Most people probably are not very familiar with the true cost of a smartphone as they are typically purchased at a discounted price with a two year subscription through a wireless carrier. With the changes in the US market, it is a bit easier to see what the costs really are because of unlocked phones becoming more widespread. For instance, the new iPhone 5C is $549 and the iPhone 5S is $649 for the 16GB unlocked versions. Those same phones are just $99 and $199 with a contract.

Let’s take a closer look at several phones, what they cost to build and what the price is for the unlocked versions:

Cell Phone	Cost To Build	Retail Unlocked Cost	Difference
Apple iPhone 5		$649	$481
Motorola Moto X		$600	$371
Samsung Galaxy S4		$600	$363

A few notes about these numbers. First, I listed the iPhone 5 and not the 5C or 5S as no published data exists on the cost of manufacturing. So I used the older model’s estimated construction cost plus its previous retail price. I’m sure the numbers for the new 5S are similar as many of the parts are the same and it retails for the same price. Second, this is just the cost of production. There are other costs involved beyond just production for the price differences going to the manufacturers as profit are likely less than these numbers.

What we see here are huge differences in the cost versus the price such that it is quite conceivable that the companies can be making double what it costs to produce even factoring in other costs. In contrast, the original iPad with Retina display was for the 16GB version which retailed for $499. This is a far smaller margin than the iPhone.

Now some would say that these numbers won’t necessarily apply because the phones are generally sold for less through the two year contract deals. The problem is that the reduced cost is covered by fees the carriers pay to the manufacturers in order to get the rights, often exclusive ones, to sell that phone on their network. The carriers costs are then applied to the monthly cost factored over the two years of the contract. This is why T-Mobile’s new contract free plans can be less expensive if you are willing to bring your own phone or buy one outright.

The only real explanation that could explain such huge difference between two very similar products is how they are sold to consumers. You are often required to purchase the phone through a carrier with a supplied contract. The result is that consumers do not have the true cost in mind at the time of purchase. This creates an artificial competition. Without the ability to see the true costs of the phone, consumers are instead comparing the costs of the service contracts more than the phones. In contrast, a tablet can have its priced compared between manufacturers and models quite easily as consumers see the price up front. This is a major reason why Android tablets are far more price competitive than Apple’s iPad.

So how can this market be changed to give consumers better prices? The answer lies in the FCC essentially reworking the wireless carrier rules on handsets. Right now the carriers can lock the headsets to themselves essentially preventing their subscribers from switching networks. If consumers had to purchase their phones up front and then sign up with a carrier for service, it should reduce the overall costs as the smartphone contracts become more competitive and the phones would also drop in price as the manufacturers would have to compete for those sales directly to the consumers.

Is such a change likely to happen? Not anytime soon. Both the carriers and the phone manufacturers could potentially lose a lot if such a system were put in place. Carriers would be afraid of customers not signing up because of greater up front costs when it comes to getting a phone. In addition, a contract free market could mean a great loss of customers if a competitor drops their prices and customers switch. The phone manufacturers would also end up getting less money because they could no longer get exclusivity fees from the carriers and they would have to drop the phone prices in order to compete with one another.