Ultimate Impact of T-Mobile US Attack Remains Unclear

Most consumers should cheer T-Mobile US efforts to disrupt the U.S. mobile market, which some would characterize--not without reason--as a structural duopoly. Between them, Verizon and AT&T have about 73 percent consumer market subscriber share, and about 80 percent of enterprise account share.

Even if observers are right to worry about the long-term health of the mobile market, the benefits of the T-Mobile US pricing attack are creating better value for consumers. The issue is what happens longer term.  

Most would likely say a return to monopoly is unwanted, just as most would likely prefer robust competition, consistent with long term sustainability. And that will be the trick: fostering maximum feasible competition while not endangering the long term ability of suppliers to reinvest in next generation networks.

It is a tough balance to achieve.

Right now it is hard to say, as the U.S. mobile market has a structure some of us would say is fundamentally unstable. That isn’t to argue about who will gain, or lose, in the coming years. It is to argue that the present market structure does not have the classic form of most stable markets.

It also is possible to argue that the U.S. mobile market is close to stable, though.

Some would cite the rule of three or four in making that argument.

In most cases, an industry structure becomes stable when three firms dominate a market, and when the market share pattern reaches a ratio of approximately 4:2:1. In other words, the top provider has market share double that of number two, which in turn has market share double that of number three.

The U.S. mobile market now is bifurcated, with AT&T and Verizon--depending on how one measures--roughly equivalent, with Sprint and T-Mobile US far behind.

Still, some might argue the market is effectively competitive, and is currently becoming more competitive. Dish Network, for example, potentially will enter the market, and Comcast certainly will as well. How each firm makes its entry will affect possibilities for changing the market structure.

The point is that the U.S. mobile market is in a period of instability.

Economists differ on the effects of duopolies on the market. According to the Cournot model, duopolies lower prices, although they not so much as markets with perfect competition, a condition marked by market circumstances in which no one participant dominates.

The Bertrand model of competition, on the other hand, predicts that duopolies will eventually lower prices as much as perfect competition would. Like most theoretical models of economic forces, both the Cournot and the Bertrand models can be persuasive, but neither is viewed as definitive.

Nobody believes the mobile business ever will be as competitive as retail apparel, for example. But few probably believe a duopoly or monopoly is a good idea, either. The issue is what market structure might yield the greatest amount of competition. Some might call that a contestable market.

A stable competitive market never has more than three significant competitors, the largest of which has no more than four times the market share of the smallest, according to the rule of three.

In other words, the market share of each contestant is half that of the next-largest provider, according to Bruce Henderson, founder of the Boston Consulting Group (BCG).

Those ratios also have been seen in a wide variety of industries tracked by the Marketing Science Institute and Profit Impact of Market Strategies (PIMS) database.

By those rules, most mobile markets, globally, are unstable. Using those ratios, the U.S. fixed network business also is unstable. So are some other related markets.

Many have noted the concentration of smartphone profits by just two suppliers--Apple and Samsung--for example.

A couple of important additional ratios seem to be important. Under certain conditions, competitors can reach a point where destabilizing the market is viewed as dangerous.

A ratio of 2:1 in market share between any two competitors seems to be the equilibrium point at which it is neither practical nor advantageous for either competitor to increase or decrease share, Henderson has argued.

That would seem to explain why marketing attacks in stable markets are not designed to upset market share, but only to hold existing share.

Any competitor with less than one quarter the share of the largest competitor cannot be an effective competitor. In a market where the largest provider has 30 percent share, that implies an attacker has to gain at least 7.5 percent share to remain viable.

There are some very-important strategic and tactical implications. Virtually any market that does not yet have the “rule of three” pattern and the 4:2:1 market share structure is going to be unstable, unless there are government-imposed restrictions on competition that allows the market structure to change.

And that is why revenue growth, and subscriber growth, are so important. When markets are allowed to consolidate, all competitors who survive must grow faster than the market average, one might argue.

All except the two largest share competitors will be either losers and eventually eliminated.

So anything less than 30 percent of the relevant market or at least half the share of the leader is a high risk position, long term.

Firm strategy also therefore is clear: cash out of any position quickly if the number-two market position cannot be gained, or aim to take the number-two spot.

Shifts in market share at equivalent prices for equivalent products depend upon the relative willingness of each competitor to invest at rates higher than the sum of market growth rates and the inflation rate.

In other words, if markets are growing at two percent, and the inflation rate is two percent, than a leading contestant has to invest at rates greater than four percent annually.

Any firm not willing to do so loses share. If every contestant is willing to do so, then prices and margins will be forced down by overcapacity until at least one firm stops investing.

The faster the industry growth, the faster the shakeout occurs, Henderson has argued. There also is one rule that applies directly to the U.S. mobile market: near equality in share of the two market leaders tends to produce a shakeout of everyone else.

That is the case for Verizon Wireless and AT&T Mobility, and underpins the argument advanced by Sprint and T-Mobile US that they cannot prosper, long term, unless they merge.

The market leader controls the initiative. And though equity holders do not like the practice, cutting prices to maintain share is the “right” strategy. Any market-leading firm that chooses to maintain near-term operating profit while losing share, will not survive.

If the market leader, under attack, prices to hold share, there is no way to disrupt the market, unless the company with number-one share runs out of money to maintain market share, Henderson has argued.

Under most circumstances, enterprises that have achieved a high share of the markets they serve are considerably more profitable than their smaller-share rivals, according to the Marketing Science Institute and Profit Impact of Market Strategies (PIMS) database.

The ratio 4:2:1, representing market shares in telecom markets, is key. That pattern suggests the U.S. mobile market is unstable.

Of course, some might argue that is broadly true of the entire global industry. Fixed network revenues are shrinking, mobile revenue growth is slowing, flat or negative. Competition arguably has grown and there are high capital investment requirements for new networks and spectrum.

Revenue growth is driven by mobile Internet access, but that eventually will slow as well, necessitating a search for new revenue streams. And there are other issues.

AT&T has pension obligations of perhaps $56 billion--more if AT&T’s assumed annual return on its pension assets (stocks and bonds) of about eight percent falls short. The obligation is less if AT&T is able to sustain higher rates of return on its pension assets. Basically, strong equity markets help, low interest rates hurt.

It isn’t unusual, but AT&T’s pension plan pension plan also is underfunded by perhaps $9 billion.

In the fourth quarter of 2012, for example, both Verizon and AT&T booked charges against income that caused losses. And they are not alone.

U.S. firms part of the Standard and Poors 500 Index had in 2013 perhaps $440 billion of actual pension plan losses not yet reflected on their books.

Pension obligations are not at the top of the list of concerns about the long term future for the mobile industry, either for suppliers, consumers or policymakers and lawmakers. But pension obligations illustrate the the importance for multiple stakeholders in a vibrant mobile industry, long term.

European telecom regulators, for example, recently have started to adjust policies to balance  support for competition with support for investment and long term sustainability of the industry.
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