Challenges facing the Canadian wireless industry: a Q&A Part I

Canada’s wireless industry is faced with a number of key challenges as it transitions from a phase of rapid subscriber growth to one marked by a greater focus on achieving profitability. Not only are the wireless operators battling each other on a number of fronts, they are also trying to figure out how to best attract a shrinking addressable market. The following is a compilation of in-person and telephone interviews conducted by Report on Wireless with the heads of Microcell Telecommunications Inc., Bell Mobility, Telus Mobility and Rogers Wireless Inc. Both the questions and the answers have been edited for clarity purposes. The order of answers reflect the order in which interviews were conducted. In this first installment, the heads of Canada’s national mobile wireless companies provide some valuable information on key challenges facing the industry over the next few years, including ways to improve average revenue per user (ARPU), methods to reduce churn, size of buckets of minutes, and the significance of the pre-paid market. RoW: What are the key challenges facing the Canadian wireless industry going forward? André Tremblay, Microcell: If you ask me what’s the plague of the industry, it is handset subsidies. It’s probably the worst sin. It’s a huge problem because of the behaviour it creates. You decrease the value of the product you’re selling. Acquiring one million customers at $100 subsidy is $100 million a year. And if it is a $200 subsidy like it is in most cases right now, it’s $200 million a year. For one carrier, that’s a lot. I think the industry has to show profitability in a much better way than we have in the past. I believe it’s not a Microcell element. In fact, Microcell has been extremely disciplined in the last years. The other element is the capex. Companies have to rationalize what they are doing in terms of capex spending going forward, so we can have free cash flow. It’s time to go back to Finance 101. I think the industry is going to be vibrant especially with four players. We’ve been showing in the last quarter of last year and the third quarter of last year that, even though Rogers and those guys claimed that there should be only three players, they basically need us to bring packaging and concepts and push everything ahead. Michael Neuman, Bell Mobility: We can’t spur growth trying to get any more elasticity in demand on that side. Clearly part of the answer lies in providing more functionality, more value to the consumer and hence to the industry more sources of revenue. If we’re going to continue to see the prospect of growth in this industry, in order for that to occur, it’s going to be facilitated by an environment that continues to attract investment in this industry. Given that 60% of adult Canadians have a cell phone, I think it’s clear that it follows that the remaining 40% couldn’t find a compelling reason to have one at this juncture. may suggest to some degree that we have tapped the highest ARPU customers already. It follows then that ARPU of the next 40% are going to be lower and by adding lower ARPUs, it then follows that the industry cannot afford to keep subsidizing telephones. I am of the view that the days of the subsidies are numbered and that we will in the very near future see very significant increases in prices of telephones across Canada by all carriers. George Cope, Telus Mobility: It’s time to reap the return on capital that’s been invested in the industry. I think you’re starting to see that kind of focus certainly of the major wireless carriers. The challenge is to move the industry from a pure revenue growth industry to a free cash flow generating industry and that has really started to happen in a significant way this year. Nadir Mohamed, Rogers Wireless: I’d say the biggest challenge is to make sure that certainly the three largest operators, hopefully the whole market, have discipline in our approach. If you look back over the last couple of years, the one thing that we’ve had in the market arguably more so than ever in the history of wireless in Canada is discipline in terms of pricing, discipline in terms of approach to market. I think as an industry the whole customer experience is something that we’ve got to do a better job of. At every point of customer interaction, we’re asking how can we actually do it right for the customer. Not just answer calls, but deal with the customer’s issue or requirement. Clearly the penetration rate is not growing as fast, it’s still growing fairly steadily in our view, but more and more it’s about what more services, what more features can we offer to our customers and I think data will play a key role in that. RoW: Three of the national wireless operators have moved to per-minute billing and moved the clock back for the start of evening time. How do you see these two changes affecting ARPU and do you think this is a case of ‘biting off the hand that feeds you’?AT: I don’t see how we could benefit in our plan in changing the basic nature of transparency. We’ve tried to be simple. Now if people are going the other way and trying to finesse around some packages and pricing, it’s a differentiator for us. It’s more value for our offering. I don’t judge what they do. They believe that it’s the way to grow the ARPU and if the analysts and observers applaud this then go for it. We do not believe it’s the way to grow the ARPU. We believe we can grow ARPU by giving more value to the consumer. I wouldn’t say they are trying to bite the hand that feeds them. My point is it’s not good for us. It would be counter-intuitive. It works against the branding we have been trying to establish for years. MN: It’s a tough question to answer because it depends on so many factors. As you compare the three major players, Bell Mobility, Rogers and Telus in that order, the impact is very different for each. And the impact difference hinges on MOU (minutes of use). Clearly a company with the biggest MOU will have, all other things being constant, the bigger impact of going to per minute, for example. You’re dealing with an entire industry that has grown dramatically over an 18-year period, has a population of 12 million subscribers that enjoy some of the lowest prices in the world, prices that are too low to enable the companies in question to get an ROI (return on investment). Witness Microcell. Both Telus and Rogers aren’t yet cash positive after that length of time. I think it’s a clear picture. GC: We grandfathered all current clients at that point. So the first benefit of the grandfathering was the jumping between carriers became less attractive for the client and therefore we thought churn in the industry would decline and that’s exactly what happened. As for the second point, we analyzed even on a per-minute basis that Canadians benefited from some of the lowest rates in the world and we didn’t view that the move to per-minute billing would actually have any impact on the demand curve. NM: I think those are two of the most positive moves we’ve made as an industry. I’ll declare my bias early. I absolutely don’t buy into the notion of biting the hand that feeds. One of the interesting things is a lot of it is about the foundations that the industry has been built on. To get the industry to be healthy, we’ve had to attack in a couple of the ways the pricing plans have been built, and I think looking at the clock change and the per-second to per-minute billing, those are two ways of actually creating a much more rational pricing environment. RoW: Is it important to consider the number of minutes in buckets and what is the impact of larger buckets? AT: Those are the kinds of trends we’ve been seeing in the States, many more minutes in buckets. It’s what Microcell did in 1996 when we launched 400 minutes for $40, any time of the day, any day of the week, and 20 cents per extra minute. Our competitors said we were killing the industry. In fact, what we were doing was changing the product definition for consumers. What we have to do now is to provide more minutes, give people more reason to displace landline and really choose us as the carrier of choice without increasing the pricing in a big way. MN: The increasing size of bundles in my opinion is largely a U.S. phenomenon. The U.S. industry went so far in this direction that it has reached a point where, for all intent and purposes, you get unlimited access to local and long distance at a flat price nationwide. To me that’s wireline substitution in a very big way. But it’s also a bloodletting because it says ‘use my network 24 hours a day local and long distance, pay me a flat fee and load it up.’ I question the long-term viability of virtual flat-rate pricing for unlimited usage. The Canadian industry has, in my opinion at least, been more prudent. GC: We have not seen in Canada the U.S. move where they added thousands of minutes into their buckets, and quite frankly it’s been a real benefit to the Canadian market because capex spending in the U.S. is dramatically higher now than in Canada because they’re having to fund these incremental minutes of use. Part of that’s the impact of a market where you have seven competitors. From our end, we’re quite comfortable with the range of prices in the market today to allow the penetration to grow at the million subscribers a year in Canada. We don’t think there’s a dramatic need to take another dramatic move on the pricing curve to drive demand. NM: If you look at U.S. pricing, buckets of minutes have expanded dramatically from two years ago or a year ago. Our path has been somewhat different. The approach of segmenting customers and looking at the consumer side particularly led the industry to a pricing practice where one of its cornerstones has been pricing evenings and weekends differently. If you look at the cost side of the equation for extra minutes, whether it’s by fatter buckets in the U.S. or by unlimited evenings and weekends in Canada, the reality is the way network capacity is built is essentially around what we would define as peak usage hours. Wireless has become a lifestyle product or service and what’s happened is the peak time has shifted to much later in the evening, reflecting people using wireless as much for lifestyle as they did for business. RoW: What are the key challenges in addressing churn? AT: We have extremely stringent policies on churning pre-paid customers. We have the least amount of grace days. We treat pre-paid very seriously, so we do churn pre-paid. It’s not for no reason that we doubled the revenue per sub of Rogers and Bell on pre-paid because I think we had fewer subscribers on an inactive basis. We build products around that. In fact, we tried to attract the high users of the pre-paid mass and we’ve defined products last year for that. At Microcell, you can get 15 cents a minute on pre-paid, but it’s on a voucher of 15 days for $15 and 30 days for $30. So if you provide a company with $1/day, you’re going to have extremely effective rates. MN: Churn is the best proxy we have in the industry for customer satisfaction and loyalty. Getting them is great and getting that high ARPU is great, but not if they don’t stay with you long enough to let you get a return on investment on the COA (cost of acquisition). So if you can check that last box and also have low churn well that’s when you can actually say you have a successful wireless business… We’ve actually seen in many months over the last year our voluntary churn has been below 1%, I think it hit a low of .72%. We’ve spent a lot in customer service, customer service training, customer service processes. This is a huge factor in our ability to retain customers. But it is a constant challenge to keep it within reason. In other words, you’re always balancing churn and the cost of preventing churn. If you want to be profitable, you can’t prevent churn at any cost. And we’ve figured out how to do it as reasonable costs and drive productivity to new heights. GC: We probably spend over $100 million a year in retention in all sorts of programs, re-contracting programs, outbound calling, a number of things. I constantly say to the investment community that the three million clients Telus Mobility has today are more valuable than the next 300,000 clients we’re going to get. And that doesn’t mean the 300,000 clients aren’t going to be important, but on a relative basis it is very clear to us the clients we have are the ones we’ve got to keep. NM: I look at what do you do to get churn down. One is better execution of programs life cycle management. We’ve phoned customers the day after they’ve joined to welcome them into the Rogers organization doing business with us. We have bill explainers after the first month. We’ve got renewal offers, life cycle management. This is day-to-day bread and butter stuff that you have to do for good customer base management. The next order is really life cycle management using CRM (customer relationship management) systems that really start understanding usage patterns so you can better tailor your retention offers. I’m sure if you talk to Bell and Telus, the top two or three reasons for churn will always be the same. Customer service, customer experience is always one of the top three. RoW: The pre-paid market in Canada will become increasingly important as subscriber growth has slowed in the last two years. How important is the pre-paid market? AT: We want those pre-paid customers and we’re happy to have them. But we want to attract the pre-paid base of customers that want to use the product, not want to use it for security. We will provide those subscribers with good and better value, but we will ask them to provide us better value as well. The intent we have is to get rid of that characterization of customer between pre-paid and post-paid. We believe that over the next years that at least 40% of the newcomers are going to be on pre-paid. So far it’s only been 25%. But going forward at the size of our business case right now, we see at least 40% coming from pre-paid. MN: It’s a significant portion of our overall four million subscribers and a very significant contributor to our size, to our growth, to our revenue and to our bottom line. But it’s a question of getting the right ones. Within the pre-paid segments, there are sub-segments that have higher ARPU. You know that to be true if you examine Microcell’s financials that they’ve got a lot of pre-paid, but they’re not all created equal and some of them have got to be higher than the average $11-$12 pre-paid subscriber. There’s got to be $30 pre-paid subscribers. So you say to yourself, ‘there’s some gold in them there hills.’ But just like gold mining, you don’t dig a thousand holes. GC: We came to the market last because we didn’t believe in the model early on. We didn’t think it was profitable. We didn’t believe a $10 ARPU was a viable business. We’ve now got our pre-paid ARPU into the low $20-range and that’s significantly higher than most. We’ve done a number of specific targeted marketing programs with pre-paid that are working for us and given us a competitive advantage. Roughly 20% of our net adds over the last little while have been pre-paid. We have nailed that model in a way that we like the financial return from it. NM: There’s no question that there’s a segment of customers that absolutely value the notion of pre-paid. The most compelling segment is those customers that actually like the freedom of being able to use as much as they want in a given month. It allows freedom, flexibility and control over their usage patterns. The trick from a carrier perspective is matching the value from a customer point of view to the cost that you incur to deliver on that value. The reality is over time, particularly if you’re thinking three to five years, I don’t think we’ll be talking about pre-paid and post-paid as two segments. They’ll be a range of billing options and ways people want to buy wireless and I think the distinction will be blurred over the next 24 months. The next issue of Report on Wireless will feature Part II of the Q&A. In the second part, the CEOs will provide their thoughts on the evolution of the competitive market in Canada and talk about the various regulatory challenges facing the industry.

Challenges facing the Canadian wireless industry: a Q&A Part I

News | July 22, 2003

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