Balance Swings to Customer Retention
With carrier subscriber bases swollen by the recent string of mergers, the pendulum is swinging from customer acquisition to customer retention.
Maintaining happy customers is certainly wise, considering that each subscriber costs several hundred dollars to sign up. But keeping existing customers has its costs, too. Carriers must provide satisfactory coverage, an array of calling plans, excellent service and the latest devices. And don't forget that periodic handset upgrade.
Twin Trends Bear Stearns analyst Phil Cusick says the increased focus on retention makes sense in light of the lower-quality potential customers that accompany rising penetration rates and the data offerings that carriers can use to entice customers to stay.
"The results of these two trends, we believe, is that carriers may be able to find more value in 'farming' their current base of customers for additional revenue rather than 'hunting' for new subscribers," Cusick wrote in an industry analysis last year. "While a carrier would be foolish to do either exclusively, we believe that carrier focus will shift more to farming as the hunting gets worse."
Raymond James analyst Ric Prentiss agrees. With the subscriber bases of the three largest carriers each hovering around 50 million, economies of scale can be realized. "Carriers can spread costs over a larger number of subscribers," Prentiss says.
But farming implements don't come cheap. Bear, Stearns forecasts that retention costs will rise over the next two years due to customers expecting a new handset every 18 to 24 months. Most carriers upgrade from 5 percent to 7 percent of their customers each quarter, with subsidy levels commonly reaching $100 or more.
"We have definitely seen some higher subsidies for some of the hot products," says Michael Walkley, senior research analyst at Piper Jaffray & Co. "The replacement plans keep getting more and more competitive."
As carriers clamor to get top sellers like the Motorola RAZR into customers' hands, it's not uncommon to see price drops of $100 or more. Devices that encourage customers to embrace new technologies are also subsidized, Walkley says. Offering lower-subsidy phones for family plans helps carriers balance the high cost of subsidies for the hot sellers.
One thing that did not lead to widespread industry churn, as some expected a couple years ago, was local number portability (LNP). Carriers reacted by offering multiple services and industry churn remained stable, Prentiss says.
Still, its full effect may not be yet felt. "We're seeing the 2-year anniversary coming up. In the first half of '06, it will be interesting to see what carriers do to retain customers coming off contracts," Walkley says.
Blurry Picture Because few carriers break out customer acquisition or retention costs, it's difficult to gauge how much is being spent. The picture is blurred by the fact that carriers vary on whether they include the handset upgrade costs in cash cost per user – CCPU – or cost per gross addition – CPGA. Bear, Stearns analysts would prefer that they remain part of the CPGA number.
Still, some hints can be found in federal filings and earnings reports. In its third-quarter federal filing, Cingular Wireless listed an array of higher costs associated with transitioning and retaining the 22 million AT&T Wireless customers absorbed when the two companies merged in late 2004. Included was a $42 million increase in commissions due to a surge of handset upgrades in the quarter. During the first nine months of last year, Cingular spent $238 million on handset upgrade commissions, up 56.5 percent from the year-ago period.
Higher costs associated with the handset upgrade program also contributed to a 16-percent year-over-year increase in the cost of Sprint Nextel service and products, COO Len Lauer told analysts. Hurricane recovery and higher network and EV-DO backhaul costs also took their toll, he said during the company's third-quarter call.
Even Leap Wireless, with its low customer acquisition costs, struggles with the handset subsidy issue. The carrier reported higher handset subsidies in the third quarter, but was able to hold the line on CPGA due to lower sales and marketing costs per gross addition.
At T-Mobile USA, subscriber acquisition costs (SAC) per gross add are dropping. The carrier, which serves more than 20 million customers, reported third-quarter SAC per gross add of $121, down from $139 in the previous quarter and $149 in the year-ago quarter. Still, the American unit boasted higher acquisition costs than any other unit of the Deutsche Telekom-owned T-Mobile International.
Prepaid provider Leap Wireless International in the third quarter spent just $142 for each new customer, in line with year-ago comparisons but less than one-half of what was spent for customer acquisition three years ago.
Regional carrier MetroPCS has been able to keep its customer acquisition costs low by limiting advertising and handset subsidies and capping network costs by operating only in large cities.
CPGA Still High But the large, national carriers apparently haven't been as successful in getting acquisition costs down. Before the Big Five became the Big Three, they were spending an average of $392 to acquire a new customer, up from $349 in 2004, according to Bear, Stearns. A $300 to $400 customer acquisition cost was common when carriers were reporting CPGA several years ago.
One way carriers can cut acquisition costs is to operate strong direct distribution channels – boosting online subscriber signups or operating company-owned stores or kiosks. That's what Verizon Wireless has been trying to do. Its direct distribution channel delivered 68 percent of the carrier's third-quarter gross additions.
In addition, the carrier is ending its agreement with indirect distributor RadioShack in favor of retail kiosks staffed by Verizon Wireless employees. The carrier, which added 5.4 million new subscribers as of the end of the third quarter in 2005, uses its own staff at Circuit City and BJ's stores.
Carriers' current love affair with MVNOs also might help them reduce acquisition costs. The arrangements leave MVNOs picking up sales, marketing and distribution costs, leaving carriers to focus on the networks.