In countries like the UK where the MNO (Mobile Network Operator) subsidises the cost of your phone, they need to make back notonly the running costs of the network and your number and services, but also recoup the cost of your mobile phone (which you've probably got for free).
The actual cost of your "free phone" that the MNO pays out to the Manufacturer can be anywhere between £50 and £400+, depending on the handset, even excluding VAT and taking into account bulk unit ordering discounts (a single MNO in the UK may order anything up to 40,000 units of a single model of handset in one go to meet future anticipated demand). That average handset cost to the MNO is around £250-£300 and is increasing as time goes on due to the ever-increasing technical complexity (and therefore R&D and manufacturing costs) of mobile phones.
The more an MNO can persuade it's customers to keep their phones for longer via cashback, credits to your account or extended term contracts, the more money it saves.
In some countries I believe that it is illegal for the MNOs to subsidise the cost of the handset. You pay the full-on handset only cost of the phone as if you'd bought it directly from the manufacturer, but you then pay a lot less over the duration of your contract as the price of your monthly tariff is not covering the cost of your phone.
Personally, I'm still using my Sony Ericsson P910i that I've had for two-and-a-half years; the battery life isn't quite as good (I need to charhe it every 2 or 3 days now). Apart from that it works perfectly, despite me having dropped it down two flights of stairs and under a bus since I got it.