What Happens in a Competitive Market When the "High Cost" Supplier Loses Lots of Customers?

The thing about leverage is that it works both ways. What helps accelerate business results on the way up also accelerates a decline. Dell, for example, benefited for a long time by using a "build to order" strategy that limited cash tied up in inventory and also created cash "float" when its retail customers paid Dell before Dell paid its suppliers. 

While the company was growing fast, Dell was getting paid to make products faster than it is paying to make them. All that goes in reverse when sales slow. Now Dell is seeing the process in reverse. Lower retail sales mean less cash is coming in the front door, while supplier payments for older and larger orders are going out the back door. 

You might argue a similar process is at work in the fixed network telecom business. Incumbent telcos are losing customers, market share and gross revenue to cable companies and competitive suppliers including competitive local exchange carriers, for example. 

And that means fixed costs are spread over a smaller base of customers. You know what that means: incumbents will have to find new services to sell, or must raise prices on the remaining customers to cover the overhead. 

The process is most clear in the voice business, where telcos once had 90 percent or higher share of consumer and small business voice accounts, and now have perhaps 60 percent to 40 percent. All other things being equal, that means the sunk costs and overhead supporting the voice network have to be spread over a smaller base of customers. 

The other problem is that nobody ever argues that incumbent telcos are the "low cost providers" in any market. Since, in a competitive market, over the long term, the low cost provider generally wins, that poses another layer of trouble. Not only are fixed costs going to become a problem, but incumbent telcos also face institutional barriers to reducing those costs. 

Mobile, cable and CLEC contestants, for example, generally operate with non-union work forces and generally have leaner work force structures (fewer employees per $100,000 of revenue)  as well. 

Thus begins a vicious cycle. Telcos raise prices to cover overhead. Higher prices drive customers off the network. That means overhead per remaining customer gets higher. So prices have to be increased, which causes more customers to flee, and so on. To be sure, all other things are not equal. Telcos are creating new products to replace lost revenue. 

But you see the problem: large fixed costs are a real problem for any business that starts to shrink. 

High fixed costs are a potentially devastating problem for competitors who start with the disadvantage of the highest cost structure in a market, with the heaviest regulatory burdens and price controls.