Wireless Telecommunications Industry Analysis: Market Dynamics and Competitive Strategies

1. Wireless Telecommunication Carriers Tillman Elser, Isabelle Nunberg, Nikkita Mehta, Julie Greenberg

2. Agenda • The Industry • General Background • Consumers • Main Players • Competition • Pricing Strategies • Bundling and Versioning • Three Part Tariff • Network Externalities • Tacit Collusion • Penalty Pricing • Discounts • Cell phone pricing Recommendations • Investments

3. The Industry - General Background - Consumers - Main Players - Competition

4. Primary Products • Wireless voice communication • Text Messaging services (SMS) • Advanced PCS (personal communication services) • Other data services • Other wireless services

5. Industry Snapshot • Lower pricing -> competitive advantage over wired services • Consumers embracing newer/more expensive technology • Retail presence decreasing in importance IBISWorld

6. Primary Consumers • Corporate clients (15%) • Stable market characterized by long term contracts and predictable patterns of usage • Most concerned with reliability (voice) and speed (data) • Big target for 4G technology • Small/Medium Businesses (30%) • Laptop data plans and fixed mobile services attractive to this market • General consumer/residential clients (55%) • Most price sensitive • Demand growing fastest in this group

7. Differentiation among consumers vs • Heterogeneous preferences for cell phone usage • High use • Low use • Focus on Data • Focus on Voice • Focus on Text

8. Why pricing beyond Minutes is important.

9. Expenses Breakdown • 24.8% - Cost of service • 14.5% - Depreciation • 12.5% - Equipment Purchases • 8.4% - Wages • 5.9% - Advertising • 6.7% - Rent/Utilities fees • 6.5% - Profit • ~20% other expenses

10. Network Technology • 1G • Analog, usage stopped in 2008 • 2G • Basic voice and data functionality • Popularity declining as newer standards develop • 14.4Kb/s • 2.5G • Stepping Stone from 2G to 3G • 50-150Kb/s speed • Wireless Application Protocol (WAP) mobile Internet as well as MMS • Most advanced iteration of 2.5G is the EDGE network (AT&T/T-Mobile) • 200-1000Kb/s

11. Network Technology (cont.) • 3G • Current standard among smartphones • Beginning to assume market dominance from 2G and 2.5G • Speeds of 300-600Kb/s • 3.5G • Middle ground between 3G and 4G • Speeds up to 14.4Mb/s • AT&T/T-Mobile • 4G • Epitomizes shift from voice to data among telecommunications carriers • Conflict between WiMax (Sprint) and LTE (Verizon) standards • Speeds up to 100Mb/s for mobile devices (1Gb/s for stationary devices)

12. Market Concentration • Trends of M&A • Method to gain subscribers and coverage • Saturated market: harder to build new customer base • Economies of scale • Higher margins and available capital enable firms to invest in their networks and services

13. Market Concentration • Top 4 Firms Market Shares: • Verizon Wireless: 33.4% • AT&T Inc.: 31.2% • Sprint Nextel Corporation: 16.2% • Deutsche Telekom AG (T-Mobile): 11.0% • CR4 = 91.8 • HHI = 2472.44

14. Verizon Wireless • 33.4% of market (market leader) • Part of Verizon Communications– VW contributes almost 2/3 of revenue • Originally merger of three companies • Acquired Alltel in 2009 to give VW largest market share in industry • Now transitioning to 4G LTE • Revenue growth of 11.7% annually over past 5 years • In 2011, expected to generate $66.1 billion in revenue and net income of over $4.4 billion

15. AT&T Inc. • 31.2% of market • Largest market share until Verizon-Alltel merger • Started as joint venture called Cingular Wireless • In 2006, AT&T acquired both companies and became AT&T Inc. • AT&T wireless contributes to ½ of company revenue • Plans to acquire T-Mobile within next 12 months • Problem of congestion on data networks • Revenue growth of 10.3% annually over past 5 years • In 2011, expected to generate $61 billion in revenue and net income of $16.5 billion

16. Sprint Nextel Corporation • 16.2% of market • Sprint and Nextel merged in 2005 • Only major company losing subscribers • Backs WiMax instead of LTE for 4G network • Annual revenue decline of 4.1% and has failed to turn a profit since 2006

17. T-Mobile • 11% of market • Brand of Deutsche Telekom AG in US • First wireless carrier to offer Android phones • Large carrier of WiFi with T-Mobile Hot Spots • Plans for AT&T to acquire T-Mobile • In 2011, will generate $28.2 billion in revenue and net income of $1.8 billion

18. Competition • HIGHEST in whole telecommunications sector • WHY? • Churn rate of 1.5% to 3.5% per month • Types: • Price • Service offerings & quality of service • Product innovation • Network dependability and call quality • Marketing strategies • Geographic coverage

19. Competition:Pricing • Firms all offer similar products, coverage, and services  price competition is vital • Try to undercut competition • Discounts, network externalities, etc. • Partly enabled by recent M&A activity by improving firms’ economies of scale

20. Competition:Service Offerings & Quality of Services • Service becomes important weapon in the industry as customers increasingly value reliability and attention • High investment in upgraded technologies and networks • Customer service becomes vital in gaining customer loyalty and reducing churn rates • Expansion of service offerings: “one-stop” bundles • Telecommunications Act of 1996

21. Competition:Product Innovation • New technologies incredibly useful in increasing usage, margins, and customer base • Short life cycles for products and applications • New technology includes: • E-mail • GPS mapping • TV feeds • E-commerce . . . • 3G  4G

22. Competition:Marketing Strategies • Promotional tactics • Rebates, discounts, etc • Advertising • Supply side: Combative advertising • Mature market; goal is to shift consumer demand toward advertising firm but not expanding consumer demand • Demand side • Persuasive: alters consumers tastes based on service providers’ attributes, strengthens barriers to entry especially in industry with economies of scale • Complementary: appeals to “social prestige” with new phones, appeals to attributes complementary to use (coverage, overage, etc.)

23. Competition:Geographic Coverage • Ultimate goal: maximum US nationwide coverage • Enables furthering economies of scale and higher efficiency • Over 277 million Americans (approx. 91%) can choose between three or more providers while 250 million of those Americans (approx. 82%) can choose between only top four

24. External Competition • Mobile virtual network operators (MVNOs) • Companies that purchase airtime from a major wireless network then resell it with their own logo • Increasing as communications and media leaders have recognized potential growth • Mobile strategies developed by Comcast and Time Warner Cable • Google looked into bidding in 700MHz auction in 2008

25. Barriers to Entry • Barriers to entry are high and increasing primarily due to… • Regulating spectrum scarcity • High costs • Market saturation

26. Barrier:Spectrum Scarcity Regulations • Spectrum scarcity refers to a finite number of companies being able to operate cellular/PCS services with a designated geographic location and frequency • Distributed through licenses within a specified area • Closed to new entrants until next auction • Cost at time of auction is high; over $19 billion was spent in 2008 700 MHz auction

27. Barrier:High Costs • High initial costs • Base stations, towers, and other necessary infrastructure reaches the billions • Costs of R&D and other investments • Dependency on product innovation and up-to-date technologies • Marketing strategies

28. Barrier:Market Saturation • Existing firms already established their strong positions • Cost advantages due to economies of scale • Ability to spread expenses over large customer base • “one-stop” bundles differentiate from pure wireless providers and reduce churn rates • Slowing growth in customer base

29. Pricing Strategies - Bundling and Versioning - Three Part Tariff - Network Externalities - Tacit Collusion - Penalty Pricing - Discounts - cell phones

30. Bundling and Versioning • Feature bundling on cell phones -> facilitates feature bundling on contracts • Customers pushed onto smart phones • Increases access to additional features • Versioning • Family plan vs Individual plan • Extensive bundling seen in cell phone plans • Considerable variance between companies • Common themes: Avoid pure bundling, target heterogeneous preferences

31. AT&T • Focus on mixed bundling • Most profitable bundles listed more prominently • In some cases, no price difference between bundled and non bundled services • Customer ‘opts-in’ to services

32. Verizon • Pure and mixed bundling • Similar services grouped together • Customer forced to ‘opt-out’ of some services • Fewer options than AT&T, but still many additional services offered • Minutes and text packages offered as initial service bundles • Can also add text package after choosing minutes

33. T-Mobile • Lower utilization of mixed bundling, focus on pure bundles • Customer required to opt-in to several free services • Huge number of bundles -> confusion pricing

34. Sprint • Focus on pure bundling • Search obfuscation used more prominently (‘premium data add-on) • Fewest additional service options

35. Three-part tariffs • Monthly fee and per minute fee • Now, mostly three-part tariffs: monthly fee with included minutes but high overage fee • Customers choose three-part tariff over two-part tariff because of flat-rate bias • Most customers underestimate usage (use only half of minutes allowable on average) • Those that do exceed allowance, exceed by 40% on average

36. Confusion Pricing • Many versions so consumer surplus extracted from those less willing to search for correct plan • Customers underestimate uncertainty about usage (overconfidence) by 81% and underestimate volatility of usage (projection bias) by 57% • When first signing up, average customer underestimates usage by 40% • Companies gain an average of $60 per customer • Slow to correct mistake and switch plan • AT&T “rollover” plan targets sophisticated consumers who understand that usage changes monthly

37. Plans And Add-Ons

38. Network Externalities • Companies create network externalities as an incentive to gain new customers • Free texting within Verizon network • Free minutes within all networks • Only significant after critical mass reached • Customers benefit from others on the same network • The greater the size of the network, the greater the benefit to user

39. Tacit Collusion • How does it work? • Industry is an oligopoly • Top four firms dominate almost the entire market • Homogenous products • Same phone (e.g. iPhone from AT&T or Verizon?), data services (text, e-mail, etc) • Agreement on price is easier to come by and cheating is easier to catch • Nondurable goods • Less incentive to cheat because it is a one-time sale product rather than a product from which sellers could gain a series of sales

40. Tacit Collusion:Pre-Announced Rate Changes • Service providers typically pre-announce rate changes they plan on implementing • Advanced notice gives competing firms time to respond • Can test the market and competitors

41. Tacit Collusion:Infrequent High Changes in Rates • Rate changes in the industry have been high and infrequent, yet coordinated across all four firms • FOCUS: Text Messages • Supply is almost unlimited so in a competitive market prices should decrease not increase over time • Since 2005 price per text has doubled. IBISworld • Service providers do not claim that these increases were driven by higher costs so other methods must be at work. • Doubling of prices pushes prices from inelastic portion of demand curve to elastic portion to capture unrealized revenue

42. Penalty Pricing: The “Typical” Consumer • Barriers of Adoption • Unpredictability of use • Profit Margin due to over and under usage. Unattentive Overconfident Underestimates

43. The Fees: Sources: VerizonWireless.com ATT.com Sprint.com T-mobile.com

44. About 16.5 million people exceed their cell phone minutes every month in the US (according to cellknight.com) • In 2005, Minute-Watch.com show that if the average family took their cell phone overage charges and invested them in a standard index mutual fund (yielding 10.65%) for 22 years, they would have over $19,500 - enough to send a child to many state colleges for two years. An Idea…Numbers wise

45. Discounting • Penetrative • Competitive • Permanent

46. Verizon vs. AT&T in Ithaca • Advertized coverage • All claim GREAT reception. • What drives consumers to pick one over the other? T-Mobile(above) AT&T(below) Sprint(above) Verizon(below)

47. Peak and Off-Peak Pricing • Incentive to reduce the quantity of users on the network at high times and spread them out over other times which saves them infrastructure costs and prevents overloads • Started out as different rates for different times • Evolved to the free nights and weekends

48. Cell Phone Manufacturer Market

49. Cell Phones as a Pricing Strategy • Bundling • Tying • Contract • Specific plans/add-ons • Inter-temporal price discrimination • Network Externalities • Subsidized