"Opportunity Cost" Might be the Biggest Downside to "Upgrading" Existing Product Lines

Marginal cost has proven to be a key concept for products sold in most mass markets, and telecommunications is not exempt from that trend.

Any number of retail prices and packages are set basically to reflect the marginal cost of adding the next incremental customer. In fact, over time, economists might argue, current retail costs for goods and services tend to move towards marginal cost.

The concept has lots of relevance in telecommunications, where large amounts of capital investment are “sunk,” and incremental usage actually imposes little additional operating cost.

The traditional way of illustrating the principle is to answer the question “how much does adding one more minute of use of the voice network cost?” In practice, the cost is almost solely limited to the cost of adding one more transaction on a billing system.

In the Internet era, we are accustomed to the notion that the next increment of usage of any consumer app actually costs the suppliers almost nothing.

In most cases, that next increment of usage costs the end user almost nothing, as well. You of course know the business problem thus created. When costs are nearly zero, retail price will tend to move towards zero as well.

As useful as that is for consumers, it is a huge problem for communications suppliers. Very low marginal cost explains why VoIP and messaging providers are able to offer their services literally for free, or nearly for free.

Low marginal cost is the foundation for the business model known as “freemium.”

Low marginal cost explains why suppliers of long distance calling, facing declining margins, try to compensate by encouraging additional usage volume.

And low marginal cost will be the reason why gigabit access services costing only $70 to $80 a month are possible, in large part.

Observers offer any number of suggestions to service providers about how to sustain their businesses under conditions where retail pricing for many products drops to marginal cost, and when marginal cost is quite low.

Many of those suggestions, though sound enough, have problems. Solutions that call for adding more value to existing products assume users will value the incremental new value enough to pay incrementally more revenue.

Strategies that call for creating new lines of business face execution risk (can telcos really do it?) as well as scale risk (will the new revenue streams be big enough to justify the effort?).

Assuming that creating new lines of business is both essential and realistic, the subsidiary issue then is how much to continue investing in legacy businesses that are declining in absolute value.

Two fundamental approaches can be taken: harvest or invest. The former essentially admits a business is mature, and will decline. The objective then is to preserve the magnitude of the revenue stream as long as possible, at the highest level possible.

The latter calls for spending more money to upgrade products, adding enough value that prices and usage can be sustained, or hopefully that usage and prices can even raised.

Low marginal cost might suggest harvesting is the more realistic strategy for most service providers. Adding more value might be capital and human capital intensive enough that the net result is a negative number.

Some of us would argue that if a given product line is powerfully affected by low marginal cost, the wiser choice is harvesting. The upside from big, or even significant investments, might not be large enough to justify the cost, time and human effort.

“Opportunity cost,” effort that might have gone elsewhere, also is a concern. No matter how large, organizations only have so much ability to invest in brand-new lines of business and revenue streams.

Must Telcos Cut Dividends and Structurally Separate Networks?

At least some small telcos that once paid rather sizable dividends have had to cut back or end such payments. 



Typically, when that happens, the company risks disruption of its owner base, as equity owners formerly buying a dividend payer are replaced by equity owners that seek growth. 



On the other hand, such moves free up capital to invest in the network. 



How well that strategy works long term remains to be seen. `But such decisions are anything but casual. 



Forrester Research analyst Dan Bieler argues that so important is the "connectivity services" function that  telcos should consider two courses of action they have traditionally opposed, namely separating network operations from retail operations, and paring back dividends.



Separating network operations from retail operations has been proposed before, and never to any widespread agreement on the part of telco executives. In part, that reflects a concern about commoditizing the access function.



Also, though, such structural separation also tends to come with greater pressure to sell transport and access services to third parties. 



Potential wholesale customers tend to argue that makes rivals "customers."  Facilities owners tend to argue structural separation eliminates a key perceived source of business advantage. 



Australia's National Broadband Network is among the more-prominent examples of the structural separation approach. Of course, that move was fought vigorously by Telstra, which arguably had the most to lose. 



Reducing dividend payments might not have direct competitive implications, but to the extent a stock price is a currency that can be used to acquire other firms, there is a negative strategic impact. 



Calls to slice dividends and separate network operations from the retail sales organization are not new. Neither are the business repercussions. 



Structural separation, and its related "mandatory wholesale" policies, arguably have proven to help competitors more than such policies help the owners of the facilities. 



The exceptions have been scenarios where the facilities owner traded vertical integration for regulator permission to enter new markets. SingTel did so. So did Rochester Telephone. 



But most telco executives continue to see more downside than upside, no matter how much advice they get to the contrary.

Could Google be Regulated Like a Common Carrier in Germany?

Google could be regulated as a common carrier or utility in Germany, if German regulators conclude Google has gained too much power and influence, a report by the German Federal Cartel Office suggests.



Such regulation could include price regulations governing prices for advertising, if regulators think Google's market position allows practices that violate antitrust rules. 

SoftBank, Deutsche Telekom Reach Fundamental Agreement on T-Mobile US Buy

With the caveat that antitrust review and clearance from the Federal Communications Commission is required, and by no means certain, SoftBank and Deutsche Telekom apparently have reached agreement on the broad outlines of a Softbank deal to buy the assets of T-Mobile US.



That would merge Sprint with T-Mobile US, the number three and number four national U.S. carriers.  



Under the plan, Softbank will buy more than 50 percent of T-Mobile US shares through Sprint, directly from Deutsche Telekom, which owns 67 percent of T-Mobile US. The deal is valued at about $16 billion.



The chances of regulatory approval are highly uncertain at the moment, though. Some might rate the odds of success as high as 70 percent. 



Others rate odds of success at about 55 percent. And some think the  odds of success are no better than 10 percent. 

A Second Wave of MVNO Growth Coming?

In January 2014, China issued 11 MVNO licences. In March 2014, Virgin Mobile acquired a MVNO licence from Saudi Arabian regulator. Those are potentially-important agreements because in many markets in the Global South, it has not been possible to lawfully operate as a mobile virtual network operator.

It is impossible to say how well such new MVNOs might fare. But past experience suggests that, in most markets, growth much beyond 12 percent customer share could be a challenge.

In 2009, for example, the market share held by MVNOs in Western Europe and North America was about nine percent, according to TeleGeography.

Globally, MVNO market share was about one percent. So MVNOs were a significant market presence only in two regions.

But logic would suggest that growth will occur in most markets globally where MVNOs either are not legal or commercially viable because carrier interest in supporting wholesale is low.

Asia is one of the regions where MVNO market share could be poised to grow from 50 percent to 100 percent annually, albeit from very-low installed customer bases.

The long-term issue is how much market share such new MVNOs might gain.

At least so far, it has proven difficult for MVNOs to break out from about 12 percent market share, perhaps because many MVNOs have focused on the “value” segment of the market, and “standard” offers from the facilities-based carriers have grown in that segment as well.

Whether that also will be the case in MVNO markets in the Global South is the issue. One might note that retail offers already are fairly aggressive in those markets. That suggests niche market strategies will be important, as the lure of “lower price” will be harder to create, than has been the case in Western Europe and North America.

By 2011, a separate analysis by Pyramid Research suggested MVNO adoption had reached about 12 percent, while in other regions MVNOs had less than three percent market share, most less than one percent market share.

That lead Analysys Mason to suggest that MVNO market share had essentially reached its limit, in Western Europe. To the extent that growth remained, it would come from wholesale-based offers adopted by device suppliers and service providers targeting market niches.

But in 2011, Scandinavian MVNOs faced falling market share. Denmark’s MVNO penetration fell to 4.2 percent from a peak of 10.9 percent.

In Finland, MVNO share fell to two percent from a peak of 11.7 percent. In Sweden, MVNO share dropped to 0.4 percent from a peak of three percent.

In 2010, there were abut 60 U.S. MVNOs in operation, according to the Federal Communications Commission. Most were quite small, but Tracfone had about five percent market share, earned by focusing on prepaid customers with low average revenue per user.

New "Information Markets" Raise Issues

Increasingly, information about products gets intertwined with the actual products, raising new legal and ethical issues. MonkeyParking, for example, is an app that allows people who are parked to alert out drivers that they are about to pull out of a spot, and allows those other drivers to bid on the right to take the vacated parking spot.



You can see the issue: such apps create new information markets whose value lies in the procurement of physical goods, such as parking spaces. 



At the heart of the dispute over these services is whether apps should be able to use a public asset to make a profit. The app developers of course argue it is information about parking, not parking, that is the foundation for the business. 

How Much Revenue can Carriers Make from Their Own Apps?

Some service providers believe they can, and must, become more active developers of applications. Telefonica and SingTel might be the best examples of such thinking.

Others have chosen to partner or acquire communications-related apps. Deutsche Telekom is a good example of that approach.

But it would be reasonable to argue most telecom service providers have not done so on a significant level, though some would argue third party development is another matter.

One can argue that is because communications service providers historically have not been good at app development or innovation, though an argument can well be made that telcos have managed a couple of key business model transitions fairly well.

The first transition was from a reliance on long distance revenue to drive profits, to mobile services. Now a transition is being made from voice revenue to Internet access and video revenue.

It would be a mistake to underestimate the significance of those shifts. Very few industries find they must replace about half their current revenue every decade or so, with revenue drivers shifting to  new products.

But one might argue the telecom industry already has been through one or two such shifts, and is in the process of a couple more similar changes.

Still, there is what might be called a structural problem.  Decades ago, communication apps were vertically integrated with the suppliers of network services. Voice and text messaging are the classic examples.

But even before the Internet emerged, enterprise and consumer apps were created and designed to run on operating systems independent of the communications infrastructure.

In the Internet era, all apps are designed to run independently of the underlying communication networks. That “permissionless”  mode of innovation means value now is created at the top of the protocol stack, or even above the stack, at what might be called the “business” layer.

But even if telcos were very good at innovating at the business and application layers, there is another problem. The app business is quite fragmented.

Consider the supply of apps in any large mobile app store. Even if a mobile service provider were to create a functioning app in any given category, that service provider’s app still has to compete against all the other apps in the category that are available in the app store.

You might argue that ownership by the firm supplying mobile Internet access and other services might be helpful. It might. But how many apps created by mobile service providers--other than the carrier’s apps that allow you to check usage and account details, or customize your access experience in some way--do you actually use?

Some of us could probably think of one or two apps, possibly quick response code readers or navigation. But many users would struggle to identify any such apps.

In other words, the “innovation and differentiation layer got unbundled,” according to Benedict Evans, Andreessen Horowitz analyst. So any "carrier-generated" apps must compete with all others.

That is a direct result of the fact that apps now are loosely coupled with communications infrastructure.

Up to a point, carriers can bundle apps with devices. But only up to a point. And users decide which apps succeed, not device or access providers.

The point is that revenue upside from carrier apps might be quite limited.