The true cost of churn

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).

Not all customers are created equal: price discrimination in telecoms, and in coffee shops

Believe it or not, there are plenty of similarities between coffee and telecoms services (voice, data). Both are largely commoditised product. Then it shouldn’t come as a surprise that telecoms service providers and Starbucks have so much in common. For a start: discrimination. Price discrimination.

Price discrimination in telecoms (and in coffee shops)

There is plenty of price discrimination around us. People don’t pay the same for essentially the same goods or services. If that sounds unfair, then think of ‘discrimination’ as ‘differentiation’ instead. Economically speaking, price discrimination is often socially optimal as:

IBM whitepaper quotes Investaura and the work that we are doing to reduce service provider churn

Investaura is pleased to appear in one of the most recent IBM whitepapers:

 Harness the power of data and analytics to maximize the value of each customer

Download “Smarter Communication through Analytics” 04-Smarter-Comms-through-Analytics-WirelessWireline.pdf – Downloaded 727 times – 3 MB

This excellent whitepaper highlights how mobile and fixed line telecoms service providers can leverage the data that they have about their customers to reduce Churn, boost ARPU, reduce Costs, and overall increase the Customer Lifetime Value (CLV) of their subscribers.

We also agree with IBM that four key components are required to make this enterprise a full success:

Winning the war against churn: how to use churn prediction techniques to improve customer retention

There is no question that churn is the plague of the telecom industry.  In the mobile business, annual churn rate of 20%-30% are standard.  In developing countries, churn can be as high as 60% per annum.  Do you know any other industry where companies lose 20%-60% of their customers between the 1st of January and the 31st of December?

High levels of churn are the results of both the supply-side and demand-side peculiarities of telecom service providers.  On the supply side, operators engage in intense marketing activities, launching new tariffs, handsets and promotions on a continuous basis to lure end-users to their own service offering. On the demand side, barriers to switch are very low: SIM cards are mostly free, prepaid customers usually do not have to provide much information, and in countries where Mobile Number Portability has been implemented, customers can take their phone number with them to their new service provider.

But if churn is the plague, you don’t have to be fatalistic. Tomorrow’s winners will be service providers that better understand what customers want and better anticipate how customers will behave. This applies to churn as well and raises questions such as: can we forecast which customers are likely to churn in the near future? Can we explain churn? Can we retain customers who are about to churn?

Yes, we can. Churn can be reduced, and should.

Impact of Churn prediction and Micro-campaigning (Source: Investaura, Lumata)

Are you calculating the Customer Lifetime Value (CLV) correctly?

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.

What does service costing bring to pricing?

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.