NEW YORK-Conventional wisdom may hold that scale is superior when it comes to carriers and miniaturization is most desirable when it comes to handsets. However, neither attribute necessarily implies long-term profitability, said David A. Freedman, managing director of Bear, Stearns & Co. Inc., New York.
“I want to address the myth that bigger is always better,” he said at the recent Wireless Mobile Conference, sponsored by the Yankee Group, Boston. “A nationwide footprint does confer market advantages, like purchasing power. However, the mass market is regional, so I am a big believer we won’t end up with three nationwide players.”
Similarly, while much attention is paid to the total number of customers a cellular service provider has under its belt, a far more accurate indication of a carrier’s profitability is market share.
“Penetration, not sheer subscriber numbers, accounts for profitability,” said Freedman, Bear, Stearns’ senior telecommunications analyst.
“At 7-(percent) to 8-percent penetration, there are tremendous economies of scale. You don’t need 20 percent (to gain these).”
For 15 domestic cellular carriers, increases in incremental market penetration and the resulting economies of scale have coincided in recent years to reduce their median monthly service, general and administrative expenses per subscriber, according to Bear, Stearns.
“On average, expenses have declined as quickly as [average revenue per unit] has declined. The question is, `Can you continue?’,” Freedman said.
Between the second quarters of 1996 and 1998, per-subscriber service revenues-including inbound roaming-declined to a median average of $50.14 from $61.80. Expenses for the 15 cellular providers have declined to a median average of $32 at the end of last year from $53 at the end of 1992, according to Bear, Stearns’ research. Today, depreciation is the single largest expense, accounting for a median average of $10 per customer, added the firm.
“At some point, handsets will get too small to use, and migration to digital will be complete in a few years. Then, you’ll have to look at residuals-which are anathema to some-and get more payment upfront.”
Residual value is the amount remaining after all allowable depreciation charges have been subtracted from the original cost of a depreciable asset, according to Barron’s “Finance and Investment Handbook.”
“No one expects to get a cordless phone free from Bell Atlantic (Corp.) Why is wireless different?” Freedman said.
“You should charge at least something for the handsets. Otherwise you reduce customer loyalty.”
As a rule of thumb, a half-percent of churn equates to 350 basis points of profit margin. According to Bear, Stearns’ estimates, between the end of 1994 and the middle of this year, a dozen cellular carriers have decreased their average median monthly churn rates to a hair below 2 percent from a notch above.
However, Freedman noted that as ARPU declines, the sensitivity of profit margins to churn increases. Furthermore, the larger the subscriber base, the more customers are lost to churn even if the rate of churn remains constant.
“Profitability comes down to cost per gross addition and churn,” he said.
Retention efforts, especially those targeted at users with high monthly bills, might be a better allocation of finite financial resources.
“Maybe, instead of spending $20 apiece to try to retain all existing customers, it would be better to spend $100 (each) to keep high-end customers,” he said.
One good bet might be to target “differentiated customer service” to high-end users, using airline clubs or “white glove” car repair services as a model, he said.
Today, it costs a cellular carrier an average of $350 gross per customer addition.
“Can Internet (sales) help? I don’t think that’s a panacea, but it may lower (customer) acquisition costs,” Freedman said.
Prepaid wireless for lower ARPU customers lowers acquisition costs, saves money on billing expenses and virtually eliminates bad debt. However, churn rates are higher with prepaid customers. Because of the anonymity involved in prepaid services, it is difficult for a carrier to “upsell” these customers, he said.
Looking out on the horizon for building new revenues on existing costs, Freedman offered this perspective.
On wireless data: “It’s been a zero-dollar, billion-dollar industry, but it’s getting closer. I was disappointed in the terminals available at the PCS ’98 show, and I don’t think 1999 will be the year for fixed or mobile wireless data.”
On calling party pays: “I still don’t think the [Federal Communications Commission] will force the states to adopt it. There will be guerrilla warfare, and it won’t be widely available until 2001.”
On bundling wireless telecommunications with long-distance, Internet and other landline services: “I’m not a big believer that the bundle will be the end-all and be-all, but it may be good for business customers or in rural areas where your switch may be the only one to provide Internet access.”
