Hi All, My first post here. Ive lurked for a bit. I wanted to post my thoughts on AT&Ts pricing structure and how it relates to the iPhone and iPhone 3G. This will be obvious to some, but I hope others find it useful. I am not affiliated with AT&T in any way. I am a 10 year customer. I'll update info and corrections in this post from comments deemed credible. Every phone bill is comprised of the following components: Total Bill = [overhead] + [taxes & fees] + [subsidy] + [profit] Overhead Overhead is the cost of doing business per customer. This encompasses all the expenses the company must pay including staff, infrastructure, retail outlets, etc. Costs incurred dealing with deadbeat customers also fall into this category as discussed below. How these costs are divided across AT&Ts national customer base per account type is unknown to me. Taxes & Fees Government mandated fees and taxes. Uncle Sam wants his cut. So let's now look at both the subsidy and profit portion together because they are definitely not mutually exclusive. Subsidy+Profit Subsidy is the portion from each bill that reimburses AT&T for your shiny new cell phone you received at a discount or even "free". AT&T's cost to provide you a new phone varies by phone make/model and discounts/rebates offered. If AT&T buys Motorola Razor phones in bulk quantities at $115 each and offers them for "free" with a signed 2 year contract, that $115 must be recouped within the next 24 months. Its likely that this is not a fixed sum from each bill. I would not be surprised to learn that early in the 2-year contract, the subsidy component comprises the majority of the Subsidy+profit portion of the bill. If AT&T recovers their cost for your phone as soon as possible it minimizes risk. The ratio of subsidy to profit is also not fixed and cash flow can be adjusted if necessary. For example, if you stop paying your bill, profits from your account can be used to cover the phone subsidy. Handing an expensive piece of equipment over to some random Joe, even with credit check, is risky. Enter the early termination fee (ETF). The ETF legally guarantees recovery of their cost for the phone they gave you for free and any administrative costs incurred to setup and close your account. Should you bail on your contract and cancel your credit card, AT&T will send you to collections for the ETF and ding your credit. However, this may not result in recovery of the $115 they coughed up for your phone. If you waited 6 or 8 months before turning into a deadbeat, AT&T may have already been reimbursed for the cost of the phone, or close to it. Though they may have to shift all of the profit made on your account to the subsidy component to do so. Not to worry though, if money is still owed the paying customers (AKA you) will cover it. Given the above assumptions it's a certainty that AT&T has recovered the phone cost in a few months, albeit with no profit. At some point in the contract, the subsidy component goes to $0 and the subsidy+profit portion of the bill becomes all profit. How much profit AT&T gains from an account from this point forward until another subsidy (AKA upgrade) is offered is purely at AT&T's discretion. Profit, of course, is the good stuff (for AT&T) and they want to maximize it as they should. iPhones 1st Gen iphone customers bought an unsubsidized phone. This was a sweet deal for AT&T. From day 1 of the contract, the subsidy portion of the bill was $0. All profit, no risk (neglecting administrative costs). Its possible AT&T gave a little bit back to the customer. Perhaps in the form of a discount on the data plan for example. To be sure, this was part of Apple and AT&Ts negotiations. BUT, AT&T still had a hefty ETF. Talk about gravy on top! iPhone customers owned their phone from day 1 so AT&T only had to cover their administrative costs if a customer walked away. Yet, iPhone customers were contractually obligated to hand over $175 if they walked away. Amazing. The 3G iPhone was released as a subsidized product. Its estimated on blogs and other forums that AT&T subsidizes about $200 of each iPhone sold. Id wager its a bit less, but whatever. Either way its a heavily subsidized phone. I would argue that in the context of the subsidized pricing structure, the 3G iPhone is the better deal compared to the 1st gen iphone. iPhone 3G customers are definitely higher risk for AT&T. With risk comes cost (ask your insurance agent) Also, AT&T must recover a large subsidy which takes more billing cycles than some of the cheaper phones and a contract of some length is justified. AT&T increased the data fee to help recover their costs faster, but at least the ETF is based somewhat on reality. Conclusions - phone and data services cost the same regardless of the amount of phone subsidy provided by AT&T. Its a better deal for the customer to opt for a phone with a large subsidy. - In an ideal world there would be no subsidies for phones. The customer would bear 100% of the phone cost up front, significantly reducing the risk to the phone company. And remember, YOU pay for AT&Ts losses due to deadbeat customers. Thats covered in the overhead portion of the bill. Service costs would be lower and ETFs could possibly go the way of the dinosaur as well.