Another quarter, another half a million contract subscribers gone. T-Mobile USA’s contract customer losses and revenue decline create headlines, but the really interesting number in the latest report is the big drop in prepaid customer additions. A year ago, T-Mobile added 220,000 prepaid customers. This past Christmas quarter, that number dropped to 166,000. It is not hard to find the major reason for that decline: T-Mobile’s branded prepaid ARPU sky-rocketed by 11% in one year. Let’s examine the situation. T-Mobile continues bleeding contract customers… so it opts to focus on premium prepaid service pricing, which in turn damages prepaid customer adds and increases churn. And now T-Mobile has both a contract and a prepaid crisis in its hands. How does this make a lick of sense?

Nobody wants to specialize in prepaid customers. Prepaid ARPU is literally half the level of contract customer ARPU because people who buy prepaid phones tend to spend less money. But what is striking to me is that T-Mobile does not seem to realize that beggars cannot be choosers. T-Mobile is bleeding contract subs heavily; losing half a million during a Christmas quarter is no joke when Verizon (VZ) added 2 million over the same time period. Why on Earth is T-Mobile’s prepaid ARPU going up 11% in one year as its growth sputters?

Oddly, this is how T-Mobile sees things: “Year-on-year, branded prepaid ARPU increased primarily due to the continued success of the Monthly4G products which have higher ARPU than the Company’s Pay-As-You-Go prepaid products.” This sounds like a plan. Except that the expensive Monthly4G range is not growing fast enough to offset the speed at which cheaper prepaid packages are fading.

Because of the focus on premium prepaid pricing, the churn in this category has exploded, hitting 7% in the fourth quarter last year. Consumers are not happy with T-Mobile’s prepaid pricing and they are bailing as a result. Acquiring new prepaid customers then requires expensive marketing and advertizing pushes. The increasingly desperate marketing efforts are damaging the bottom line, and T-Mobile’s profitability is plunging — adjusted OIBDA margin tanked from 31% to 25% in one year.

That brunette who looks like Zeta-Jones keeps buzzing around in her helicopter in primetime TV ads… and nobody cares. T-Mobile’s pricing is simply not resonating with consumers.

It may be that T-Mobile is trying to shore up its profitability by trying to become a high-end prepaid brand. Or maybe it just wants to get rid of low-end prepaid customers because they are not profitable. But its contract customer business simply isn’t there. You cannot decide that you are too good to be a mass-market prepaid carrier if you are losing half a million contract subs a quarter.

What is the end game? T-Mobile’s shrinking contract business will soon be joined by a shrinking prepaid business as well.