Growing the Wireless Market

With all of the competitive tactics being played out in the mobile wireless space recently, I surprised myself by saying mostly nothing about in this blog. Yet it is an interest of mine. The reason I have usually decided to give the topic a pass is because I find that most of the headline-making news is mostly smoke with little fire. That is, there's lots of activity but little of it has any long-term impact; it's just business as usual. Wednesday's throne speech caught my interest by mentioning a topic I did not expect the government to explicitly address: foreign ownership.

First, I should say that my prediction back in December was completely wrong. This is what I said then, in discussing Cabinet overriding the CRTC decision on Wind Mobile (Globalive).

"It will be interesting to see if this government opens up the law to amendment. I don't think it's a priority of theirs, so for the time being they may be content to deal with related issues ad hoc. I doubt that the government much cares for the sensibilities of the CRTC Commissioners and will think nothing of overruling them again in future."

We will have to wait for details, but that is exactly what the government intends to do. Perhaps they felt it necessary to answer the very-reasonable question from Public Mobile regarding just what the foreign-ownership threshold is, so that they can confidently pursue investors without having to guess how much they money they can take, and in what form, without incurring the wrath of the CRTC and the government. Ad hoc decisions may be helpful in a pinch, but companies need some degree of predictability to effectively function.

This takes me to the main topic of this post: the limits to growth in the carrier wireless market. There are many articles on this topic in the trade media, with most of them focused on ARPU: average revenue per user. As a wireless carrier you want to grow your subscriber base and grow your ARPU, presuming that it can be done profitably. The throne speech is relevant since increased competition typically means higher subscriber acquisition costs (advertising, phone subsidies, etc.) and lower ARPU (downward price pressure). Since the costs of providing service are not so easily reduced, profit is adversely affected, which turns shareholders of incumbent carriers against management and against the stock. The new entrants are less affected since their investors already expect that they must weather a period of low and negative margins to gain a foothold in the market.

Let's assume for the moment that there is equilibrium in the market, where there is some balance (or Mexican standoff) between competitors, so that ARPU and costs can be forecast with some confidence. In such a world, how do the carriers increase revenue and profit? This means increasing ARPU, net of inflation. It isn't as easy as increasing prices since if there is any real amount of competition, this tactic will only increase churn and therefore reduce revenue and increase marketing to recapture subscribers.

One tactic that works to a degree is the old frog-in-a-pot trick. This is often-told story of how to boil a live frog: turn up the heat slowly and the frog won't jump out of the water. If you gradually increase prices, and especially if you do it in obscure ways (various fees and surcharges), many subscribers won't jump into the arms of competitors. They even make it seem reasonable, for example by charging for heavy data usage. Eventually even the most inattentive subscriber will catch on and do something to bring their expenditure under control.

The game of turning up the heat cannot go on forever because we are not frogs. For a given bundle of services, we all have different price levels where we will jump, but we will jump. In other words, every subscriber has a fuzzy maximum revenue that the carrier can extract. When that level is reached, the subscriber will switch carriers, lower their service tier or cancel their contract entirely. Indeed, this is the reason why carriers offer a variety of bundles, knowing that not everyone has the same revenue potential. They can in any case start turning up the heat once you've signed a contract.

To successfully drive ARPU higher in a competitive market, the carrier has to increase the value perceived by the subscriber from additional services. Do you use SMS? Ok, we'll charge for SMS. Do you download lots of MP3 music, share photos and view videos? Charge for bandwidth. Since these are things that subscribers value over and above ordinary voice minutes, they will pay, both for the phones that make these services possible and for the ability to use those services.

Even that has a limit because many of those services are equally doable, usually more conveniently, from a PC+internet or a TV, which the subscriber is already paying for. What the carrier is offering is mobility and (device) personalization. Keep raising phone, broadband, cable TV and wireless prices, and eventually the subscriber will have to decide to reduce or eliminate one or more of these services. This happens when, for example, you ditch your home land-line phone in favour of the mobile phone (and, if necessary, switch from DSL to broadband cable). Therefore to grow ARPU, since subscribers have limits to these broader budget categories, the carrier must convince you to drop other, equivalent services you already use in favour of mobile wireless.

Unfortunately, the way the carrier gets revenue from most of these other services is by usage-based pricing for wireless data. It's unfortunate for the carrier since these limits (caps and overage charges) are generally at far higher levels on wired broadband services, and subscribers tend to see them as equivalent services that are not eligible for additional payment. There may be a higher cost to the carrier for an equivalent traffic volume, but their customers don't know or don't care. The mobility aspect may be convenient, but the small screen and keyboard reduce the perceived value, and they believe they have already paid for mobility in the basic service charge.

These marketing challenges make it difficult for carriers to grow ARPU and revenue. Since they can't convince their subscribers to pay more willingly, they attempt to get them to pay more unwillingly. That's where their weird fees, overages and ETFs come into play. This is coercion in lieu of increasing value to subscriber. This is where competition and regulation become important factors in controlling these legal though unsavoury tactics.

We should also mention application blocking which carriers also do, as a way to protect revenue. These include VoIP and tethering. On a bit-for-bit comparison, voice is far more lucrative than VoIP. As a (very) rough ballpark figure, 100 minutes of mobile voice (AMR codec) will consume less than 8 MB in each direction, yet the revenue (especially in Canada!) is substantial. For VoIP, which shifts this traffic to data, 8 MB is a drop in the bucket, contributing nothing to carrier data revenue.

Tethering is a problem since, as discussed above, to acquire many subscribers, those subscribers may want to drop or at least reduce their usage of wired broadband so that they can manage their total household expenses. In other words, if they can't tether they can't drop their wired broadband subscription, which pushes them over budget. By blocking tethering, the carriers are unable to increase ARPU for subscribers in this category. Of course, their real intention is to keep road warriors and similar subscribers from eating up network capacity without attendant data charges, but blocking tethering annoys both groups while still not achieving their objective.

The carriers are free to attempt to scrape every dollar they can from subscribers by any legal means, even if subscribers don't like how they do so. However, once they reach a subscriber's pain threshold every additional dollar has a heavy cost in customer loyalty and regulatory scrutiny, regardless of the availability of competitive alternatives. They have also reached a pain threshold on the cost side, by slowing network deployment and reducing customer service.

Ultimately, carriers will have to intelligently deal with the fact that there is only so much ARPU possible for a bundle of services. When the market is tapped out, stop trying to turn up the heat even more and start offering something new that the market will value.