PhotoApple shocked Wall Street this week by reporting its first quarterly earnings drop in 13 years. Sales and revenue were down, along with profits.

Of course, when you are talking about Apple these days, you are mostly talking about the iPhone, which has become the iconic company's principal product. In the U.S., the iPhone makes up about half the smartphone market.

But in what some see as a troubling sign, iPhone sales in the latest quarter were down 16%; the cause is mostly blamed on slowing sales in China. However, Apple's troubles may have less to do with its global marketing efforts than how U.S. consumers are reacting to changes in the smartphone market.

When smartphone makers, like Apple, were posting solid quarterly sales increases year after year, the system was a little different. If you were a customer of one of the major cellphone carriers, you didn't directly pay the full cost when you purchased a new device.

Smartphone subsidies

It was standard in the industry for the carrier to “subsidize” the cost, by selling the newest iPhone or Android device for $199 or less. They were willing to do that because it locked customers into a two-year contract. To repay the company for picking up part of the cost of the phone, consumers had to pay for cell service for two years.

After two years, consumers were on a month-to-month basis with the cellphone company, free to cancel at any time with no early termination fee. However, they were encouraged to upgrade to the very latest smartphone for a subsidized price, triggering the start of another two year contract.

In 2014 major carriers began moving to a different business model. The big profit was in selling data. They revised monthly plans and began phasing out the phone subsidies.

Paying the full price

Now, consumers pay the full price of a phone – either in a lump sum up front or on a payment plan over 18 months to two years. They can cancel their contracts at any time but would have to pay the balance owed on the phones, so the system has the same effect as the old two-year contract.

Carriers are doing quite well with this arrangement, but it remains to be seen what impact it will have on smartphone manufacturers. When consumers have to pay the full price for a new iPhone, will they be as willing to upgrade every two years? The Apple earnings report could be seen as evidence that they are not.

Smartphone developers like Apple may also be victims of their own success. Both iPhone and Android devices are highly sophisticated, with high-quality cameras and lightning-fast processors.

How much better can they get? And if they don't significantly raise the technology bar, will consumers be motivated to spend $600 to buy one, when their current phone seems to be just fine?

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