Fallacy of Current Cost Accounting Of Data Service at Wireless Carriers

Service pricing at all major carriers betrays the underlying cost accounting method. Even in Unlimited plans, for example the T-Mobile footnote for Unlimited plan says that “…the small fraction of customers using >50GB/mo. may notice reduced speeds until next bill cycle due to data prioritization.” Essentially, the carrier is using GB of data usage as a means of assessing the long term value (LTV) of the customer and ergo, what is economical and what is not. But, GB of data usage based cost accounting isn’t accurate and has consequences going forward.

Why isn’t it Accurate?

It’s isn’t accurate because the underlying assumption is that GB of data usage represent a close approximation of the cost involved in delivering those bits. Cost of carrying the bits can be split into cost of carrying the bits from the customers’ device to the cell tower and from the cell tower to the internet. Cost of carrying the bits from the cell tower to the internet is the same irrespective of the type of device used by the customer. The cost of the backbone data transport pales in comparison to the billions of dollars spent in acquiring the spectrum and constructing the cell towers. So, let’s ignore it for the moment.

Given that spectrum is a scarce resource, cost of carrying bits to the cell tower is based on the amount of spectrum used and the amount of time that the spectrum is used. This isn’t the same across all the devices. The amount of spectrum used is a function of the available spectrum at the cell tower and the quality of the chipset on the device – typically, the more expensive (and premium) the device is, the better the chipset is and the more spectrum it can use at the same time – technically called carrier aggregation. The amount of time spectrum is used is a function of the distance of the customer to the cell tower and also, the quality of the antenna on the device. The less signal the device receives (whether the device is far away from the cell tower or the antenna is bad), the more time the device spends occupying the channel in the spectrum.

Why Wasn’t the Cost Accounting a Problem Before?

Ok, the cost accounting might be inaccurate. Why wasn’t it a problem before?

Pre-2006 when voice was king, there was no carrier aggregation. Mostly, all devices used the same limited spectrum available. The amount of time the spectrum was used was a direct function of the number of minutes a customer used that month. If customer had a crappy antenna or was too far away from cell tower, due to the real time nature of the voice packets, the call quality would degrade. But, the amount of time spectrum is used closely mirrored the number of minutes a customer used that month. So, cost accounting based on minutes of voice calls matched the actual costs very well.

Why is it a Problem Now?

When smartphones took over and data started to be billed by GB, the device subsidy model masked the inaccuracy of the data usage based cost accounting. Subsidy enabled the customers to buy the best phones at an affordable price, which meant most customers had similar and good phones. Also, the better the phone was, typically, the higher the subsidy. So, subsidy amortization and more homogeneous device capabilities masked the cost-price matching problems of the data usage based cost accounting.

What is the Impact?

With the correct cost accounting, network planning teams at carriers will be able to allocate capital for cell tower construction better. The network planning teams can trade-off between capital cost allocation vs. lower operating costs for those customers helped by the new cell towers.

Also, without the correct cost accounting, carriers cannot expect to compete in the hyper segmented world that wireless carrier market soon will be. If the costs are wrong, how can the price be right?

With BYOD coming in a big way and consumers conscious of the cost of the devices, not all devices will be of the same quality. A customer consuming the same amount of data on a device with low quality antenna will have dramatically higher cost than a customer consuming the same amount of data on a much better device. This is why, in the hyper segmented world, the price will be a function of the device as well. A customer using a high amount of data with the latest phone (say, an iPhone X or a Samsung Galaxy S9) might be paying the same as someone with a Moto G. That's similar to the guy with a Ferrari paying the same insurance rate as the guy with Honda Civic! It's still fair because of the different costs they put on the network. In the car world, the vendors wiped that difference by improving reliability. The device vendors can similarly wipe the difference off by ensuring that the antenna is not compromised due to cost.

Unlimited - What Comes Next for the US Wireless Carriers?

The more things changes, the more they remain the same! The wireless market play till now was similar to the dial-ups of old days with data limits and multiple competitors. Could that offer a window into the future of wireless carriers?

A Brief History of Landline Business

The customer access and economics were similar. Service providers had to invest in bandwidth locally, similar to wireless carriers today that have cell towers and spectrum. Customers weren't typically mobile, but, could connect from anywhere. So, service providers like AOL, could service customers anywhere as long as the customers had a local service number the carrier had invested in. Otherwise, it was too expensive for the customers due to the long distance charges. Customers were able to self select initially based on which service provider was cheaper overall. Over time, service providers built capacity across all local service areas.

Two key things that made this a competitive market were regulations that allowed any business to have a local service number and sufficient peer to peer bandwidth (that telephone carriers built) for anyone to provide service. This made the connection commodity. Internet service was the differentiation and the service providers were able to segment their customers based on usage. The more you used, the more you paid. This was the world of wireless carriers till Unlimited came around.

Then came the shorter range technologies such as DSL, cable and fiber that were no longer peer to peer. No regulation was enacted to ensure that local connection was universally accessible. So, anyone other than the service provider that built it couldn't provide an alternate service. Internet was commodity, but, the local connection wasn't any more. Something else had changed. For the service provider, it really didn't make sense to segment the customer based on usage any more. The real costs were based on speed rather than the usage as the cost of carrying bits over long distance became extremely low. Higher speeds required higher investment in the local access infrastructure. So, speed, instead of, usage became the segmentation parameter. This also had parallels to wireless as I will explain later.

Economics of Unlimited

Coming back to wireless, unlimited is tough on the carriers. With spectrum still the primary cost driver and revenue limited to the line access charge, revenues from customers don't match up with the costs of customers that consume disproportionately. With every carrier now offering unlimited, US customers are likely to "super size" on data. Of course, every carriers has come up with a band-aid patch for this with network prioritization over a certain level of usage. That only regulates perhaps the top users of data. Affecting a significant portion of the customers with a low threshold for network prioritization would likely risk customer dissatisfaction and backlash. You can create speed and usage tiers, but, pricing can become quickly complicated. So, what's a carrier to do to match pricing to the costs?

A New Model for Wireless?

Let's now look a little farther away to another retail market. Consider that the service plan revenue is a given and the carriers don't know how much risk a prospective customer presents in terms of network cost. If we consider the service plan revenue as premium and the data usage cost as risk cost, the wireless market looks a lot like a huge market we know very well - the consumer auto insurance market.

Consumer auto insurance companies are able to assess the risk posed by different segments of the population and present a personalized quote to individual customers. The costs are matched to the price, thanks to hyper-segmentation and data analytics on each potential customer.

In a market such as this, it's important for the company to know which customers to bring on and how to get them off the insurance, if the risk profile changes. This is why Progressive has an insurance comparison site - it helps convert prospective customers that fit a risk profile become current customers and later encourage current customers to go away, if they no longer fit the risk profile that Progressive wants to insure. Segment purity might be a key differentiating factor in keeping the churn low - an important factor for investors.

Segmentation and Future of Retail Wireless

Taking a leaf out of the auto insurance market, wireless carriers need to be able to segment the customers based on usage and speed needs and offer the pricing that caters to them. A customer that consumes lot of video presents a different risk profile from a voracious reader of news and e-mail. To be successful, the wireless companies need to be able to hyper segment the customer base, just like the insurance market. This will avoid the morass of ever complicated price offerings.

In a world of such hyper segmentation, each brand might mean different things to customers. One that is known for its customer service will not likely be the cheapest. You might argue that it's true today too. But, retaining segment purity will require the right combination of the channel, customer service, network service and of course, pricing along with the means of identifying the customers that belong to the segment. A carrier going after the urban millenials might have a purely online/ mobile presence, might advertise on social media, might make it easy for the customers to BYOD, focus on WiFi offloading and will look very different from a carrier that is going after baby boomers that might use TV and radio ads, provide phone and store support and provide low cost phones. This is no different from how Esurance or AARP Auto Insurance target their customers. Identifying the customers in the segment requires not just demographics, but, also, data usage and data type behaviors, device ownership etc. This ensures that the discover, evaluate, buy, use, support and exit phases of a customer journey are properly matched to the customer segment.

Unlike auto insurance market that depends on the reinsurance companies to insure the insurance companies, wireless carriers, today, are their own re-insurers. So, that's where the similarity might end. But, the interesting thing about the auto insurance market is that it is a whole lot more competitive than the wireless carrier market. To compete effectively and maintain segment purity, would a carrier need more than one brand - perhaps as many as three or four to ensure a match between customer journey and the segment? Or, a carrier could spin off its retail operation, become a pure network operator (the re-insurer of the wireless market) and let the others duke it out!

An interesting question is what happens to customers when carriers can hyper segment this way? How do the customers compare the service/price combination with their friends? The consumer auto industry again provides a clue: they can't! If they can't, would that lead to more churn or less?

Potential Disruptors

Who could help upend this happy story? Clearly, carriers need help prospecting new customers and understanding their data usage. Nielsen and other data collectors will be happy to help. Retail carriers that can best use predictive analytics to understand the customers will win.

The interesting players are Google and Apple that have a hold on the OS and the underlying amount and type of data. Could they potentially use that information to either stand their own retail carrier or help others compete? Given my previous prediction about Google, you can guess who I think will jump into the fray!

The biggest disruptor, though, might be technology again, similar to how the landline market unfolded.

5G: A Rewind?

5G, as is currently implemented in the US, is based on shorter range frequencies such as 28GHz and 39GHz with the potential of providing up to 3Gbps. But, the range of 5G cells is much lower than a typical LTE cell tower, closer to 200m, not the 20km of LTE. This means only highly urban areas will have dense deployments necessary to enjoy the high throughput. Coverage will vary wildly across the US. It will take a long time for a country like the US to attain 5G coverage similar to that of LTE. Countries such as Korea and Japan that are highly urbanized would have much better coverage than a country such as the US. As with the shorter range technologies in landline, 5G will have a profound effect on the cost of mobility. Will 5G change how the industry evolves in the short term?

So, What Comes Next?

My bet is that, in the US, 5G adoption will not be fast enough to impact the industry forces discussed before. So, I expect that the US wireless market will evolve into hyper-segmented multiple brands within the next four years before 5G could ever become dominant.