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The Basics

Is a prepaid cell phone right for you?

Wal-Mart's entry has added to the already-growing competition as cost-conscious consumers shy away from contracts. But look closely at what prepaid plans offer.

By SmartMoney

If you haven't already considered switching to a prepaid cell phone plan, here's some news: The option is growing as an alternative to traditional plans -- and now it's getting a major boost from a retail giant.

Prepaid cell phone plans, which allow users to pay for service as needed and without signing a contract, have been growing rapidly and supplanting other mobile services. The plans are attracting new users and luring many cost-conscious consumers with traditional plans to opt out of their contracts, many of which were signed during better economic times.

Wireless providers are not celebrating. Some are losing traditional, or post-paid, customers in droves. Others curbed those losses by offering their own prepaid plans, which are typically less expensive and include fewer ancillary services.

Now, a battle for prepaid customers is under way, and a new price war is brewing among the major players.

Prepaid is here to stay, says Chris Watts, an analyst with London-based Atlantic Equities. Although the recession has spurred growth in prepaid offerings and subscribers, both big-name and startup carriers already had been exploring the category to penetrate the lower end of the market. "The carriers would have you believe they can segment these markets quite clearly," Watts says.

'Inherent limitations' to prepaid plans

Still, big carriers aren't worried about losing the bulk of their business to the prepaid market yet.

"Despite the value (of prepaid) for consumers, there are inherent limitations," Watts says. The allure of new, multifunctional handsets like the iPhone -- not available to prepaid users -- will keep many consumers on contract. Prepaid plans also have more limitations on location with local calling plans and larger roaming areas, which could put off even occasional travelers. And convenience of contract plans, which don't require monthly (or more frequent) subscription action, could also keep many subscribers loyal.

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Who will profit most from the growing prepaid market is unclear, says Watts. AT&T, T-Mobile and Sprint all have prepaid offerings, while Verizon is playing the market by reselling its network to smaller prepaid providers like TracFone Wireless.

But the large companies' profit margins from prepaid are slim because they're already paying to build and maintain those networks. Smaller carriers like MetroPCS and Leap have more room to profit, but they face competitive pricing pressure from big carriers and newcomers to the market. "They're worried they're going to get crowded out," Watts says.

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With so many options in such a new space, prepaid plans can be complex for consumers, so success is likely to go to the companies that can simplify their offerings (like unlimited plans) at a low enough price point to appeal to bargain-minded consumers who want to avoid a contract, Watts says.

Continued: Prepaid service is bad for you if . . . 

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