What Happens When Data-Friendly Phones Come to Prepaid?

The gap between the top two U.S. carriers – AT&T and Verizon Wireless – and the rest of the field is beginning to grow, as budget-conscious users continue to eschew contracts in favor of bargain-basement prepaid services. The two postpaid behemoths have made hardware the key differentiator, keeping consumers who are in love with their iPhones and Droids and letting users of lesser phones slum with the prepaid guys.

But how long will that strategy continue to work?

Prepaid service providers are consistently claiming about two-thirds of new mobile subscribers, according to recent figures from the New Millennium Research Council, lured by services that seem to get cheaper by the day. The brutal price war in prepaid continued this week when Sprint launched an effort to capture the bottom tier of the market with plans that include unlimited messaging, data, e-mail and web access for as little as $25 a month for 300 voice minutes. Those kinds of efforts proved effective once again in the first quarter, as MetroPCS and Leap Wireless grew their customer bases substantially.

But the prepaid business is built on minimizing data traffic. Take a stroll through prepaid companies’ Web sites and you’ll find a host of phones that are fine for voice, SMS and maybe e-mail, but are limited when it comes to more data-intensive functions. Even Sprint’s Boost Mobile, which is marketed as a kind of prepaid service for tech-friencly hipsters, fails to offer a handset that any respectable superphone owner would look twice at. Indeed, a quick Google search of the words “prepaid” and “smartphones” turns up little other than a couple of BlackBerry devices — and while Research In Motion owns a commanding U.S. market share, its phones aren’t exactly the little entertainment centers so many consumers pay dearly for. Also, while prepaid providers charge a bit more for BlackBerry service (Boost Mobile’s all-everything plan costs BlackBerry users $60 a month), the charges still pale in comparison to contract plans from AT&T and Verizon.

Meanwhile, the nation’s two biggest network operators can stay above the fray while their smaller counterparts fight ruthlessly for low-end users. While all-you-can-eat voice and data services can be had in the prepaid space for $45 for most handsets, Verizon Wireless seems quite content with the number of users who’ll pay twice that much and accept a contract. AT&T, too, has shown little interest in lowering its price for postpaid service, competing primarily with AT&T and ignoring the rest of the market.

That’s a strategy that makes sense – for now. Some feature phones can provide an acceptable mobile web experience, but none can offer the multimedia capabilities that iPhone and Android users enjoy. Even BlackBerry, which continues to deliver a superior mobile e-mail service, fails to generate the kind of app consumption and mobile Web traffic the iPhone and Android gadgets do.  So while prepaid users are getting what seems to be a rock-bottom price on mobile data, they’re surely consuming a tiny fraction of the data that their counterparts on postpaid plans consume.

But the lines between feature phones and smartphones continue to blur as lower-end handsets become more sophisticated. Prepaid service providers only recently began offering expanding beyond rudimentary phones to higher-tech handsets. In addition to the new prepaid BlackBerry offerings, Leap earlier this year announced plans to come to market with a new Android handset.

That trend will surely gain momentum as smartphones overtake feature phones in the U.S. in the coming year or two. What happens when multimedia-centric handsets are increasingly available through prepaid providers at an acceptable price? Or when a less popular but high-powered device like the Palm Pre appears on prepaid shelves?

The move toward cheaper prepaid services is beginning to collide with surging smartphone uptake. That will surely force some prepaid service providers to raise their prices to accommodate the certain increase in traffic, and it will require a restructuring of the network operator/MVNO agreements upon which much of the prepaid service is based. But it may also force the largest carriers to lower prices to compete with the lower-end providers they have thus far been able to ignore. There will still be market opportunities for prepaid outfits who offer unlimited services on the lowest-tech phones, but that market will get smaller as mobile data growth continues. Everybody else will have to find better ways to differentiate than simply phone portfolios and pricing models.

Question of the week

Will the move toward smartphones force major carriers to compete with the prepaid counterparts they’ve long ignored?