Service Provider Economics

Thursday, June 7, 2007

This is a note on something that I learnt from a colleague.

A lot of us have been annoyed at all those one-year and two-year contracts that we are made to sign when we get a new mobile connection. It can sometimes be perplexing when we are not happy with the service provided, quality of phones etc but then have to wait until the mandatory service period to get over before we can switch.

The bottomline however is that for any business to continue to exist, it needs to be a profit making proposition. And with most basic plans in the market, the carriers lose money if someone quits midway! And here's why-

When someone gets a new service, he/she gets a cool new gadget to go with it at unbelievably low prices. If the same phone were to be bought outside of a service agreement, it would cost us a fortune. So, clearly, the service provider is subsidizing the cost of the phone. The average Cost Per Gross Add (CPGA) or the cost associated with adding a new mobile-line (including the subsidy, cost of setting up etc.) is around $300. This along with the Capital Expenditure (CapEx) per user amounts to around $600. Now, with a $40 per month plan, it would take 15 months to break even! So, then doesn't a 2-year contract now make sense from a service provider perspective? That is when the Average Revenue per Unit (ARPU) is appreciable enough to make a business case. That is also perhaps the reason why most additional services/minutes cost us a lot more than the basic plan itself.

The key thing to take off this note is that the 'percentage churn' or the number of users switching service providers is an important factor for the service provider. If this number is kept low, then all power to the service provider. They will start showing profits. More so if they can keep their customers happy for more than the minimum period. Else, it is a lost cause and no business is philanthropic.

Now you know why the service providers strive for good customer care!

Posted by Vijay Nagarajan at 1:58 PM  

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