How can carriers make 40% EBIDTA margin at 2 cents/min tariff?

operators

The mobile tariffs vary a lot across the globe and in some countries it could be as high as 35 cents/min. However, Indian carriers have consistently delivered over 40% EBIDTA margins at a tariff less than 2 cents/min. This article presents a case study on how Indian operators manage high returns at such low prices.

Situation: India has the second highest subscriber base after China at 350 million. The telecom sector was thrown open to private players in 1995 with the launch of mobile services. At the time of launch, the tariffs were very high at 50 cents/min for outgoing as well as incoming calls which meant that only 2-3% top income individuals could afford the service. Gradually competition was introduced in the Indian market and soon it was clear that volumes only could bring profitability to carriers. The number of players in each telecom circle went up from two to four to seven in 7-8 year’s time. At the same time, CPP (Calling Party Pays) and IUC (Interconnect) regimes were introduced in the country resulting in free incoming calls. As competition grew, the focus shifted to mass market and the tariffs started to come down. Indians responded well to the tariff drops and soon India emerged as the fastest growing market. The chart (fig 1) below shows the how the fall in tariff led to high growth.

History of Indian Telecom

Indian carriers were clear that they need to reduce tariff to stay ahead of the competition and the mobile services cannot remain a niche service. They followed the following seven steps to attain their aim:

Paradigm shift from ARPU to revenue per min – Indian carriers stopped looking at the ARPU as one of the performance measures. They started considering themselves as the producers and sellers of minutes. Hence the new metrics emerged like the revenue per min and the cost per min. This meant that they needed 40% margin on every minute they sold to achieve the objective of 40% EBIDTA margin. Once they defined the tariff per minute that they could realize from subscribers, they got the target for cost per minute. I would rate this single change in the mindset as the biggest game changer

Outsourcing non-core activities like IT, network – The Indian carriers created many firsts on their journey of cost reduction. Network was considered as a core function of any operator but in the quest of reducing the cost, the Indian carriers outsourced their networks in the year 2003 to the companies that best know how to manage the networks. They roped in companies like Ericsson, Nokia Siemens to manage their networks. Multi-year managed network deals were struck that guaranteed continued business to the network companies at a low cost. It was a win-win situation for both the entities. The carriers managed to change the cost type from fixed cost to usage based costing (based on erlangs per min) and more importantly, they managed to scale up their networks faster on consumer demands. The managed service companies charge on the basis of peak capacity (in erlangs) and the carriers are free to utilize it as they wish. This has resulted in creative tariff plans like night calling to make the traffic pattern more uniform and reduce the peak load. As with any outsourcing deals, the cost came down significantly with enhanced efficiency. Later the carriers emulated this strategy in the area of IT and call centers. Companies like IBM are entrusted with the responsibility of scaling up the IT infrastructure as per the changing needs of the carrier. The deals managed to make the IT cost a variable cost normally at ~2% of the gross revenues. These deals gave the carriers a chance to fight against the best of the world. After the outsourcing of the call centers, the next likelytarget function for outsourcing could be customer activation and service provisioning. In the end, the carriers would have the responsibility of just managing and owning consumers. Who knows, even that could be outsourced to MVNOs!!!

Focus on Prepaid – The carriers in India have focused on the prepaid market (currently over 99% of new additions are prepaid and over 93% of base is prepaid). Prepaid has a lower cost structure and lower channel commissions which means lower cost to the carriers.Currently, the prepaid card is much more attractive in terms of value than postpaid. Postpaid is currently being subscribed only by corporate connections as a bill is required by corporate. Higher prepaid proportion means lower billing costs, lower bad debt and even lower customer service delivery cost as prepaid customers are much less demanding when it comes to service. The flip side to this is that the churn (3% of base every month) is very high as the loyalty is low amongst prepaid subscribers. The acquisition cost being low, this is not yet pinching the carriers but I believe soon the focus would shift to consumer loyalty

Economies of scale – With falling tariffs, the subscriber net additions started to jump (a mind boggling 15 million subscriber net additions in Jan’09 in India). This ensured that the operators reap the benefit of economies of scale. They started to reduce the tariffs even further filling up the network with minutes. Since the cost increase was in steps due to outsourcing deals, the cost per minute started to fall faster than the revenue per minute and hence the EBIDTA margins stared to increase

Infrastructure sharing – Virgin Mobile may have introduced the concept of site/infrastructure sharing but it is the Indian carriers that followed it with whole heart. Currently, over 40% of the total sites in the country are shared with an average tenancy of over 1.5 per site. This has resulted in huge savings in network running expenses. The operators are now willing to share active infrastructure if the Government so allows. There is strong co-petition in the Indian market

Low cost distribution, e-Charge – carriers developed the low cost distribution model keeping the channel margins low and compensating the channel by way of volumes. They also focused on reducing the transaction costs and India was one of the first few countries in the world to introduce electronic recharge. The electronic recharging eliminated the need of the paper coupons thus reducing the need for multiple stock keeping units at the retail level. This resulted in lower cost to the carrier and low working capital requirement for the channel and on top of this, there were no stock out situations as well. In 2005 itself, electronic recharge was over 85% of the total recharge in the market. The electronic recharge facility helped carriers introduce micro-charge which exploded the market. The recharge could be done with a value as low as 20 cents. This resulted in higher usage leading to further reduction in cost on account of spreading of costs over a larger number of minutes.

Low Acquisition cost (no handset subsidy) – In India, the handset is not sold along with the SIM card. The handsets are distributed and sold separately by the handset vendors. This significantly reduces the requirement of working capital and other inventory carrying costs. The carriers can have a much leaner organization with no handset subsidy burden. In a country like India, where there is no social security number and enforcement agencies are weak, the bad debt should be significant for carriers. Carriers did a smart thing by staying away from the handset subsidy game.

The regulatory framework has been very strong in India and has continuously ensured lower tariffs and consumer interest safeguard. This ensured that the tariffs are transparent (though they are far too many!!!). Regulators also ensured sufficient competition in the market and are in fact planning to introduce mobile number portability soon. They recently awarded licenses to 4-5 new players in each circle taking up the number of players in each circle to 12. This would mean that India would be by far the most competitive market in the world.

All the above initiatives led to tight Opex control by carriers which are reflected in their cost structure (fig below).

operator-opex

Though the cost structure does not throw light on the absolute cost, the cost distribution when compared to other carriers in the world can provide ample pointers to the areas of cost reduction that the carriers in other countries can focus on. Indian operators are on the lookout of acquiring other operators in Africa and Middle-east as they believe that they can replicate the Indian experience there as well. The economies of scale may not be present in smaller markets but does it not call for cross-border consolidation especially in Europe? I am sure that if follow the simple steps of the Indian carriers, the consumers in the other parts of the world may soon enjoy the low tariffs as they are there in India

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23 Comments on "How can carriers make 40% EBIDTA margin at 2 cents/min tariff?"

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arvind
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arvind
7 years 2 months ago

hey

i am not quite sure of the economies of scale part. as you outsource most operations and reduce ur capex , u hardly are left with any assets to leverage upon .how does then scale improve the margins ?

thx/arvind

Anonymous
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Anonymous
6 years 2 months ago

On the opex part

Mohit Agrawal
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Mohit Agrawal
7 years 2 months ago

Hi Arvind,

The point on economies of scale is that the operator needs to pay a fixed amount for a given peak capacity utilization. If it does not use it fully, its cost per min goes up as minutes of usage is the denominator. Increasing minutes would lower the cost per min. Also, the distribution cost, personnel, marketing and other costs would depend on the scale. Hope it clarifies.

Regards,

Mohit

Ankush Bansal
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Ankush Bansal
7 years 2 months ago

Hi Mohit,

Very nice article.

Just one point in “Focus on Prepaid” section:

Don’t you think that with Number Portability around the corner and with more licenses already given to new operators, the customer churn would be more as the brand loyalty will definitely decrease once this is implemented.

Even as of now the churn is around 3% which is substantial, but once number portability happens, this figure can rise. So i believe along with focusing on new customer acquisitions, the operators have to start focusing on retaining their base in pre-paid segment.

Regards
Ankush

Paul Singh
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Paul Singh
7 years 2 months ago

Great article Mohit

SVN Arvind
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SVN Arvind
7 years 2 months ago

Hi Ankush,

I tend to agree with you on the issue of customer retention in prepaid also. I think operators need to have a mindset change and start looking at the total customer lifetime value instead of just subscriber acquisition.

It is going to be more critical as the new subs are coming from rural and low income urban segments with low ARPUs.

Unfortunately, analysts till recently have been only talking about net adds. This is changing now with focus on profitability and we should see more activities on retaining customer base from the operators.

Regards
SVN Arvind

Ankur Lal
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Ankur Lal
7 years 2 months ago

Great Article. very nice website!!!

Do you know how the prepaid revenue is accrued in the operators books. Since 99% is prepaid – this could be significant – 70 – 80% of their total revenue. Do they book it on sales, or they actually book it on usage.

Ankur

vijay
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vijay
7 years 2 months ago
Dear Mohit, Real interesting article and thanks. While I agree with the factors listed out by you that have helped to reduce the tariff rates to the lowest possible in the world thereby mutually benefitting the customer as well as the operators themselves. But I still feel there is great scope to further reduce the rates which I expect one of the operators in India to initiate as has been done with “Nano” that will change the dynamics in the Telecom Industry globally. Thrust of the tariff reduction is yet to come in India is what I foresee when sharing… Read more »
Mario Castro
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Mario Castro
7 years 2 months ago

Hi Mohit, thank you for remarks on this article.
It is quite interesting how emerging markets where ARPU is low in comparison to developed markets, profit is proportionally higher. One of the main reasons is scale economies will reduce impact of fixed costs, another component is the labor cost in two ways: people remuneration is lower and efficiency per worker is higher. People well prepared in IT and focused on Research and development traduces in a better resource allocation.

regards,

Mario

Mohamed Maher
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Mohamed Maher
7 years 2 months ago

Many ideas for cost saving initiatives (I would call it quick wins without investments first and then initiatives) as Operators were focusing on competing and not optimizing enough due to excellent profits.
I would recommend reading Blue Ocean Strategy book for growing the cake also

Philippe Prodhomme
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Philippe Prodhomme
7 years 2 months ago

Reaching 40% Ebitda with such low prices is certainly achievable with high volumes, efficient operating structure and optimized transmission framework.
At this type of revenue per minute, and considering present technology costs, there are very little chances network investment can be repaid (especially if it include backbone in order to transfer transmission from Opex to Capex). Then the key question is not which level of Ebitda you achieve but how and when you break even

Rupesh
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Rupesh
7 years 1 month ago
Its not 40%, its more than that. How? : All Indian operators are big time in Site sharing, specially Bharti-Vodafone-Idea thru Indus towers (with more than 95k towers as on Mar09), they pay infrastructure rentals to Indus towers, This payment is treated as Opex and reduces EBITDA, but revenue generation thru this business is taken as other Income (Below EBIT line) as revenue flows are Dividend from Industowers. This is right accounting practice but this practice reduces EBITDA by around 1.5%-2%. 🙂 I worked with Bharti and Hutch in India, Since beginning indian operators are concentrating big time on costs,… Read more »
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[…] one of the many reasons mentioned by him: Paradigm shift from ARPU to revenue per min – Indian carriers stopped looking at the ARPU as one […]

raj
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raj
6 years 11 months ago

Good article.

Reducing ARPU and price wars cannot continue for long. The only way out is VAS which is in a boom. Complete advertising campaigns are being designed through this channel and complete infrastructure is being supported by MVAS companies. Rural market penetration is a slow process and even new subscriptions at a 20-30% growth will not add much to the bottom line looking at so many players. New models of revenue are the only way out.

Jagadish
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Jagadish
6 years 11 months ago

Hi Mohit,
A great article and this demonstrates the succes of outsourcing or Managed IT Services.
However with MNP round the corner, there are two challenges for the operators
1. Customer Churn – They have to come up with innovative services and pricing / service models to retain thier customers
2. The investment that they have to put in Interconnet billing platforms

Rgrds,
Jagadish

sn55
Guest
6 years 10 months ago

Hi All,

Some creative idea to reward loyalty in the era of MNP. Give additional 1% discount every month to both post and pre paid customer with a max cap of 10 to 15%. This will ensure higher loyalty as they loose on discount reducing churn rates. Your views???

rgds // Sourav

admin
Admin
6 years 10 months ago

Good idea. However, the benefits offered by the other operators could exceed 10%

santosh
Guest
santosh
6 years 6 months ago

Its gonna be very interesting and tricky once MNP comes into play. There will lot of aggressive promotions to counter that small 1% or even 10% bonuses. Just one month of aggressive promotions and a chunk of customers can move from one to other service provider. This is India and we have seen such things happening in the past also.

As someone pointed out. VAS is going to play a bigger role in the coming years.

Vineet Garg
Guest
Vineet Garg
6 years 6 months ago
Hi Mohit, This article is having in depth analysis of Indian market. But i do’t understand how would incumbent operators will response to tariff war started with per second billing. I have read somewhere that a call cost 40 paise to Reliance and they are offering 50 paise per minute for local,std and even roaming. How could operators will be able to sustain EBDITA of 40% . Moreover 3G auction is supposed to be held in near future; for which base price is Rs. 3500 Crores. I think in future we will see lots of happening coming in Telecom Industry… Read more »
Mohit Khurana
Member
5 years 8 months ago

Mohit,

A request – the images in this post are too small for a naked eye to see. Can you please larger version of these?

Mohit

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