The Evolution to 4G LTE – For Customers, It’s great; For Carriers, Profitability still matters!

With more wireless connections than people in the US (104% penetration rate)¹ and an insatiable appetite for data-enabled applications and devices (data traffic increased 110% from 2010 to 2011)¹, Carriers have a huge incentive to roll out higher bandwidth 4G LTE networks. The nation’s 2 largest carriers, Verizon Wireless (~108MM subscribers) and AT&T Mobility (~103 MM subscribers) have already taken the lead. The other carriers including T-Mobile, US Cellular and Sprint-Nextel (with WiMax) are also moving fast. Of course Customers are excited, but Carriers need to take a hard look at their Business Models, especially their Operating Revenue and Expense structures. Looking at the financial performance of both Verizon and AT&T in 2011, it is obvious that they are struggling, with significant reduction in their Operating Income. This article analyzes the decline in their performance and identifies the steps Carriers should undertake to remain profitable.

Verizon and AT&T – Operating Revenues, Expenses and Income:

Analysis:

Although both Verizon and AT&T have increased their Total Operating Revenues by 5.03% and 1.97% respectively, a significant increase in their respective Operating Expenses led to a decrease in their Operating Income. Excluding their unique activities (Verizon’s acquisition of Terremark and AT&T’s loss with its failed acquisition of T-Mobile) that adversely affected their Operating Expenses, there are striking similarities that inflated their costs. Some specifics:

• Verizon Wireless – The sales of smartphones (Apple’s iPhone 4/4S) and other data-enabled devices are accompanied by higher average commissions which in turn increased selling costs. Further, the increase in data consumption (by 40%) has led to an increase in local inter-connection costs for the existing Evolution Data Optimized (EV-DO) network and Ethernet facilities costs, both of which augment the 4G LTE network.
• AT&T Mobility – The expense increases were primarily due to higher smartphone handset costs (driven by higher commissions) and higher Universal Service Fund (USF) costs. Increases in advertising and support expenses also led to an increase in costs. Finally, network system, interconnect, and long-distance costs increased substantially due to higher network traffic (increase in data consumption by 23%), recurring personnel-related network support costs and leasing costs.

To summarize, both the carriers are struggling with the increases in costs associated with selling data-enabled devices as well as maintaining huge, expensive networks. In fact, this is typical for the other carriers in the industry. The Wireless Telecom industry is characterized by high upfront Fixed Costs (large CAPEX associated with rolling out the 4G LTE networks) and low Marginal Costs (the cost of adding a new subscriber is almost zero). Consequently, carriers must ensure that Average Revenues from customer remain well above the Average Total Costs of serving them.

So, what should Carriers do?

Focusing on traditional cost reduction initiatives such as improved Supply Chain Management, decommissioning legacy billers, Business Process Re-engineering/improvement etc. is essential and must be undertaken in a quick, coordinated fashion. However, these initiatives are just not enough to sustain profitability. Carriers need to orient their fundamental business models towards better satisfying customers’ (Enterprise and Retail) needs. Here a few critical Action Items:

• Develop a customer-centric business model – Stop segmenting markets on the basis of Wireline/Wireless customers and geographies. Instead, focus on each segment’s (Enterprise/SMB/Retail/Government/Wholesale etc.) holistic communication needs and develop relevant solutions for each segment.
• Develop Core Objectives – Develop realistic objectives by benchmarking them vis-à-vis competitors. Also, focus on key metrics such as contribution margin per product, the average costs of acquiring a customer and serving a customer.
• Rationalize the product/service offerings – Don’t inundate the market with dozens of products and service plans. Have fewer offers that satisfy the needs of a majority of customers in each segment. Encapsulate the heterogeneity in demand by bundling products.
• Streamline Operations – Focus all the resources and activities toward satisfying the needs of each segment in a manner such that competitors find it hard to replicate. Continually anticipate customers’ needs and keep the organization nimble enough to meet those needs.
• Monetize the network – Upgrade the network (backhaul) to an all-IP network and retire the legacy networks (ATM, Frame Relay etc.). Besides reducing Operational and Maintenance costs, this would enhance focus on the monetization of network.