Sometimes, Not Matching Competitor Offers is the Wise Strategy

France Telecom says it will not match the low-cost mobile offers recently launched by Iliad because such aggressive pricing would be bad for network quality and innovation in the long-run, says France Telecom CEO Stephane Richard. That Orange won't compete on price might strike you as unwise.

Goldman Sachs, for example, forecasts that Iliad's market entry will cause France Telecom to lose a third of its operating profits in its domestic market by 2015.

But there are ample precedents for France Telecom to do so. Beyond higher marketing costs as competition escalates, sometimes all an incumbent can do is harvest a business. That, in fact, was AT&T’s strategy when it was a dominant long distance provider facing growing competition from a growing number of competitors, and as prices for its product continually declined.

A similar strategy has been taken by incumbent telephone companies in the face of growing competition from VoIP providers. You might argue that telcos should have jumped into VoIP aggressively, matching competitor lower prices.

They generally haven’t done that. The reason is that incumbents lose more than they gain by matching lower prices, even when everyone would agree lost market share is the inevitable result.

For an incumbent telco, matching lower competitor prices implies lower retail prices across the board, for the entire customer base, not just for the consumers buying the VoIP service. A rational telco executive would do better to preserve gross revenue and profit margin on a gradually-shrinking base of customers, rather than adopt across the board lower prices in an effort to slow the market share losses.

"The real risk is that all the operators become 'low-cost', meaning less investment, fewer services and jobs," said Richard.

Iliad, which markets its services under the name Free, touched off a price war on January 10, 2012  with an offer of unlimited calls to France and most of Europe and the United States, unlimited texts, and 3 gigabytes of mobile data for 19.99 euros ($25.83) per month, without a contract.

France Telecom and Vivendi reacted by cutting some mobile prices but only on the offers sold without phone subsidies and contracts.

Some analysts predict that France Telecom, Vivendi and Bouygues will all become structurally less profitable as Iliad takes market share in the coming years.

But that has happened before, in the telecom business. Firms as large as AT&T was, or MCI, watched profits gradually decline, to the point that both were purchased by other providers in the market.

Right now, local telcos are essentially harvesting their legacy voice business, essentially “allowing” VoIP competitors to take market share. That is a rational strategy, especially in the consumer segment of the business.

The point is that there are times when an incumbent simply cannot match prices, and has to prepare to lose market share. That might be a bigger issue for lots of mobile service providers, soon.

There is growing evidence that the high-margin mobile text messaging market is past its peak.

Danish SMS traffic, for example, decreased by over 20 percent in the first six months of 2011, according to Strand Consult, and the trend will continue in 2012.

Text messaging revenue is not declining in all markets, but is slowing in most developed markets. The most-recent data from the CTIA suggests slowing growth in the U.S. text messaging market of about nine percent.

In the Danish market,  three out of four mobile operators have been experiencing a steady decrease in their test messaging (short message service, or SMS) traffic month after month.

From 2010 to 2011, TDC experienced an SMS traffic drop of 17 percent, Telia lost 18 percent and Telenor 26 percent, while the fourth operator 3 was the only operator that had growth in their SMS traffic.

That 3 saw text messaging growth is largely attributable to the fact that 3 is gaining customers and share in the market. SMS traffic on the 3 network grew by 29 percent.

But, overall, the number of Danish SMS messages fell during the first half of 2010 to 6.4 billion and to 6.2 billion during the first half of  2011. That is a drop of about seven percent from 2010 to 2011.

Facebook messaging is the reason for the drop, Strand Consult argues..

So what are Danish operators doing? They are bundling mobile broadband with SMS and MMS packages as part of a smart phone purchase. That means service providers get paid even as the volume of text messages declines.

Finland's largest carrier, Sonera, for example, recorded a 22 percent decline in texting on Christmas Eve in 2011, versus the same night in 2010.

It isn't that people are communicating less. They are just using different methods of communicating. Text Messaging Declines  

Hong Kong also apparently saw a similar decrease on Christmas, dropping 14% from the same day in 2010. Netherlands service provider KPN provided an early warning when it announced significant declines in messaging volume earlier in 2010. KPN text message declines

Dutch telecoms regulator, OPTA, which shows a significant decline in the number of SMS sent in the Netherlands in first half of  2011 compared to the previous six-month period.

The country's largest operator, KPN, has also reported declining year-on-year messaging volumes over the last few quarters due to what it calls "changing customer behavior."

Wireless Intelligence says text messaging volumes are falling in France, Ireland, Spain and Portugal as well.

According to OPTA, the total number of SMS sent in the Netherlands stood at 5.7 billion for the first six months of the year, down 2.5 percent from 5.9 billion in the second half of  2010, even though total text messaging revenue rose slightly (0.6 percent) to EUR378 million during the period.

That should not come as a surprise. The number of over the top and social messaging alternatives has been growing for years. But there is a "network effect" for messaging, as there is for any other communications tool. Until a user is fairly sure that nearly everybody he or she wants to communicate with can be reached by a particular tool, adoption is slower.

But there always is a tipping point, where the expectation changes from "I doubt this person uses this tool" to "there is a good chance they use this tool." Finally, there is the point of ubiquity, when the assumption simply is that "everybody" uses the tool.

Also, the history of text messaging and email are instructive. Though most cannot remember a time when it was so, email and messaging services once upon a time were not federated. In other words, you could not send messages across domains.

History also tells us what happens after federation: usage explodes. With alternative messaging platforms, we still are not in a "full federation" mode, where anybody can send messages to any other user, irrespective of what device, operating system, service provider or application they prefer to use. That day will come, though, and text messaging usage and revenues will suffer.

The.maturing market illustrates a key element of business strategy.

A rational service provider strategy, when confronted by such challenges, might simply be to harvest existing revenue streams, using bundling and other approaches to maintain as much revenue as possible in legacy lines of business, while investing in the next generation of services.

As CenturyLink halted Qwest’s old VoIP business, to emphasize sales of legacy voice services, sometimes the wisest course is not to embrace disruptive services, but “cope with them,” while growing services and revenues in other areas.