Will a Lower Profile Lead to Higher Profits?

Does everybody want to do wireless? At first glance, it seems that way. New wireless services are cropping up at some unusual venues, such as 7-Eleven convenience stores, and bearing non-telecom brand names such as Virgin and MTV. Having spun off its wireless unit in 2001, AT&T Corp. plans to get back into the wireless business now that it has regained the AT&T Wireless brand following the completion of the Cingular-AT&T Wireless merger. Like other wireless service resellers - known as mobile virtual network operators or MVNOs - AT&T will piggyback on another company’s network. Sprint Corp. will be the host, as it has been for Virgin Mobile USA LLC.

MVNOs have been getting most of the attention from media and analysts. But their rise is also changing the business environment for the incumbent carriers such as Verizon Wireless, Cingular, Sprint, AT&T Wireless, Nextel Communications and T-Mobile USA. For them, the MVNOs represent new customers but also potential competitors.

Not all carriers have rushed to embrace wholesale wireless. Sprint is clearly a believer: As of June 30, 2004, more than 10 percent of its customers used its network through resellers, up from just 1 percent at the end of 2001. But Verizon has stuck largely with retail marketing.

Cingular also has been getting some of its recent growth from resellers, but other large carriers don’t distinguish between retail and reseller customer bases in their public reports - a possible sign they don’t see wholesale channels as strategically crucial.

The wholesale business model does have potential pitfalls. The economic arguments for it can be compelling in certain kinds of target markets and with certain types of partners. But carriers have reason to be cautious.

Under the right circumstances, for instance, wholesaling can enable carriers to make more efficient use of their networks and recoup their huge investments in spectrum and equipment.

Partnering with MVNOs is one way to add customers and traffic, especially from target demographic groups that are remote from the carriers’ core retail business.

Growth of MVNOs and wholesaling has been helped by the surplus capacity in many markets. But not all networks are so roomy. In some metropolitan areas, capacity constraints force carriers to balance wholesale opportunities with the need to maintain service quality. That problem is likely to intensify if wholesaling takes off and MVNOs proliferate. Carriers might then need more space for their own growth on the retail side, not to mention the addition of spectrum-hungry services such as data transmission.

Adding customers and features to existing capacity, which is already a sunk cost, is highly efficient. Adding expensive capacity to accommodate a booming MVNO business may not be worth the cost.

Wholesale wireless also promises access to low-cost customers. Signing up a new retail wireless customer isn’t cheap. But acquiring wholesale customers is, at least from the carrier’s point of view. David Sult, a principal with Deloitte Consulting LLP’s TMT Group specializing in strategy and operations, describes the economics: On the retail side, he says, it costs about $400 to add a customer. Monthly revenue per customer averages about $60, while the customer service costs - fulfillment, customer care and other operating expenses - eat up about $50. “So if it costs you $400 to acquire a customer and your margin is $10 a month, that’s 40 months just to break even,” he says.

In the wholesale alternative, the carrier gives up revenue in exchange for shedding costs. For instance, says Sult, the carrier might simply sell wholesale network time at 5 cents per minute to an MVNO that will resell them at 20 cents. It’s up to the MVNO to cover customer acquisition and care costs with that 15-cent margin, with some help from sales of equipment and premium services. The carrier, on the other hand, gets its 5 cents free and clear.

That’s how the wholesale model works in a market where carriers can make deals with MVNOs on carrier-friendly (i.e., exclusive) terms. But a tilt in power toward the MVNOs could reduce that wholesale margin to a point where the carrier would be better off switching to retail. And when the carriers lose exclusivity, they can lose control as well as money. They can lose further if an MVNO goes under, since wholesaling exposes them to larger credit risks in the event of financial failure.

Wholesaling through MVNOs also holds promise as a way for big wireless carriers to reach beyond their traditional business of selling billable (post-paid) service to businesses and consumers with good credit. MVNOs tend to focus on the prepaid market and draw customers through their media-content tie-ins, group affinity and a youth-culture attitude.

When everything goes right, a carrier and MVNO can be perfect complements, selling to their respective target groups without stepping on each other’s toes. That’s clearly the goal being sought by Sprint and the youthoriented prepaid MVNO Virgin Mobile USA, a joint venture between Sprint and Richard Branson’s Virgin Group of companies.

But markets aren’t infinite. At some point, one side of a carrier-MVNO partnership could grow to the point where one party is poaching on the other’s turf.

The main marketing risk of wholesale wireless is cannibalization - stealing your own customers rather than gaining real market share. Michael Doherty, a Bostonbased analyst for the telecom research firm Ovum, says cannibalization “has traditionally been less of an issue because up to now, you’ve seen complementary MVNOs.” But he adds, “Once AT&T is up and running [with its MVNO] and is after the same enterprise customers Sprint is after, then it’s a different ball game. At some point we’re going to see … MVNOs approaching their carrier partners’ audiences.”

Despite the potential pitfalls, wholesale wireless has some strong economic momentum behind it. Until (and unless) spectrum capacity starts to run short, the virtual network option should be available to plenty of newcomers. If MVNOs continue to look for more space on the wireless network, the network operators should continue to have a healthy wholesale market.

To at least some degree, carriers should be able to avert the risks of cannibalization, capacity squeezes and other partnership problems by crafting deals that clearly define (and separate) the carriers’ and MVNOs’ market reach. But it’s impossible to know whether the well-crafted deal of today will look so good - and mutually beneficial - a few years from now. One constant in wireless is rapid, disruptive change. Wholesaling may be just what some players need to adapt to new conditions.

But it’s not for everyone, as can be seen from the choice of at least a few to steer mostly clear of it.

Philip L. Asmundson, a partner based in the Tri-State region, is the deputy managing partner for Deloitte & Touches technology, media and telecommunications practice (TMT). Asmundson has worked with virtually all segments of the communications industry including LECs, CLECs, optic networks, wireless and satellite.

Cingular Closes AT&T Wireless Acquisition

Cingular Wireless completed its $41 billion acquisition of AT&T Wireless in late October after receiving regulatory approvals from the FCC and the U.S. Department of Justice.

Cingular Wireless, a joint venture between BellSouth Corp.and SBC Communications Inc., now has about 46 million customers, surpassing Verizon Wireless as the No. 1 U.S. mobile operator.

The acquisition brings to Cingular service in new areas, including Denver, Minneapolis, Phoenix and Pittsburgh, and positions the company to offer advanced third-generation, or 3G, wireless services, Stanley Sigman, president and CEO of Cingular, told reporters on a national conference call.

AT&T Wireless, of Redmond, Wash., already is offering 3G services in five markets, Sigman said, and Cingular is aiming to deploy the technology beginning in the fourth quarter of 2005.

Cingular announced closing the acquisition after the FCC and Justice Department granted approval with some conditions. Sigman said Cingular must divest assets in 16 markets, which will affect less than 350,000 customers.

All five FCC commissioners approved the acquisition, but the two Democrats, Jonathan Adelstein and Michael Copps, partially dissented.They cited concerns with how the combined company would affect competition in the wireline market. BellSouth, SBC and Verizon Communications Inc., the three biggest local phone companies, also own the two largest wireless carriers, representing more than half of all wireless subscribers, Copps said.