizon Wireless (VZ, Fortune 500), AT&T, Sprint (S, Fortune 500) and T-Mobile -- there are 13 smartphones priced at $199 with a two-year contract. There are no phone models with a higher starting price (add-ons like more memory can increase the price tag), and there are more smartphones selling at $199 than at any other single price point.

But spending $199 doesn't guarantee you a top-of-the-line phone. On AT&T's (T, Fortune 500) network, $199 will buy an iPhone 4, the best-selling smartphone of all time. But you'll need to fork over the same amount for a BlackBerry Bold 9700, a nine-month-old phone that lacks a touch screen.

It will also cost you $199 to get an HTC Tilt 2, which runs Windows Mobile 6.5 -- an operating system so out of date that Microsoft (MSFT, Fortune 500) is set to completely abandon it in the next few months.

So what's so special about $199?

"The obvious answer is that $199 is a magic price point for smartphone volume," said George Appling, partner at consulting firm Booz & Co. "The not-so-obvious reason is that carriers are not charging customers what they pay."

In other words, wireless carriers pay significantly more for smartphones than you do. In exchange for your signature on an expensive two-year contract, they'll offer you the smartphone for less than it costs them but as much as they think you'll pay for it -- and right now, that's $199 across the board. Buy an unsubsidized iPhone 4 straight from Apple (AAPL, Fortune 500) and you'll pay $599 for the 16 GB phone that AT&T sells for $199 with a two-year contract.

Smartphones generally cost carriers around $500 per unit. Volume deals and other negotiations with manufacturers can shave down that price tag, but the hotter the phone, the more a carrier will pay to buy it.

But that's just the start of their calculations of what a phone "costs."

Phones that tend to eat up more bandwidth -- hello iPhone! -- add to the carrier's overhead. Put together the upfront cost of the phone and the back-end cost to service it, and you're left with the phone's profit margin. For a model with really tight margins, the carrier might find itself essentially forced to charge more upfront than it otherwise would -- it can't discount the purchase price and still scrape out a profit. That sometimes leads to inferior phones, like the BlackBerry Bold, carrying the same price tag as more advanced rivals, like BlackBerry's Torch.

It wasn't always that way. Before the age of tricked-out smartphones with expensive touch screens and processors, cell phones were much cheaper to manufacture. That gave wireless companies more leeway to compete on cost, and prior to the iPhone's mid-2007 release, phones had a wide variety of price tags.

But as phones got more expensive, a tiering of prices developed. Even the iPhone couldn't hold the high ground: Initially priced at $599 -- yes, even with a two-year contract -- the phone plunged to $399 just two months after its debut. By 2008, it had settled into the $199 groove.

If you don't need the latest and greatest, you can certainly score a gadget for less. Older, less exciting smartphones like the LG Ally, Palm Pre and Motorola (MOT, Fortune 500) Devour go for $149, or even $99.

But you won't find many phones priced outside those $50 tier increments.

"There's no $189 price point any more because operators don't want to suggest that one phone is a little better or a little worse than another at the same tier," said Charles Golvin, analyst at Forrester Research. "Carriers are looking for simplicity, even if that doesn't reflect their margins."

So will any carrier try to shake up the market and sell a cutting-edge phone for less? Don't hold your breath.

"No price war is going to happen," Appling said. "If Verizon got the iPhone tomorrow, it would probably sell for $199. They're already in a $300 hole when they add a customer, so they'll be extraordinarily hesitant to make that worse."

That's not to say the wireless carriers are getting a bad deal. They're happy to take the initial hit in exchange for a data plan that costs subscribers an extra $30 or so a month on their bill. And smartphone users tend to stick with their networks longer than low-end phone users, according to Soumen Ganguly, principal at Altman Vilandrie & Co. That makes them dream customers: They pay more and churn less.

The $199 price point has another perk for carriers. We're in the midst of a smartphone innovation boom, with companies pumping out new top-of-the-line phones every few months with better screens, memory and features. When those new phones are offered at the same price point older models once were, they seem like a steal in comparison. That draws new customers into the market -- and inspires those with aging phones to trade up and lock themselves into a fresh contract.

"There will always be a next big phone coming out in two months that will justify the $199 price," Ganguly said. "Manufacturers are innovating faster than the willingness of carriers to compete on price." To top of page

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