Crunching iPhone 3G Upgrade CostsCrunching iPhone 3G Upgrade Costs

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Apple iPhone 3G S

At first glance, the policy doesn't make sense: Most companies try to hang on to return customers. So why are AT&T and Apple apparently penalizing return customers -- charging people who bought last year's iPhone 3G a $200 premium to upgrade to the new iPhone 3G S?

The answer has to do with the practice of "subsidies," the standard way that cell phones get sold in the United States. It works out well for consumers, at least most of the time. It remains to be seen whether the subsidy process has broken down in the case of the iPhone 3G S, or if complaints are coming from a tiny, but vocal, minority.

Apple introduced the iPhone 3G S at its annual Worldwide Developer Conference on Monday. The device offers a processor upgrade and other hardware improvements that boost performance by double or triple previous models. The new phones now include video recording, a better still camera, and a built-in compass to improve location-based applications. The phones also have double the storage of current models. The price is $199 for 16 GB of memory, $299 for a 32-GB model -- for most users. For people who bought an iPhone 3G, the price is $200 higher.

It's The Subsidies

iPhone 3G customers aren't being singled out here; the reason for the price difference has nothing to do with whatever model of phone you're carrying around in your pocket. It's the terms of your contract that matters. AT&T and other American wireless carriers offer steep discounts, called "subsidies," for new handsets, but only to people who sign service contracts.

And, for customers who already have service contracts with AT&T, discounts on new hardware are only available near the end of the contract cycle. The iPhone 3G came out a year ago, so owners of that device have at least a year left on their two-year contracts. This isn't an issue for first-generation iPhone users; their two-year contracts on the devices, introduced in summer 2007, are running out.

And of course, it's also not an issue for new iPhone buyers; they don't have AT&T contracts to worry about.

The discounts are called "subsidies" because AT&T -- like other American wireless carriers -- buys the handsets from Apple, and pays significantly more for them than it charges customers. AT&T makes money by signing you up for a two-year contract, and recouping the cost and making a profit over the life of the contract.

These costs are clearly laid out in the contract that users agree to when signing up for service and buying their handsets, said AT&T spokesman Mark Siegel.

Users are eligible to upgrade at the subsidized price before the contract runs out, but eligibility kicks in at the end of the life of the contract, Siegel said. The formula also takes into account whether the customer had paid bills on time, which accounts for why one customer who bought an iPhone in June 2008 might be eligible for an upgrade next month, while another who bought at about the same time might be eligible in December.

Angry, Vocal iPhone Customers

The upgrade policy has some iPhone users crying foul. "This is ridiculous and a slap in the face to long time loyal iPhone customers like me who switched from T-Mobile and the only reason was the iPhone," wrote one unhappy iPhone customer on the AT&T support forum. "We have to mount a vigorous campaign to change this policy. Call your local AT&T and ask for the manager and complain. Send e-mails and post in forums everywhere."

Given the backlash that the subsidy system has generated from iPhone users, is the subsidy system a good one? "Absolutely. It's not a good system, it is a brilliant system. It allows consumers to get innovative devices like the iPhone for as little as $99," Siegel said. (Apple and AT&T are now offering the iPhone 3G for $99.)

Consumers unhappy with the subsidy system have a few options: If they want an iPhone without signing a contract, they can pay $599 for the 16-GB model and $699 for the 32 GB model. That's a $400 premium over the subsidized version.

Some iPhone users suggest canceling your contract, paying a cancellation fee of a maximum $175, minus $5 for each month you've already served on your contract. Then, sign up again for a new contract, and buy an iPhone 3G S at a subsidized cost. Siegel says that would work, but it doesn't take into account a $36 activation fee, and it's a lot of hassle for a relatively small savings.

And, if you know someone else who would be happy with your current iPhone, you can sign up to add a line on your existing plan. Price information on that option was unavailable, but if it's worth looking into if you want to get a subsidized iPhone 3G S. Of course, then you're paying for two lines, so the net cost is higher.

Consumers can find out about iPhone pricing plans, and existing AT&T customers can find out whether they're eligible for a subsidized upgrade, by visiting att.com/iPhone.

Another option for iPhone 3G customers looking for a better price on the iPhone 3G S: Wait to become eligible for the subsidized pricing -- or wait for Apple to offer a better deal, which it might do if enough consumers are mad enough. "It'll be interesting to see if Apple responds to this in a couple of weeks," said Gartner analyst Charles Smulders. There's precedent to be hopeful, he noted: Two years ago, when the original iPhone was introduced, Apple dropped the price by $200 two months later. Consumers who'd just paid the earlier, higher price were angry, and Steve Jobs apologized and offered a $100 credit toward any Apple product.

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