Feature Article

August 13, 2012

Mobile Operators Must Choose Between Maximizing Revenue or Profit

Selling fewer smartphones might seem an odd way for mobile service providers to boost their sales of data plans, widely and justifiably seen as the necessary near term antidote to declining revenue from voice and texting plans.

But as sometimes is the case, there is a clear difference between maximizing gross revenue and maximizing profit per unit sold. And in many mobile markets around the world, that is an immediate business decision to be made.

“We seem to be entering a new phase in the U.S. market,” said Leon Cappaert at KBC Asset Management in Brussels, whose holdings include shares of Deutsche Telekom. “Margin pressure in the sector is diminishing significantly, and that may mean a positive surprise on the margins for T-Mobile," he argues.

What does “less margin pressure” actually mean? In many cases, it now seems to mean that mobile service providers take active steps to reduce the amount of handset subsidies they must incur to sell a smartphone data plan.

And for every firm that might find the tactic works, in other cases, the evidence could be interpreted to mean that the tactic can backfire, dramatically reducing new customer acquisitions of the postpaid smartphone sort.

Compared to other key competitors, AT&T historically has sold more iPhones than other U.S. mobile service providers. So if it can shift smartphone purchases to devices that “cost” AT&T less than selling Apple iPhones, it wins. It can keep growing its mobile data revenue and smartphone customer base, without incurring so much operating cost.

Some European mobile service providers were early to experiment with a total end to device subsidies, Vodafo9ne and Telefonica among them.

But Vodafone's Spanish division is bringing back cut-price smartphones for new customers for a limited time, prompted by a mass client exodus in recent months after scrapping handset subsidies in the recession-hit country, Reuters reports.

The move illustrates the clear danger for any single service provider that attempts to break from established practices that consumers find helpful, such as selling hot new devices at subsidized prices, even if that means consumers need to sign a service contract.

Vodafone and Telefonica, with almost 70 percent market share between them, have suffered huge subscriber losses since they decided to use Spain as a test case for a new business model that cuts subsidies for smartphones.

Vodafone has lost over 600,000 mobile clients since April 2012, when it stopped slashing prices on smartphones, while Telefonica's Movistar lost 572,000 in April and May, according to data from Spain's telecoms regulator.

It remains to be seen whether Vodafone actually will reinstate the "no subsidies" policy after September 15, 2012, its announced date for ending the “temporary” policy. The issue is that nobody can be certain that it is the “no subsidies” policy that has caused the bleeding. Given the financial and economic crisis in Spain, it is conceivable that losses would have occurred, at about those levels, even if handset subsidies had been retained.

Mobile service providers in Spain lost a quarter of a million clients in May 2012, the fourth consecutive month of subscriber losses, la Comisión del Mercado de las Telecomunicaciones says.

The industry also lost 380,000 customers in April 2012, according to the Spanish telecommunications commission.

Some might argue that the churn has been caused by postpaid customers dropping postpaid service and adopting more affordable prepaid plans.

Just how big a deal that might be in the U.S. market isn’t entirely clear. Mobile service providers aren’t happy about the cost of device subsidies that cause a drag on earnings. For AT&T, the financial impact of iPhone subsidies is clear. AT&T profit margins had grown for five straight years beginning in 2005, but reversed in 2010, apparently related directly to iPhone 4 demand and subsidies, BTIG argues.

BTIG argues the iPhone subsidies have reduced AT&T margins by at least 10 percent in 2011, for example.

In the past, Verizon has not charged a fee to its subscribers when customers decide to upgrade to a new device. But Verizon in April 2012 announced it would charge a $30 fee when that occurs. For Verizon Wireless, that could add up to $1 billion to Verizon’s annual earnings, and also boost profit margins, BTIG Research argues.

Verizon Wireless now will provide incentives for users to pay full retail for their devices, using the bait of “unlimited” mobile data plans. That is likely to cause buyer sticker shock, though.

The new Verizon Wireless plan to end "unlimited" service and move users to capped plans primarily is aimed at matching end user data consumption to usage. But Verizon Wireless also appears to be using the opportunity to wean customers off device subsidies.

Smartphones have been very helpful for mobile service providers, boosting average revenue per user by driving mobile broadband subscriptions. But the subsidies generally used to spur sales are becoming a major drag on earnings, and change is coming. Basically, service providers will have to risk lower sales growth, and less mobile broadband revenue growth, to limit handset subsidies. It might be a Faustian bargain.

In fact, what seems to have happened is that user behavior has changed, with users upgrading those “expensive” smartphones faster than they had generally been upgrading their feature phones, analysts at BTIG say.

In the United States, BTIG expects iPhone sales to decline four million sequentially to nine million with the largest impact coming from AT&T, Apple’s largest customer.

In fact, AT&T says it has built its business model for 2012 around the idea that it will sell no more smartphones, overall, than it did in 2011, about 25 million units.

Perhaps the U.S. device market is being redefined in ways that will, at the very least, encourage users to buy smartphones that cost mobile service providers less. The issue is how far the trend can be pushed. At least in Spain, there is at least some speculation that too rash a change can destroy postpaid smartphone account growth.

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Edited by Brooke Neuman

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