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Tuesday, September 15, 2009

Tough times ahead for US Wireless Carriers?

~93% of US population has a cellphone. The US wireless market is getting saturated (in terms of new subscribers). To continue the revenue growth, the Wireless Carriers (WC) have seen in the last few years, the WC will have to find new ways since what was a growth driver-new subscribers- in the past is no longer there. Let's look at a few other reasons and understand why I think that the WC may have tough times ahead of them.

1. Decline in Voice Revenue: WC make most of their money from voice calls. The revenue from voice (per user) has declined in the last few quarters and will continue to decline in the coming years. The product is mature and there are not many ways to differentiate it. There is increased pricing pressure from low-cost carriers like Metro PCS and MVNOs (Mobile Virtual Network Operators) like Tracfone. A customer can easily get an unlimited voice minutes (and SMS, and some amount of data) service plan from these low cost carriers for $50 or less with no contract. For similar rate plans, the major WC usually charge double that amount with a two year contract. Furthermore, in the coming years, the threat of VoIP will continue to increase, depending on the regulation. Skype on iPhone is one of the top 5 downloaded iPhone applications even though one can not receive Skype calls unless the Skype application is running.

2. Increase in Data Usage: WC are updating their networks to 3rd Generation (3G) which has enabled customers to get average data speeds of 300kbps to 500kbps. And, with availability and capabilities of devices like iPhone the data usage has increased tremendously-400% in last one year. The data usage will continue to increase as more and more people get smartphones like iPhone. There will be more applications, more videos, and more social networking on mobile devices. Furthermore, new form factors like netbooks, on WC networks, use huge amounts of data. There is no end to how much bandwidth users need. The problem is that the revenue increase from data usage is not proportional to increase in data usage. Data is now around 25% of ARPU (Average Revenue per User). 3 years ago, it was around 15% of ARPU.

3. Margins and CapEx: The network cost of generating $1 in data revenue is ~4 times cost of generating $1 in revenue from voice. As data usage continues to increase and voice revenue (per user) continues to decline, the WC's margins will shrink. At the same time, to cope with increased data usage, the carriers will have to continue to invest CapEx in upgrading their networks with 3.5G and 4G networks. This is a tough position to be in. To reduce CapEx requirements, WC are offloading data traffic on WiFi networks which are much cheaper to install and to maintain. You may recall that AT&T bought Wayport, a WiFi service provider, last year and is now present at Starbucks coffee shops. Furthermore, since the market is saturated, it would cost more money to acquire new customers and to keep the existing customers, affecting the margins.

4. New Opportunities: We are only at the beginning of what wireless will enable in future. There are eReaders like Kindle, location based services like loopt, and machine to machine communication like telematics, etc., which are working today. There will be many more new services. However, these new services generate little revenue for WC. The services will have new players in the middle of WC and customers who would want to make money as well. So, the revenue and the margins would be split among more parties just like search revenues (or margins) on mobile phones are split with search companies. For example, in case of iPhone, consumers have a direct billing relationship with Apple for application and digital content downloads and AT&T does not get any revenue when you download a song or an application on your iPhone.

5. Bundling: To create a competitive position and to increase customers' switching cost, WC will bundle wireless services with other services they offer. Especially, AT&T and Verizon which have wireline operations to offer video (cable) and broadband services. Bundling also enables these carriers to reduce back-end costs and offer integrated wireless-wireline services. Remember, long distance companies like MCI, Sprint, etc. They disappeared because the bell companies started to bundle local and long distance after telecom act of 1996. In response to WC bundling, the cable companies will offer bundles and reduce prices which WC will have to match hence reducing margins.

6. The New Consumer: Although we avoided a depression with the recent financial market meltdown, the economic growth and hence the wage growth will be slow in the coming years. Consumers are getting more cost conscious and saving more. These days, having a cellphone is necessary but spending a lot of money using it is not. The consumers may be unwilling to try new applications which are expensive. To keep the customers, WC will have to offer higher handset subsidies and consumers may switch to cheaper service plans reducing WC margins.

The WC may try to grow with international expansion or with consolidation in the US. They may start providing new services like cloud computing. Furthermore, if one major WC makes a big strategic error, like Sprint & Nextel integration a few years ago, then other WC may continue their growth at the expense of the erroneous WC.

No one knows the future. However, based on how things are today, it is likely that the WC will see declining margins in the coming years. And, the consumers will see more wireless innovation and better prices.