Mobile price wars catch operators off guard

Bharti Airtel two weeks ago fired the first salvo in the battle to wrest market share from Kenya’s dominant telecommunications player, Safaricom.

With slightly less than 10 per cent market share, Kenya’s second largest operator Zain, which Bharti bought recently, pales in comparison with Safaricom, which commands 80 per cent of the market.

Bharti, with its aggressive pricing, has thus started a war that none of the other players, Safaricom, Telkom Kenya or Essar has much stomach for at the moment.

Safaricom does not want a price war because it will affect its profit margins and its moneymaking machine.

Telkom Kenya has just completed a painful renegotiation with the government for subsidies that will help fund the business and a regulatory intervention that was supposed to level the competitive landscape.

The fog was just starting to clear in the mind of Telkom Kenya strategists before this war broke.
This could explain why Mikael Ghossein, the boss of Telkom Kenya, was making such fuss last week over the Communications Commission of Kenya’s allowing a lower interconnection rate on its fixed line network.

According to data from Synovate, Telkom spent $10 million last year advertising its Orange branded GSM network, which so far has attracted 552,294 subscribers — but of whom only 37,000 can be counted as unique.

Essar, the operator of the Yu brand, has been enjoying a quiet party luring teenagers to its network with the cheapest rates in the market.

So far, out of the 1.5 million people who use its network, it can only count 110,013 as unique customers. It too lowered its prices last week.

Bharti, which spent $8 million on advertising in 2009, has with its strategic move set Ksh3 (US cents 3.75) per minute as the industry standard.

This is still significantly higher than the Ksh0.88 (1.1 US cents) it costs to complete a call in Kenya, according to a network cost study by Analysys Mason.

For investors, the current situation is a real puzzler. What will be the long-term effect of this price war and how are operators going to be affected? With the exception of Bharti, the other operators think the current pricing is not sustainable.

Nothing signals this more clearly than Safaricom’s half-hearted response to Bharti with a complicated menu pricing option.

Teenagers and churn

Indeed, Safaricom’s outgoing chief executive Michael Joseph told The EastAfrican that the current rates are not sustainable unless each subscriber increases the volume of their calls by a multiple of 10.

This raises the question that, as much as the price war has generated a buzz in the market with people switching networks, is the demand for calls really going to grow exponentially?

Analysts say the new tariffs will certainly encourage more people to call However, as with everything else in life, the demand for calls will plateau at some point even if the services are offered for free.

The present risk is that consumers will hit threshold quicker than the operators anticipate and start reallocating the money they have saved to buying unrelated products such as soda and beer.

Coca Cola and EABL suffered a similar fate when mobile phones were first introduced in Kenya, and they could enjoy a reversal of fortunes as consumers start spending the savings on their mobile phones on drinks.

This problem is more acute in the East African market because most of the new subscribers are either price-conscious teenagers or rural folk.

In 2008 and most of last year, Zain experienced the same effect when it responded to the entry of Orange and Yu with a price cutting promotion dubbed “Vuka” and a number of products targeting the teen and young adults market.

While many of these consumers moved over to its network, they were soon hopping across networks hunting for bargains, a phenomenon known as “churn” in the industry. As of August this year, Zain had 1.8 million subscribers, but only one million were unique loyal customers.

The problem with newtwork surfing in the mobile phone sector is that it becomes difficult to recover the cost of customer acquisition per customer.

Ideally, due to the heavy capital expenditure, operational costs, staffing, sales and marketing expenses, once a customer has been signed up, an operator would like them to stay long enough for it to at least recover these costs by selling them more profitable products.

The low pricing is a loss-leader and the real action lies in rolling over customers to high value calling plans that lure them to data services such as surfing the Internet or watching movies and television over their networks.

France Telecom understood this game when it came into the Kenyan market and when it was thinking through its business plan. However, the French company was slow to execute the plan.

Safaricom understood the risks and played the game much better by investing heavily to boost its capacity to sell access to data, which today accounts for 13 per cent of its revenues.

Safaricom now seems to have a head start in the market with its 3G network and it will soon start testing 4G, which is a much faster vehicle capable of delivering high bandwidth content like video.

Telkom Kenya slumbers

In an environment characterised by price wars, experts say the best survival strategy is innovation and paying attention to costs.

The game will now shift to launching new products that promise higher customer loyalty and good profits. Telkom Kenya is best positioned here because of the lucrative concessions it has extracted from the Kenyan government.

It now operates the national fibre-optic network, in addition to its fixed line and CDMA business, and it got a free pass to win annual multimillion-dollar government contracts to provide telecommunication services exclusively.

The French firm seems to have all it needs to dominate the data markets.
However, the feeling at Kenya’s Ministry of Finance is that France Telecom has a muddled strategy and poor strategic vision and execution. In the past two years, the company has blown tens of millions of dollars on trying to fight for market share in the GSM mobile market, where the odds are stacked against it.
Instead, they say that the French should have exploited the fixed wireless business, where Telkom, according to the Analysys report, enjoys almost zero cost of funding.
Last week, Telkom Kenya seemed to be allowing itself to be sucked further into the price war, lowering its call charges to Ksh2 (2.5 US cents) per minute, while at the same time seeking another intervention from the regulator.

It wants CCK to increase the interconnection rates for its fixed line businesses to create a barrier of entry against competitors, instead of thinking ahead to 2014, when interconnection rates will be scrapped in Kenya.

The paralysis at Telkom Kenya and its tendency to seek state protection could hamper it in terms of innovation and leave room for other operators to capture a bigger share of the data market.

Looming cuts

Analysts believe that Bharti’s low-cost operator strategy is bound to force a restructuring on Safaricom.

Bharti is counting on the fact that it can use its purchasing power, which delivers lower unit costs in India due to high volumes, to lower equipment costs for its African operations. But these costs do not in any case account for more than five per cent of the total.

In Kenya, due to the relatively small size of Bharti’s operations, the costs of maintaining base station sites are low. However, Bharti’s sales and distribution costs will be higher due to the higher commissions it must pay.

The big question now is whether Bharti’s cost base is lower enough than Safaricom’s to sustain the prices it has imposed on the market.

“That’s why they are fighting for regulatory intervention against us!” says Mr Joseph.