The events in Kenya’s mobile phone industry this week seemed almost like a textbook problem that an economics professor would pose to his or her students.

Imagine you are Michael Joseph, the boss of Safaricom, running a company so dominant at 80 per cent market share that it is virtually a monopoly.

What do you do if a regulator and three scrappy and money losing operators — which between them command a 20 per cent share and are overburdened with high fixed costs and thin profit margins — were to declare a co-ordinated price war against you out of the blue?

Remember, you are a dominant operator with 15 million customers — 12 million of whom are unique — and running a business cushioned by fat profit margins and that is estimated by African Alliance to generate $1.2 billion dollar in free cashflows over the next five years, or $4.2 billion in perpetuity.

Furthermore, all your rivals owe you interconnection fees, with some of the operators falling behind in the negotiated repayment plan. How would you respond?

The standard textbook answer would be the classic David versus Goliath battle that is happening in Kenya today.

You, as a monopoly, could reduce your prices, way or slightly below the costs that your rivals pay when their customers connect through your network.

Even put some of their debts in collection and deny them more credit, and wait as everyone flinches at self-destructive losses that they can hardly bear any more — then raise the prices back to monopoly level.

Among the things Safaricom can do is shift the battlefield to the mobile money market, where it is a dominant player.

There, it could exploit customer loyalty to M-Pesa by both delaying regulatory attempts to force interconnection with Zap, and Orange Money, and punishing, through surcharges those of its customers who send or receive money to and from rival networks.

A variation of this scenario has been played out in Kenya before, only that Safaricom did not have to cut prices much because of its “club” of 15 million voice customers and over eight million M-Pesa or mobile money transfer customers — which it jealously guards by offering them low rates on its network and charging exorbitantly when they call other networks.

Because of its market share, Safaricom earns a big chunk of its revenues from payments made by its rivals for letting their customers connect to its network for Ksh4.42 (5 US cents) a call.

Experts say that a “club effect” happens when consumers decide to subscribe to a mobile network and favour an operator with high market share because they can make cheaper calls to a larger pool of subscribers and will receive calls from a larger pool of subscribers.

This happens when the dominant player charges different rates for calling on and off its network. It limits consumer choice.

Indeed, so awesome is Safaricom’s market power through the “club effect” that two years ago, when rivals Zain, Orange and Yu launched an aggressive price war, Safaricom hardly seemed bothered. It continued charging the highest rates on the land.

The effect was that Zain lost such a huge amount of money compared with the network’s losses in Nigeria, that its parent company in Kuwait decided that it had had enough of the African adventure for which it had paid $3.35 billion in March 2005.

Zain Africa was sold this year to Bharti Airtel for $10.6 billion.

However, the decision by the Communication Commission of Kenya to lower the rate at which mobile operators can charge each other for connect calls across networks was meant to work as it is doing by sparking a price war in the Kenyan mobile phone market.

Last week, two Indian operators, Zain Kenya, which will soon change its name to Bharti Airtel, and Essar, which runs the Yu network, cut their calling rates to $0.0375 (Ksh3), which is in line with minimum rates charged in Tanzania.

This is $0.01 above the interconnection rate of $0.028 (Ksh2.21) set by the CCK last week.

Predatory retaliation

Faced with a situation with its rivals, who are loss makers, shouldering high fixed costs and razor thin profit margins and holding only a fifth of the market, Safaricom could easily wipe out its rivals by offering very cheap rates of perhaps Ksh1 per minute for a limited period for customers who call within its network.

However, a review of the advice given to CCK by Analysys Mason, the firm that was hired to consult on interventions needed to increase competition in Kenya’s mobile phone sector, shows that it had anticipated that Safaricom had this option, which in game theory could have seen it use a predatory retaliation strategy that would have still resulted in an imperfect market.

Thus, it is emerging that under the new pricing regime, Safaricom has been boxed in by ensuring that it charges its customers the same price for calls made to its network and those made outside its network. The same rule applies to all operators.

Analysys anticipated similar retaliations in the mobile money market and indeed it is likely that the next battle in Kenya’s mobile wars will be in the booming mobile cash transfer sector dominated by Safaricom’s M-Pesa services.

Analysys Mason advised that the regulator force operators to interconnect their mobile payment services.

CCK should also force operators to stop charging different prices that punish consumers who send mobile money across networks.

This is expected to box in Safaricom further in its response to the industry price war.

Under this pricing regime, customers will be able to send money easily between services like M-Pesa, Pesapap, Zain’s Zap, Orange Money and M-Kesho without price discrimination.

However, implementing such a system would need legal reforms instituted jointly by CCK and the Central Bank of Kenya.

This regulatory measure is expected to further cut Safaricom’s dominance, and boost the ability of Zain Kenya, Telkom Kenya/Orange, and Essar’s Yu to compete on a fairly level ground in both the mobile money, data and voice business.

Analysys Mason argued that due to the popularity of m-payments,, Safaricom could maintain its grip on the market because its over 8 million M-Pesa customers would see little value in switching to rival networks just because they were being offered cheaper rates.

The consulting firm feared that one of the options open to Safaricom in the face of the price war is to offer cheap rates on its M-Pesa service to perpetuate the same club effect that the regulator is seeking to stamp out by forcing it to charge the same price both for calls made on its network and to rival networks.

Safaricom’s options

This leaves Safaricom very few options, apart from matching its rivals, which will see its calling rates reduced from Ksh8 (10 US cents, its highest tarrif) per minute to nearer the Ksh3 (3.7 US cents) that its rivals are charging, in order to maintain its profit margins or cushion against the effect of the price war.

Safaricom still has a lot of retaliatory room that could wreak havoc in the sector.

One of the most important findings from the Analysys Mason study is the true costs of setting up a mobile phone call on GSM technology, of a fixed wireless line call using CDMA and text messages in the Kenyan mobile phone industry — which were arrived at by simulating a notional start-up in each of those markets.

The study put the cost of setting up a call for a minute on a GSM network at 88 cents in Kenya or $01.1; and at 56 cents or $0.7 on a CDMA fixed wireless network, like that owned by Telkom Kenya.

It put the cost of SMS as low as Ksh0.04 (0.05 US cents) against the negotiated interconnection rate of Ksh2 (2.5 US cents), which it advised CCK to leave alone for the market to set.

It is feared that lowering SMS costs will result in spam and unwanted text messages, mostly from marketers.

If the actual cost of setting up a call is Ksh0.88, it explains the huge profit margins that Safaricom has been reporting since very few of its calls go out of its network and it was charging Ksh8 for its most expensive calls.

It also signals that Safaricom still has a lot of room to play in because it can afford to charge way below the Ksh2.21 interconnection rate.

Most of the operators can charge as low as they want profitably within their network.

By 2015, when the interconnection rate will be eliminated, this will not matter at all.

With pricing in the retail market converging, the focus will now turn to innovation and cost cutting.