Operators Need To Take A Closer Look At Handset Subsidies
BMI View: 2014 is a big year for 4G technology. Korea leads the 4G race with LTE-Advanced. China and Taiwan will start introducing 4G services in 2014 and operators will be expected to further expand their 4G coverage in countries like Malaysia and Philippines. 4G, with much faster speed than 3G network, is a huge source of data revenue. But CEOs need to consider that the widespread use of smartphone subsidies could exert pressure on their bottom lines, at least in the short term.
The Smartphone Conundrum…
In South Korea, regulator Korea Communications Commission (KCC) suspended LG U+ over the violation of handset subsidies limit in November 2013. This is not the first time LG U+ has breached the subsidies law, with operators KT and SK Telecom equally culpable for similar violations on other occasions. The ratio of subsidies to handset prices stood at 65.8% at KT, 64.3% at SK Telecom and 62.1% at LG U+, with their average amount of subsidy at KRW430,000, KRW421,000 and KRW380,000. These exceed the upper limit of KRW270,000 set by the regulator. The KCC will be strict on the handset subsidies law to ensure the operators meet margin improvement targets.
Singapore's M1 reported its EBITDA margin fell by 3.4% in 2012 despite a 1.1% increase in operating revenue, due to higher handset subsidies. China Telecom also experience a 10% drop in net profit in its first year of offering the iPhone due to higher subsidies.
It is tempting to simply put a cost on smartphone subsidies by looking at the short term impact on operators' bottom lines. Subsidies can stimulate smartphone penetration, raise mobile data subscription, lifting ARPU and reduce churn rate due to the postpaid lock-in period smartphone buyers commit to. Furthermore, if exclusive agreements are reached, being the sole distributor of popular handsets can boost an operator's position. China Mobile saw a dip in its market share of 5.4% over two years period to 2012 as it lost subscribers to competitors China Telecom and China Unicom, which both have iPhone distribution rights.
Because of the tradeoff between market share and subscriber acquisition cost (SAC) - when handset subsidies increase SAC increases - any resolution to this smartphone conundrum needs to take account of these two opposing forces. If we look at the handset subsidies as a form of investment, then positive net present value will only come about when the lifetime value of a subsidised customer is higher than the cost of subsidies. There are at least four factors that make up the lifetime value of smartphone subsidies investment - ARPU, customer retention period, discount rate and the amount of handset subsidies.
|Operators Need To Consider Several Factors|
|Factors Driving Subsidies Economics|
A total ban on smartphone subsidies seem out of the question, given the high risk of losing customers. The risk is too great to be taken lightly given our outlook that data revenues are the key drivers for most operators. Instead managing the four factors we have identified are keys to balancing the subsidies economics:
Lengthen customer contract period
In developed countries, most of the handset subsidies are incurred during renewals or upgrades rather than new customer acquisition. Therefore, increasing the length of time customers hold on to existing plans can increase the lifetime value of handset subsidies investment. In many countries, the minimum contract period is two years on average, which tends to give operators enough time to recover the cost of subsidies. The problem comes when consumers cut short their contract in favour of a new contract or terminate it. Incentives need to be provided to customers to delay device upgrading, such as AT&T which doubled its smartphone upgrade fee for those moving up to the new model before the end of their contracts.
Tiered Pricing To Increase ARPU
The main revenue contribution for handset subsidies lies in monthly data plans. Our research shows that majority of the operators tend to give one-size-fits-all mobile data plans and allow unlimited data bandwidth to all consumers. However, this fails to take into account of the higher monetizing potential of heavy data users, which we expect to grow with the ever-increasing number of internet applications made available. Shifting towards a tiered pricing structure enables operators to monetise the data opportunity while providing transparent pricing models for consumers. This has the effect of increasing ARPU from heavy data users.
Reduce risk (discount rate) via reverse subsidies
In the typical model where a handset subsidy is given upfront and operators rely on the monthly subscription fees of customers to recover in excess of their initial investment, the entire risk is borne by the operators. When customers terminate their contract before the committed timeframe, or default on their monthly subscription payment, operators do not generate the expected rate of returns. Reverse subsidies is a concept whereby an initial subsidy is not given selling price of the handset, but rather, discounted from the monthly data plans of the consumers. This does not reduce default risk but increases stickiness through the monthly discount it generates. Reverse subsidies are now being offered by a growing number of operators, including Bharti Airtel, Aircel, China Mobile and China Unicom.
Reduce SAC by sharing cost with third parties or recovering part of it
OTT providers such as WhatsApp and WeChat share in the revenue boom when smartphone penetration increases. Henceforth, operators can explore the option of sharing the cost of handset subsidies with these application providers. Alternatively, operators can also opt to reduce their SAC by requesting the customers to trade-in their old handsets to qualify for a new subsidised smartphone. In this way, operators can recover a portion of their handset costs by refurbishing and selling devices to the secondary market (such as developing markets) or by selling them for spare parts. For example, SingTel offer its customers cash discount on the new handset when they recycle in their old ones during subscription renewal or new purchase. The amount of cash discount given depends on the value of the trade-in device.