Microeconomics Paper: The UK 3G Mobile Broadband Market

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Consult the Examinations section of your course handbook Speak to your course organiser or supervisor Consult the Essential Information for Students p 32-33 Candidate ID 202735 MANAGERIAL ECONOMICS F ORMAL A SSESSMENT TABLE OF CONTENTS Market structure ............................................................................................................................... 2 Demand for 3G Mobile Broadband Services ...................................................................................... 2 Important features of costs ............................................................................................................... 4 Structural barriers to entry ................................................................................................................ 5 Price discrimination .......................................................................................................................... 5 Nature of competitive and strategic interaction................................................................................ 6 VNO Approach for New Entrants .................................................................................................. 7 Incumbent Strategy for protecting the oligopoly from new entrants ............................................ 8 Profitability Assessment of a new entrant to the UK 3G Mobile Broadband Market ...................... 8 References ........................................................................................................................................ 9 Submission Date: August 20th 2008 Word Count 3,712 Managerial Economics Candidate ID 202735 Page 1 of 9 MARKET STRUCTURE The 3G mobile broadband market in the UK provides Internet access to laptops and 3G-enabled handsets - also called smart phones, through the use of the Global Systems for Mobile (GSM) communications family of network technologies. Whilst 3G mobile data traffic is generated by both laptops and 3G-enabled handset devices, because more than 90% of 3G mobile broadband traffic is generated by bandwidth-rich applications used on laptops, the report will focus on the market serving the laptop user as opposed to the smart phone user. Whilst mobile operators have offerings targeted at both business users and consumers, this report focuses on the enterprise market. Business-grade 3G mobile broadband services may be purchased by an individual business user, or procured for multiple users by the IT department. In the case of the latter, the enterprise customer is issued with one invoice covering all users. Prices may be tiered with decreasing per-user rates as the number of users increases. It should be noted that enterprise 3G mobile broadband services must be integrated with virtual private network (VPN) applications which establish a secure tunnel to the private corporate network, over the public Internet. The UK 3G mobile broadband market can be described as an oligopoly, with the four players being Vodafone, T-Mobile, Orange Business Services and O2. The mobile operator 3 also offers a 3G mobile broadband service, but because 3 only targets the very low end of the small to medium business (SMB) market, it is not a player in the enterprise market. With precise market share figures measuring enterprise 3G mobile broadband use on laptops unavailable, the following table shows the number of combined enterprise and consumer, laptop and smart phone 3G devices for Vodafone and Orange, as at June 2008: 3G Mobile Broadband Provider Vodafone Orange O2 T-Mobile Number of 3G devices in the UK (UK combined voice and data mobile customer base)* 4.1 million (18.5 million) 2.452 million (15.76 million) (18.7 million)* (16.8 million)* *UK 3G mobile broadband data was not available for O2 or T-Mobile (Vodafone, 2008; France Telecom, 2008; Telefonica, 2008; Deutsche Telekom, 2008). DEMAND FOR 3G MOBILE BROADBAND SERVICES Demand for mobile Internet and enterprise network access is very likely to continue in growth. Laptop sales surpassed desktop personal computer sales in 2005; end users take it as a given that laptops will be able to connect to the Internet. Flexible working schemes and green initiatives, too, drive demand growth for remote and mobile working, both of which stipulate reliable, broadband Internet access as a pre-requisite to the VPN. Remote and mobile working is no longer restricted to the senior executive. Indeed sales, IT and business support staff who frequently attend meetings away from the office also require reliable Internet access whilst on the move. From a profitability perspective, Vodafone recently reported a net profit of £6.75 billion for the full year of 2008, driven by a 52.7% growth in data revenues (Datamonitor, July 2008). O2, a subsidiary Managerial Economics Candidate ID 202735 Page 2 of 9 of Telefonica, reported a 46.1% growth in mobile Internet data revenues, with data annual revenues per user (ARPU) growth of 10.8% (Telefonica, June 2008). Demand for service offerings targeted at individual business users is more elastic than service offerings for large enterprise customers. Individual business users from the SMB market are typically more price sensitive than enterprise customers, and are more likely to look to substitutes or alternative ways of working should prices rise. Large enterprise customers, on the other hand, have IT budgets to cover remote and mobile access costs. Because these services are typically implemented as part of a larger VPN and/or network solution, enterprise customers are less sensitive to price variations. They are also typically tied into service contracts with penalties for early termination, making switching to other providers less attractive. 3G mobile broadband providers as such enjoy greater customer loyalty and less elastic demand from their enterprise customer base. That said, enterprise customers are also becoming increasingly scrutinising of supplier contracts, and are under pressure to reduce IT costs. With the increasing availability of free or subsidised WLAN hot spots, enterprise IT departments may in the short term limit 3G mobile broadband to senior management and those requiring access to business-critical information resources and software applications. Whilst flat rate pricing applies to network access within the UK, usage-based per megabyte charges usually apply whilst roaming abroad. With bandwidth-rich applications – the synchronisations of e-mail Inboxes in particular generating large amounts of data traffic, roaming charges can accumulate rapidly and lead to unexpected spikes in usage-based roaming fees. Whilst roaming fees charged for 3G mobile broadband have fallen, they remain far higher than the marginal cost of less than 20p per MB. Regulatory pressures may drive the wholesale cost of roaming fees down in the future. However this has not as yet occurred; whilst the EU is considering some form of regulation, the GSM Association maintains that regulation will jeopardise the future of 3G mobile broadband (Ricknas, 2008). As it stands today, the cost of roaming remains the factor with the greatest impact on demand elasticity. For enterprise customers, 3G mobile broadband roaming costs can be offset by using roaming authentication services that integrate a range of wireless and wired broadband together with narrowband (modem and ISDN) access points worldwide. By providing an extensive global footprint of less expensive access methods, roaming authentication service providers reduce end users’ dependence on 3G mobile data networks, and present an attractive alternative to IT departments. Players in this market, however, are small and lack the resource necessary to reach the wider market accessible to incumbent mobile operators. Two players in this market, iPass and Fiberlink, both have a UK active user base in the tens of thousands as opposed to millions. Throughout 2007 and 2008, iPass has seen a decline in the use of their global wireless local area network (WLAN) footprint (iPass, 2008). The growing prevalence of free WLAN hotspots at cafes and gastro-pubs, for example, are eroding the value of subscription-based roaming authentication services. Cheap 3G mobile broadband services provide a more ubiquitous alternative to an aggregated footprint of WLAN hot spots and narrowband access methods. Because ubiquity is a differentiated feature enjoyed by 3G mobile broadband, the growth in free WLAN access is more of a threat to the roaming authentication service providers, than it is to 3G mobile broadband providers. Managerial Economics Candidate ID 202735 Page 3 of 9 The Wireless Broadband Alliance (WBA), too, aims to provide a wireless roaming authentication platform for wireless Internet Service Providers (WISPs). The WBA, however, whilst successful in securing membership from WISPs worldwide, has not in its five year history achieved a commercially viable platform for global wireless Internet roaming. As such, incumbent mobile operators enjoy a powerful market position and do not consider the competition from roaming authentication providers to be an immediate threat. 3G-enabled smart phones such as Blackberries, Symbian and Windows Mobile devices are also a potential substitute for laptop-based 3G services. Presently these are used predominantly for mobile e-mail, but as smart phone applications such as Internet browsing, contacts and calendar management become increasingly feature-rich and user friendly, laptop mobile broadband users may consider smart phones to be a viable substitute. Fortunately for the mobile operators, both laptops and smart phones require the underlying network access. Whilst more smart phones are being shipped with WLAN capabilities, technologies allowing for the seamless handover between 3G mobile broadband and WLAN access methods are still under development for smart phones. As such, 3G-enabled smart phones are seen more as a complementary service rather than as a competing one. In the future, emerging technologies such as Wi-Max may present alternatives for mobile broadband users; however Wi-Max has not matured as a technological standard, and commercial business models have not as yet been presented to the market. Given the relative inelastic demand of enterprise customers, the limited market reach of wireless roaming authentication alternatives, the superior ubiquity of 3G mobile broadband over WLAN and the relative infancy of technologies integrating 3G mobile broadband with WLAN, growing demand for 3G mobile broadband is likely to continue to strengthen the position of incumbents in the oligopoly in the near term. IMPORTANT FEATURES OF COSTS 3G mobile broadband providers have invested large amounts of capital both for the 3G license auctions in 2001, which allocated spectrum for each successful bidder, and for the upgrade of 2G networks to support data on top of the voice and text services. Having made the initial capital expenditure in network deployment, average costs are decreasing with each additional network user and economies of scale have been achieved. With enterprise and consumer uptake of 3G mobile broadband growing, 3G mobile broadband providers are finding that data traffic will soon approach capacity. In the near term, the capacity issue can be addressed by maintaining a balance of enterprise and consumer users, who typically access the network at opposite times. However with aggressive advertising and pricing strategies likely to drive traffic to network capacity, all four enterprise 3G mobile broadband providers will need to increase capacity for the backhaul infrastructure linking mobile and terrestrial networks. Failure to do so will result in diseconomies of scale. As network traffic reaches capacity, end users will become frustrated by a poor connection experience. Already, the mobile operator 3 who targets the consumer market, has been punished by bad word of mouth of disgruntled customers. Managerial Economics Candidate ID 202735 Page 4 of 9 Increasing capacity on network infrastructure is capital intensive and mobile operators will need to recover costs through higher prices. STRUCTURAL BARRIERS TO ENTRY Significant entry barriers are the high cost of deploying a 3G mobile data network and limited availability of licenses. Whilst it is possible to enter this market as a virtual network operator (VNO), it is difficult for VNOs to compete on price because they must generate margin from the service provisioned by an incumbent license holder. As such, VNOs can only compete on service differentiation, which may include sophisticated client software to manage the end user connection, and the management and reporting of mobile connections and devices. Whilst the capital expenditure required to deploy a 3G mobile broadband network will remain an incontrovertible barrier to entry, competing technologies which provide short range wireless access to terrestrial infrastructure will present competition in the future. These technologies include WiMax, an evolution of WLAN, and femptocells, which allow short range access of GSM devices to the same terrestrial infrastructure. PRICE DISCRIMINATION The four 3G mobile broadband providers serving the enterprise market offer various price packages based on the target market, thus demonstrating third degree price discrimination. Target segments are based on two variables, the volume of usage and roaming requirements. Figure 1 below shows the packages offered by Vodafone for different market segments: Figure 1. Vodafone's UK 3G mobile broadband pricing for target market segments (Vodafone, 2008). The term of the contract, whether 12, 18 or 24 months, determines the degree of subsidy for the 3G modem required. Because the market is an oligopoly, price discipline across the market is enforced; UK-centric packages offered by T-Mobile and Orange Business Services also start at £12.77 or £17 per month respectively. Differentiation is established as follows: Managerial Economics Candidate ID 202735 Page 5 of 9 3G Mobile Operator O2 Market Differentiation Strategy Bundled with voice and text, with unlimited calls to UK land lines; entry level pricing starts at £45 per month. UK-centric offering; roaming charges not disclosed Does not allow Voice over Internet Protocol (VoIP) applications such as Skype Bundled with UK only WLAN hot spot footprint; entry level pricing starts at £12.77 per month UK-centric offering; roaming charges not disclosed Highest fair usage allowance of 10 GB per month High end package allows VoIP applications Bundled with UK or global WLAN hot spot footprint; entry level UK pricing starts at £17 per month. Roaming charges included for the Business Everywhere Traveller Most comprehensive global WLAN footprint allows for price differentiation of £45 per month for international roaming package. Pooled usage for more than 200 users offers even lower per user prices T-Mobile Orange Business Services Figure 2. Market Differentiation Strategies for O2, T-Mobile and Orange Business Services (O2, 2008; T-Mobile, 2008; Orange Business Services, 2008) NATURE OF COMPETITIVE AND STRATEGIC INTERACTION At the entry level, price discipline is enforced by the oligopoly. Whilst Vodafone and T-Mobile offer entry level packages starting at £12.77 per month for a 3GB fair usage policy, Orange Business Services starts at £17 with a 5GB fair usage policy. In practise, few users exceed 200 MB per month, so the 3GB and 5GB fair usage policies reflect strategies to maximise gains from trade by extracting value from high-end customers willing to pay more. With O2’s differentiated approach of bundling 3G mobile broadband with voice and text services, entry level pricing starts at £45 per month. To discourage switching and encourage customer retention, all providers offer some form of discount for 24 month contracts, over 12 and 18 month contracts. This may be in the form of modem subsidy or discounted monthly charges. This landscape reflects current under-utilisation of the 3G mobile broadband networks, where 3G mobile broadband providers can offer deep discounts approaching marginal cost. As such, at the entry level, the oligopoly resembles the Bertrand model, where there is excess capacity and additional network users are easily accommodated. Packages targeting high-value customers, however, resemble the Cournot model of oligopoly. With 3G mobile broadband providers anticipating the imminence of demand consuming all available network capacity, prices for high-value customers are set well above marginal cost to help subsidise the cost of increasing backhaul capacity linking the mobile and terrestrial networks. For high value customers, pricing strategies vary considerably; higher margins are justified or concealed by different strategies to bundling, fair usage and roaming. There appears to be disagreement within the oligopoly as to how to maximise gains from high-value customers. To illustrate, whilst Vodafone offers a £95 per month international roaming package, Orange Business Managerial Economics Candidate ID 202735 Page 6 of 9 Services offers advanced centralised device management capabilities and dedicated customer service to justify higher prices. Incumbents are taking one or more of the following measures to deter market entry: Partnering with managed network service providers and systems integrators to become the preferred service provider for larger network and application solutions Bundling mobile voice and text services to simplify procurement and provisioning and to justify higher prices Bundling WLAN hot spot access to present more cost effective wireless Internet roaming services to enterprise customers Embracing complementary short-range, less ubiquitous technologies such as WLAN and WiMax to mitigate the risk of substitution and to prevent capacity issues on the 3G mobile broadband network Developing or acquiring software capabilities to allow seamless integration of different network access technologies Pre-emptively increasing capacity on the mobile network terrestrial backhaul Because of the very real structural barriers to entry, namely the limited availability of 3G licenses, this is an attractive market for incumbents; however they cannot be complacent due to imminent capacity issues and competition within the oligopoly and from emerging technologies. VNO APPROACH FOR NEW ENTRANTS Given that new entrants can only enter the 3G mobile broadband market as a VNO, where they cannot compete on price, the only strategy for a new entrant is to offer bundled, differentiated services to justify higher prices. Re-selling an incumbent’s existing 3G mobile broadband service rebranded for the new entrant is possible, but this would need to be done on a large scale to leverage economies of scale and economies of scope. The new entrant would need the bargaining power of a large existing customer base and a very strong brand to prevent the incumbent from trying to recover the cost of the 3G license through the supplier contract. Virgin Mobile, a mobile virtual network operator (MVNO) in the voice and text market and a VNO in the terrestrial home broadband market, is one player who could possibly enter the 3G mobile broadband market as a VNO. Because of its substantial existing customer base for voice, text and home broadband services, which in fact make use of T-Mobile’s GSM network, it is conceivable that Virgin Mobile could enter the oligopoly and sustain a profitable service by bundling 3G mobile broadband with its other mobile and home broadband Internet services. New entrants without the marketing capabilities or customer base of Virgin Mobile will find it difficult to compete profitably in the 3G mobile broadband market. However Virgin is a brand targeting the consumer market, and as such would be competing predominantly against 3, rather than with the enterprise oligopoly. Enterprise customers consider mobile voice and text providers to be a natural supplier of 3G mobile broadband services. As such, a new entrant in the enterprise market will need to have a very strong brand and substantial customer base to make in-roads against the incumbents. Cable&Wireless is an established player in the enterprise telecommunications market with a substantial existing customer base and extended market reach. By leveraging its new fixed-mobile convergence (FMC) Managerial Economics Candidate ID 202735 Page 7 of 9 strategy, Cable&Wireless could be a credible new entrant to the enterprise 3G mobile broadband market as a VNO. However Cable&Wireless competes against systems integrators and managed network services providers, who are themselves distribution channels for the incumbent 3G mobile broadband providers. As such, Cable&Wireless will face stiff competition in the form of subsidies and margin offered to the channel partners of incumbents. INCUMBENT STRATEGY FOR PROTECTING THE OLIGOPOLY FROM NEW ENTRANTS Incumbents should protect their market position by planning for future technology integrations whilst simultaneously maintaining sufficient capacity to benefit from economies of scale. Whilst a new entrant may offer 3G mobile broadband services as a VNO, the long term threat to the 3G mobile broadband market lies in technology substitutes and wireless Internet roaming services. The incumbents should aim to distribute wireless Internet traffic over both the 3G mobile broadband infrastructure as well as the WLAN and emerging Wi-Max networks. This will mitigate the risk of diseconomies of scale which would result should the 3G mobile broadband network reach capacity. Distribution of traffic across the different networks will also allow for more manageable roaming costs, and present opportunities for more attractive price bundles to enterprise customers for wireless roaming Internet (and VPN) access. Incumbents should also continue their tactics of deterring competition from WLAN and emerging technologies, namely: Develop strong partnerships with managed network service providers and systems integrators who benefit from customer loyalty, to become the preferred service provider for larger network and application deployments. Launch both local and global WLAN hot spot bundles to present more cost effective wireless Internet roaming services to enterprise customers; consider partnering with an established WLAN roaming authentication provider to leverage their footprint. Integrate complementary short-range, less ubiquitous technologies such as WLAN and WiMax to mitigate the risk of substitution and to prevent capacity issues on the 3G mobile broadband network. Develop or acquire client software capabilities to allow seamless integration of different network access technologies in one user-friendly connection manager application; consider partnerships or joint ventures with small software houses specialising in these technologies. Pre-emptively increase capacity on the mobile network terrestrial backhaul to prevent negative customer loyalty and diseconomies of scale. PROFITABILITY ASSESSMENT OF A NEW ENTRANT TO THE UK 3G MOBILE BROADBAND MARKET As applications and services become increasingly bandwidth rich, it is possible that the market for wireless mobile broadband will grow to accommodate both 3G mobile broadband providers as well as integrated wireless roaming authentication providers. With a powerful oligopoly in place, however, new entrants to the UK 3G mobile broadband face many challenges in gaining a share of the market. iPass, the global leader in roaming authentication and enterprise mobility, has attempted to enter the UK 3G mobile broadband market as a VNO leveraging T-Mobile UK’s 3G network; the result is a Managerial Economics Candidate ID 202735 Page 8 of 9 testimony to the power of the incumbent oligopoly. Cumulative 3G mobile broadband card shipments for iPass in the UK for 2008 at the time of writing stand at 463 cards, many of which were given away as part of an aggressive marketing trial programme. iPass now finds itself in a situation of escalating levels of commitment, whereby the re-seller contract with T-Mobile UK is putting intense pressure on the iPass UK sales team to sell iPass 3G Mobile Broadband to help recover the cost of the supplier contract with T-Mobile UK. iPass, with a worldwide end user base less than a third of Vodafone’s UK 3G customer base alone, does not have the critical mass nor the marketing power to take on the oligopoly. iPass has partnered with Cable&Wireless and other carriers to extend the market reach of its flagship Mobile Office service, including the re-sale of T-Mobile UK’s 3G mobile broadband service re-branded as iPass 3G Mobile Broadband. Whilst Cable&Wireless may make progress in extending the iPass 3G Mobile Broadband UK customer base, it may have enjoyed better margins by engaging with TMobile UK directly as a VNO, rather than as a channel partner re-seller of iPass-branded 3G mobile broadband. In summary, the profitability outlook for a new entrant in the UK 3G mobile broadband market is poor; wireless roaming authentication providers would be better positioned to focus on technology integration, client software development, centralised management and reporting and the development of strategic partnerships, as opposed to taking on the formidable oligopoly of the 3G mobile broadband market in the UK. REFERENCES Data Monitor, “MarketWatch: Global Round-up”, Jul2008, Vol. 7 Issue 7, p232-245 Vodafone, News Release, Key Highlights of the Quarter Ended 30 June, 2008 (Vodafone, 2008) p. 12 Telefonica S.A., Quarterly Results, 2008, January to June (Telefonica SA, 2008), p47 Deutsche Telekom, Group Report, January 1 to June 30 2008, http://www.interimreport.telekom.de/site0208/en/kb/geschftsentwicklung_der_operativen_segme nte/mobilfunk_europa_und_mobilfunk_usa/index.php (accessed 10 August, 2008) France Telecom, Management Report, Half Years ended June 30, 2008 and 2007 (France Telecom, 2008) p19 Mikael Ricknas, 2008. “3 wants EU to regulate mobile data roaming charges” in PC Advisor July 28, 2008. http://www.pcadvisor.co.uk/mobileadvisor/news/index.cfm?newsid=13837&ma (accessed 10 August, 2008) Vodafone, 2008. “Mobile Broadband Price Plans,” http://online.vodafone.co.uk/dispatch/Portal/appmanager/vodafone/wrp?_nfpb=true&_pageLabel= template11&pageID=BS_0397 (accessed 9 August, 2008) O2, 2008. “O2 Business Tariffs, Mobile Broadband,” http://businessshop.o2.co.uk/tariffs_index.aspx?x=1&term=18&groupid=29 (accessed 9 August, 2008) Managerial Economics Candidate ID 202735 Page 9 of 9 T-Mobile, 2008. “Business Shop, Mobile broadband plans,” http://www.tmobile.co.uk/shop/business/mobile-broadband/data-plans/pay-monthly/mobile-broadbandlaptop/plans/ (accessed 9 August, 2008) Orange Business Services, 2008. “Orange Business Services, Business Everywhere,” http://www.business.orange.co.uk/servlet/Satellite?c=OUKPage&cid=1135953587219&pagename= Business (accessed 9 August, 2008) iPass Inc., Unified Mobility: Annual Report 2007 (Verdecanna: iPass Inc., 2008), p2 Managerial Economics Candidate ID 202735 Page 10 of 9