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A Floor Price would Floor Indian Telecom

Compete, don’t complain

by: - Last updated on: July 13th, 2017

Jio’s free service from September to March has left quite a number of telecom operators annoyed. The results of Jio’s free services can be seen on the balance sheets of most telecom operators that are either earning vastly lower profits than before or are in a loss. Small wonder then that most incumbent telecom operators are asking for protectionist measures from the Government.

floor pricing
Image: FactorDaily

There are two demands that these incumbent operators have. The first includes reducing taxes on the industry and extending the timeframe within which telecom operators can pay for their spectrum purchase. We think this is a very reasonable demand as the telecom industry in India is one of the most highly taxed industries and extending the spectrum payment timeframe would result in the Government receiving the same payment from operators over a slightly longer timeframe but would help operators cut on debt to quite an extent.

The second demand is, however, quite controversial. The incumbent telecom operators want the Government to set a floor price for selling voice and data services – no telecom operator should be allowed to price their services below the floor price. The argument of the incumbent telecom operators is that since Jio is backed by the cash-rich RIL, the company is indulging in predatory pricing and hence affecting the financial health of the entire industry, which is making it difficult for the incumbents for invest in their networks. A floor price, according to these incumbents, would help in keeping the telecom industry in good health. However, we think that this could end up being disastrous for the telecom industry in the long run.

I have mentioned this several times before – the cost of running a telecom network at a particular QoS and coverage is more or less the same for any company operating in a particular geography. Considering the number of rules and regulations that surround the telecom industry, there is little that a telecom company can do to have a vastly different cost structure than a competitor. There can be some savings in the form of capital expenditure by buying different types of spectrum or striking deals with different types of telecom equipment vendors or low-cost backhaul, but more or less, the operating expenditure of running a telecom company is the same for a particular level of QoS and coverage.

floor price

The technology that telecom companies make use of is not even developed by them. There are standard setting organizations (SSO) such as 3GPP that develop the latest generation of telecom technology. This standard/technology developed by SSO such as LTE or WCDMA is then incorporated by a handful of telecom equipment vendors such as Nokia, Huawei, and Ericsson. Telecom companies then go on to buy the equipment from them and deploy it on their towers or towers that they have leased.

So the cost of running a telecom network is more or less the same as every operator is using more or less the same technology. What then defines the profitability of a telecom operator is its revenue. In most cases, revenue is dependent on just two criteria, namely subscriber base and average revenue per user (ARPU). For most telecom operators, multiplying the subscriber base with the ARPU gives the revenue of their mobile operations.

When a new operator enters the telecom sector, they need to compromise on the ARPU front so as to gain subscribers. The most effective tactic to attract customers towards a new telecom operator is to provide cheaper prices. The cheaper price helps the new telecom operator gain subscriber market share, after which it gradually starts improving its ARPU as well. When a new telecom operator enters, the existing incumbents have two choices. They can either reduce their rates to match the entrant and reduce their ARPU or they can lose their subscribers while keeping ARPU constant or by increasing it.

Put simply, the elasticity in terms of ARPU and subscriber base is what helps telecom operators remain competitive and keeps the competition going. Putting a cap or restricting the elasticity of subscriber base or ARPU can have a detrimental effect on the competitive intensity of the industry. Having a pre-determined floor price would end up freezing the ARPU of the industry.

Most Indian telecom operators already work at razor-thin margins and it is essentially their volumes that help them remain profitable. If the Government would set a floor price, then it would inevitably set it up in such a manner that on a unit level, the floor price would be gross profitable. The incumbent telecom operators given their scale would be more than happy to match the floor price.

When all telecom operators match the floor price, then the potential ARPU of the entire industry gets fixed. If all telecom operators price their voice, data and SMS packs at a certain amount, then that essentially fixes the ARPU of the entire industry. With the ARPU thus fixed, the revenue of telecom operators would essentially end up being a function of the subscriber base. The incumbent telecom operators would in these circumstances naturally end up earning more revenue than a new entrant or a smaller telecom operator, thanks to their large and relatively healthy subscriber base.

Considering that the incumbent telecom operators would be earning more revenue, their profits would also be higher as the cost of operating a telecom network at a particular QoS and coverage is fixed. The higher profits of the incumbent telecom operators would then allow them to invest in newer technologies while the smaller telecom operators would struggle to compete.

Put simply, a decision to create a floor price would inevitably restrict the ARPU. This would lead to a scenario where the incumbent telecom operators keep getting stronger while the smaller ones keep getting weaker. After a particular period of time, the only operators to survive will be the ones with the largest subscriber base namely Airtel, Vodafone, and Idea while everyone else fades away, and it would no longer make sense for a newer telecom operator to enter the fray. This would lead to oligopolies that would have the least interest in competing with each other which would lead to lower quality customer service and reduced network spending.A big reason why Airtel’s Sri Lankan operations failed was because of floor pricing. The Sri Lankan telecom regulator had issued a floor price below which no operator could price their services, and since Airtel was amongst the smaller operators in Sri Lanka, this meant their operations became unviable as time passed, and are now on the verge of being shuttered or merged with someone else.

If the Indian regulator (TRAI) is genuinely interested in maintaining competition in the telecom sector, then it needs to keep a keen eye on mergers and alliances (M&A.) The number one metric that determines the competition in the telecom segment is the sheer number of operators competing with each other. With the entry of Jio, a number of operators have either sold their operations or merged with each other. While some of the operators that left (such as Telenor and Videocon) were simply too small to matter, mega-mergers like Rcom-Aircel and the Vodafone-Idea merger need to be scrutinized more carefully so as to ensure that the competition in the telecom sector remains healthy. There need to be strings attached with these mergers that either help smaller operators piggyback on them or allow MVNOs to enter the market easily. However, this is not being done.

Competition of the level brought in by Jio might make life uncomfortable for existing players but it benefits the consumer and indeed the industry itself in the long run. Putting a floor price would hamper this. At the end of the day, one of the core requirements of an open market is minimal Government intervention, and this is what the incumbent players would do well to remember.

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