One of the most controversial topics recently discussed in the political scene in Germany is the proposal by the German Ministry of Transportation to introduce a toll fee for passenger cars in the country.
In Germany until now, passenger cars pay no toll on roads and motorways. With about 60 million registered passenger cars and over 12.000 km of motorway infrastructure (‘Autobahn’), there is probably no other country worldwide that lets passenger cars take advantage of so many kilometres of roads for free and without any kind of toll.
This is about to change once the Ministry receives blessing for its proposal from the political landscape in Germany. Obviously, many aspects have been fiercely discussed already, ranging from legal issues regarding compliance with EU regulatory laws, to concerns on data privacy through to the question of the overall economics of the new system.
Obviously the SMS business has been a cash-cow for mobile operators for close to 20 years now, and it was high time that something happens to shake-up the status quo. This seems to be exactly what the WhatsApp team has managed to do. No surprise that it didn’t get unnoticed. On 19th February 2014, Facebook announced that it had agreed to acquire WhatsApp, a 50-staff company, for $19 billion (about 20% in cash and the rest in equity).
This looks mind-boggling at first. But WhatsApp currently has 450 million (mobile) users world wide. Also, in view of recent social media transactions, the pricing of the WhatsApp acquisition does not look so crazy. Sure, the Zuckerberg ‘kid’ and his shareholders must know what they are doing?
Back in the early 1990s, I used a Cray2 computer. Only 27 of them were made and sold worldwide, for a price tag of $17m (per unit), or about $30m in 2014 dollars.
Since its commercialisation in 1985, the price of the Cray2 computer has gone down by a factor 100 000, equivalent to -35% per annum. Its form factor has also changed a bit.
Believe it or not, the iPad2 (2011) is as powerful as the Cray2 computer of the late 1980s. Its commercial success has also been larger: tens of millions of iPad2 have been sold so far. And it is still selling.
We are often asked how high the cost of churn to service providers really is. As often in economics in general, and costing in particular, it really depends how you look at costs and value, i.e. whether you focus on the direct costs only, or include the indirect costs as well.
The direct costs of churn mostly include:
- the SIM card costs (not much these days, but you might want to consider the fully loaded costs i.e. the sourcing, logistics, packaging, and all other costs directly associated with the SIM card, including staff costs)
- the SAC (subscriber acquisition costs), including marketing, advertising and commission of various sorts paid to the acquisition channel (indirect sales) as well as the fully loaded costs of the direct sales channel
- a portion of the SRC (subscriber retention costs), as ‘retention’ money is certainly spent on subscribers who none-the-less decide to leave.
All in all, the direct costs of churn will typically be in the range of $20-$100 per churning customer (depending in which country you are, and how much you spend on acquiring customers).
Truth be told, you don’t need a Ph.D. in data mining or statistical analysis to reduce churn. Which is good news.
Truth be also told: investing tons of money in data mining tools does not guarantee success – more often than not, it guarantees failure.
Churn reduction is a complex process. There are many reasons why it can go wrong, and from our discussions with telecom service providers, it seems to go wrong most of the time. Why is that?
There are two main mistakes that people do when they calculate the CLV. The first one is to simply multiply the customer ARPU by the EBIT margin of the company to estimate the customer profitability in a given month. This is quite bad, but the second mistake is a lot more worse: some people forget about customer churn i.e. they assume that the customer will remain a customer until the end of time. Or if they do assume customer churn, they assume that the probability that a customer churn is constant over time (and independent of the customer); in essence, they use a model of customer lifecycle and customer churn that is totally inappropriate for telecom service providers in a competitive environment. If you want to do better than most, then keep reading until the end of this article.
Comparing prices with costs is a most enlightening exercice. Unfortunately, service costing being as much an art as a science, many telecom service providers don’t do much service costing; and as a result, they don’t understand their service costs and their sources of profitability well enough.
In many cases, prices for telecom services are set too low by the marketing team. Under pressure to gain new customers and increase market share, setting low prices is certainly one of the easiest strategy to implement for new entrants. The thinking is the following: “in our business, almost all costs are fixed, so we need to build up market share quickly to reach profitability” (true) and “we have to be cheaper than the competition” (false) as well as “the marginal cost of our services is zero, so we can price our services very low” (false).
In the telecom service provider business, more than in any other business, most costs are fixed in the short-term. However all costs are variable in the long-term. If most costs are fixed in the short-term, this does not mean that the marginal costs of services are zero. In particular, for prepaid customers, commissions have to be paid to the sales channels (e.g. dealers) typically as a percentage of scratch card value. Also, off-nets call lead to interconnection charges.