Editor’s Note: Welcome to Reality Check, a feature for RCR Wireless News’ new weekly e-mail service, Mobile Content and Culture. We’ve gathered a group of visionaries and veterans in the mobile content industry to give their insights into the marketplace. In the coming weeks look for columns from Mark Desautels of CTIA, Laura Marriott of the Mobile Marketing Association and more.
For the entirety of my career in the wireless space, I have always worked for a small company selling something to or through wireless network operators. As such, I have made a good number of friends who work at these various carriers. I have observed that the most reliable way to get their dander up is to casually insert into the middle of any conversation, “Well, it doesn’t really matter because you are eventually just going to be a dumb pipe anyway.” Then I sit back, sip my mojito and watch the ensuing rant. Fun times.
Last week I tried this with a friend of mine who works at a carrier, and he said, “I prefer to think of it as ‘an open marketplace of ideas and innovation.” This got me thinking. First off, my friend is absolutely correct: When cast in a slightly different light and without the derogatory descriptor, a “dumb pipe” has the potential to be a very good thing. Could a major wireless carrier flip a switch to full “dumb pipe” mode and in so doing, take massive operational cost out of their equation and increase their value overnight?
Baseline
I started by looking at the financials and structures of some of the world’s largest wireless carriers. I could have used any of them as a model, but for my exercise, I happened to use Sprint’s publicly available financials from 2004 which I found to have a very readable structure and some useful details.
At the end of 2004, Sprint had 24.7 million wireless subscribers, 7.7 million of which were also data subscribers. Here is the revenue and margin analysis for that year: (numbers are in millions)
| Net Operating Revenues | $ 14,647 |
100% |
|
Operating Expenses |
||
| Costs of services and products | 7,096 |
48.4% |
| Selling, general and administrative | 3,406 | 23.3% |
| Depreciation | 2,557 | 17.5% |
| (includes amortization) | ||
| Amortization | 6 | |
| Restructuring and asset impairments | 30 | .2% |
| Total operating expenses | 13,095 | 89.4% |
| Operating Income | $ 1,552 | 10.6% |
| Adjusted Operating Income | $ 1,577 | 10.8% |
| Adjusted EBITDA | $ 4,140 | 28.3% |
These are solid financials, and a 10% operating margin is quite respectable. Here is some other important data:
- 26,288 employees
- $557,000 in revenue per employee
- $2.5 billion in capital expenditure
- ~$62 ARPU
- ~15,500 retail sales outlets
- 800 branded stores and kiosks
- 17.5 million direct customer base
The gross add distribution mix is interesting and also an important part of the analysis:
Stores and kiosks: 38%
Alliance partners:22%
Other direct: 18%
3rd party national/local: 22%
So now let’s make some assumptions and do some back-of-the-envelope math. First, I define “dumb pipe” as “branded access” with the closest analog being an ISP. I also roughly estimate the employee functions into four buckets, and used percentages based on anecdotal information from a few sources at different carriers:
Salespeople 20%
Customer Care 40%
Networking Operations 25%
Management and HQ 15%
Analysis
Now then, how would turning a present-day carrier into what would essentially be an ISP change our key metrics? First of all, all the company-owned stores and kiosks would close. (Have you ever seen an EarthLink store?) This is not to say that all the salespeople go away, but there would be a shift to consumer commodity sales practices, relying more heavily on retail channels like big box retailers. Direct sales would be limited to large accounts and “1-800” ordering. Let’s say roughly half of the sales personnel go away. The effect to overall sales would be negative, so that means 38% fewer gross adds, which shrinks the subscriber base.
A smaller base would obviously mean fewer customer service reps, but how else might that cost be affected? I will assume a “Bring Your Own Phone” model, where all phones are unlocked, the consumer buys it at full price and chooses whatever carrier they want. It is reasonable that the large percentage of calls to customer care having to do with the device itself will go away, or more to the point that the carrier will make them go away through effective communication and education.
Furthermore, our “dumb pipe” carrier will push “no-frills” plans for people who are smart enough to operate their mobile phone most of the time and don’t need to call customer care. I will further assume the large number of all calls about the application they downloaded that won’t work will go away, because there is no storefront and no editorial function. Billing issues will still arise, so let’s say we cut our customer service reps by 50%. This will also mean all the business development and product people who deal with application publishers and content providers will go away. So we can cut a few people out of HQ. Network operations basically stay the same.
The marketing expense of any current-day carrier is very large, and typically consists of an ongoing national television branding presence, an ongoing print presence and channel support. Given our reliance on channel partners now, I think I will keep the national television spend, kill the full-page newspaper ads and shift that part of the budget to in-store support, cutting a conservative 25% of our billion dollar budget in the process. I am also dropping the consumer price and killing the myriad incremental price plans. I like $50/month, all you can eat.
To summarize, we would lose 38% of our gross adds, bringing the total subscriber base down to 24.2 million. Total revenue obviously decreases given our new, lower price and smaller base. I lowered the COGS (cost of goods sold) to reflect the historical 48% range then took our marketing savings ($250 million) off the top. I took our cost savings on sales, customer care and management (32%) out of SG&A (selling, general and administrative expense). To be thorough, I upped our restructuring to $100 million to cover severance, etc. Here is what our new financials look like (in millions):
| Net Operating Revenues | $ 12,100 |
100% |
|
Operating Expenses |
||
| Costs of services and products | 5,558 |
45.9% |
| Selling, general and administrative | 2,316 | 19.1% |
| Depreciation | 2,557 | 21.1% |
| (includes amortization) | ||
| Amortization | 6 | |
| Restructuring and asset impairments | 100 | .8% |
| Total operating expenses | 10,537 | 87% |
| Operating Income | $ 1,563 | 10.6% |
| Adjusted EBITDA | $ 4,126 | 34% |
Conclusion
It really is not a compelling case. I shared this scratch analysis with a few friends who work at carriers, and they all agreed that it roughly made sense. I fully expected there would be more cost savings and more dramatically improved margins. The most interesting thing to me is that the bottom line is virtually unchanged in this exercise. Wireless carriers are generally very well optimized. The problem is that this is a very capital-intensive business. COGS and Depreciation are the big costs, and they are due to the high cost of spectrum, network equipment and operations.
You may contact Shawn at shawn@intercastingcorp.com. You may contact RCR Wireless News at rcrwebhelp@crain.com.
