Impact of AT&T and T-Mobile merger on the Telecommunications Market

EXECUTIVE SUMMARY

The following pages will talk about the wireless telecommunication industry with some focus on Sprint Nextel Telecommunications and how this company behaves in the telecommunications industry. Topics such as market share, where the type of market will be defined, industry demand, key determinants and demands in telecoms industry. Also covered is the cost structure and the analysis of the competitive forces as well.

Today’s market is extremely competitive; the companies have to create new products constantly and exceed their service in order to attract and retain consumers. Such broad competition has reshaped the industry demand and it constitute a large sector in the U.S economy.

The telecommunications market drives a large sector of spending, investment, innovation and technological advancement in the American workforce. To set the cost structure for the company this paper will discuss the services and  products that Sprint outsources and what part of the chain of production/service does Sprint undertakes. Porters Five will be address the competitive intensity and therefore attractiveness of the telecommunications market.

Description of the Industry

Sprint Nextel Corporation is the third largest wireless telecommunications network in the United States, with more than 50 million customers.  Sprint is also a global Internet carrier and is among the top five main providers of long distance services. Sprint is currently deploying a network upgrade called Sprint Network Vision.  The main competitors are AT&T Inc.  and Verizon Communications Inc. Sprint’s North American Industry Classification System, NAICS for short, is under the number of 517110; under this system the Federal statistical agencies are able to classify businesses organizations for the purpose of collecting, analyzing and publishing statistical data to the U.S business economy.

According to the U.S. Census Bureau, this type of industry, NAICS code 517110, “compromises establishments primarily engaged in operating and/or providing access to transmission facilities and infrastructure  that they own and/or  lease for the transmission of voice, data, text, sound, and video using wired telecommunication networks. Transmission facilities may be used on a single technology or a combination of technologies. Establishments in this industry use the wired telecommunications network facilities that they operate to provide a variety of services, such as wired telephony services; wired audio and video programming distribution; and wired broadband Internet services”.

History

The core of what Sprint Communications is now days has changed quite a bit since the creation of the company.  This company first started in 1925 as a land line telephone company under the name of United Telephone and Electric Company (UT & EC); its main opponent at that time was Bell system.  On later years, UT & EC changed its name to United Telecommunications, after the company survived bankruptcy in 1938. In 1986 GTE Sprint and Telenet merged with United Telecom to form a joint venture co-owned by GTE and United. Finally, in 1989 United Telecom purchased the rights to own the company solely; and it that same year United Telecom changed its name to Sprint, due in large to the increase brand recognitions of a successful marketing campaign. With its continuous drive to set new standards, Sprint has established itself as the nation’s largest independent local telephone provider, as well as creator for advanced local capabilities, groundbreaking IP and wireless applications and unprecedented mobility solutions (Sprint’s 10K).

Organization

The highly competitive market of the wireless telecoms industry has driven wireless carriers to become more creative and focus on their core businesses. Several of the larger wireless carriers have sold off their tower assets to managing companies, and they lease space on the towers they once owned. Sprint was one of the first carriers to sell of their towers and lease their space. Another industry fist was when Sprint outsourced the engineering, maintenance, and operation of it’s wireless network to Ericsson. The idea of outsourcing organizations or departments helps wireless carriers to focus on their core business and contractually hold the companies they have outsourced with a predetermined, and measured level of performance.

Relevant Governmental or Environmental Factors

The invention of the telephone was on the late 19 century, but it wasn’t until beginning of the 20 century when the first federal law governing the telephone industry in the United States took effect.  Local and state governments turned their attention to the telecommunications industry to adopt regulations to govern the several aspects that came with this industry. Congressmen couldn’t keep up with the fast growth of the industry and they were forced to create enact the Mann-Elkins Act of 1910, which empowers the Interstate Commerce Commission to regulate intestate telephone service. This law oversees that telephone companies will provide the services requested at just and reasonable rates without discrimination or undue preferences (“Technological and Regulatory” 2000).

Nowadays the principles and laws pertaining regulation of telecommunications have evolved and have been preserved by the Telecommunication Act of 1996. Two major changes from the original act of 1934 have happened: first, the new act is more technological biased; and second it offers more deregulation for a more competitive market. Having the government involved in the industry serves as a referee and benefits the customers as well as the service providers. Without regulations the market would suffer from monopolistic behaviors of companies with stronger presence on the market. As an example, mid 20 century a single company was overtaking the whole market, the famous case of AT&T. AT&T was dominating the local, long distance and telephone equipment manufacturing markets for decades.

With the help of the Telecommunications Act and the government interference, upcoming telecommunication companies were challenging AT&T with lower costs to a maximum number of consumers and the market turned from a monopolistic behavior to a competitive one. Now consumers have the freedom to choose the telecommunications carrier of their best interest.

The biggest governmental and political issues that faces the wireless telecommunications industry is the proposed merger of AT&T and T-Mobile. The third largest wireless carrier, Sprint, has come out strongly against this merger/takeover. Many are calling it a potential duopoly. Some interesting facts that Dan Hesse presented in his testimony are that 302 million people or roughly 96% of the population of the United States owns a wireless cellphone, and that it took land line 100 years to build 1 billion fixed land line phone lines, but only 20 years to add 5 billion mobile subscribers.  Wireless competition spurs the American economy and its revenue in 2010 accounted for nearly $160 billion, another $25 billion was spent on capital investment. Productivity gains from a competitive wireless industry are projected to drive $860 billion in additional GDP. He states that in his testimony that creating an entrenched integrated duopoly would reverse this projected growth and progress. If the proposed merger were to occur just two companies would control over 80% of all wireless customers in the US, and 88% of all revenues.

MARKET STRUCTURE

There is pretty much fair and balanced competition between all of the carriers and each of the three largest carriers can introduce new products, services, and pricing that can reshape or drive the industry direction. Many consider the heavily regulated wireless industry to be an Oligopoly, with only. Each of these carriers have market power. The size of each carrier and the efficiencies in which it operates largely drives it revenues. Typically the larger the carrier the greater the economies of scale are and they more market power they possess. Many of the smaller rural wireless carriers and the smaller MVNO’s may be considered perfectly competitive as they have no market power and must offer their services at the going market rate and can be considered as price takers. In the next several months to a year we may see a drastic alteration of the face of the wireless market structure.

The second largest wireless carrier AT&T has made a significant offer of $39 Billion to buy T-Mobile. This would reshape the wireless market because between Verizon Wireless and AT&T they would have 80% of the total wireless market, thus reducing the market power of Sprint who shares the remaining 20% of the market share with all other wireless carriers. With Sprint’s market power greatly reduced the previous near Oligopoly shared between four major wireless carriers would now almost become a Duopoly. This would return the telecommunications market back to the non-competitive days of Ma-Bell.

At one point the Atlanta, GA market had only two wireless carriers, Bell South and Airtouch Communications, Bellsouth was the monopoly in that market until de-regulation of the wireless industry and Airtouch Communications entered the Atlanta, GA market. The two competed, but Bell South had an enormous lead, and pretty much the majority of the market power. Only when Dial Call, the third major wireless competitor in the Atlanta, GA market entered the market did you see real competition. Prices started to drop, and services offered started to increase. Dial call later merged with Nextel Communications, who later merged with Sprint. Airtouch Communications merged with Bell Atlantic, and formed Verizon, who later merged with GTE’s wireless assets.

If a merged AT&T and T-Mobile were to happen then Sprint would be the only major wireless pure play left as both AT&T and Verizon are anchored in one of the old regional Bell operating companies. This is significant because back on January 1st 1984 when the U.S. Department of Justice made AT&T to divest itself of its seven regional Bell operating companies as they created a monopoly in the telecommunications industry. A merger of AT&T and T-Mobile would bring us one step closer to the days of am AT&T monopoly by creating a virtual duopoly in the wireless telecommunication market place. This is bad for consumer choice, competition, and product innovation.Our hypothesis that the merger would be bad for competition is bolstered by the recent request of Herb Kohl (D-Wisc.) who is the chairman of the senate Subcommittee on antitrust, Competition and Consumer Rights request for regulators to block the merger stating that it would “cause substantial harm to competition and consumers.”.

INDUSTRY DEMAND

There is a very high demand in the wireless industry for new products and services. The wireless telecommunications industry has gone through a major transformation in the past 5 years. This transformation has been fueled by the extremely competitive environment so much that an industry survey conducted by Yankee Group and Coda Research projected (on average) that data traffic in 2014 would be 35 times the volume of traffic in 2009. Cisco has projected that data traffic will be 56 times 2009 levels in 2015. The wireless industry in our opinion tends to follow a kinked demand curve model where if one of the four major wireless carriers lower prices, then typically the others follow suit in order to preserve market share. This in turn can put downward pressure on prices, and threaten profitability.

This growth is driven from the transformation of wireless from just a voice services provider to an Internet access technology and data transfer technology and industry. One factor that plays a big part in this growth is the ever increasing demand for Smart phones, and now tablet computers.  Companies want their employees to have instant access to information wherever and whenever they want or need it to drive productivity, and efficiencies. Consumers want access to the Internet, pictures, music, video, and other technologies developed for entertainment information access and sharing. Sales of devices such as the iPhone and Android mobile devices have created additional demand and growth.

Industry demand, growth, and competition in the wireless communications sector is very important to the US national economy. The wireless industry drives a large sector of spending, investment, innovation, and technological advancement in the American workforce. These advancements increase the overall productivity in the workplace. Congress and the FCC have release a national broadband plan, and have held hearings on job growth, and economic stimulation that can come from the further proliferation of wireless broadband data technology. One example is how the iPad 2 and the iPhone have helped to drive Apple to be the world’s most valuable company with Apple’s total market value within 12 months projected to be $433.7, surpassing Exxon Mobil.

In a CTIA report from Ovum it was estimated that the State of Texas will save about $7.5 Billion in efficiency improvements due to wireless technology access and applications. By 2016 is expected that Nationally US businesses will generate growing productivity gains of well over $127 Billion per annul through the use of wireless technology. Another area of demand and increase in labor productivity is in the ability to use wireless data access to increase the mean educational level of the workforce. Anytime, Anywhere access is said to add another dimension to the learning process by extending the online course access to virtually any location a student may be. The requirement is now to have instant access to data and information at any place and time.

This is enabling not just college students anymore, it is now moving into K-12. School districts are investing wireless data enabled devices to keep students connected anywhere and anytime to add another dimension to their classrooms and effectively extend the learning day and access to information beyond the walls of a classroom. Text books are being driven to a digital only format and distribution system which is only made possible by the advent and growth of wireless data enabled devices. The State of Texas Legislature is considering passing a bill that would move textbook funds into school district technology funds.

South Korea has set aside $2.1 Billion to nationally provide all education students with a digital device to access text books. All text books will be made and distributed to these digital devices. Updates and corrections can then be done instantly and the labor and printing to distribute this information is almost totally eliminated. With all of the demand and growth projections some reports state that if North American wireless operators do not change their business models that with current projected demand, revenues, and costs that they could run out of profit by second quarter of 2014.

That tells us that we will continue to see significant industry change and the introduction of new revenue sources. With 70% of the world’s population and 96% of the US population already owning a mobile phone, carriers must look for new opportunities to develop and expand the wireless business model. Data is the key to this growth. One place carriers are positioning themselves to grow data services is in the M2M (Machine to Machine) space.

There is estimated to be 10 or more machines for every human on the planet. Currently there is just over 80 million M2M subscribers worldwide. By 2020 that number is expected to increase to 2.1 Billion subscribers. This will be achieved by embedding wireless chip sets into devices to connect them and share data. One example is a customer that embedded Sprint chip sets into their fryolator. Status, operational, and error code messages are sent back to the manufacturer. This data helps them to improve their products and also automatically dispatch a technician if their is reported malfunction. These types of applications for M2M technology will continue to grow at a staggering rate.

COST STRUCTURE

Initially there is a very high cost to market entry into the wireless telecommunications industry. Fixed costs are high and include the build-out of the infrastructure. Carriers that are larger have a benefit of economies of scale. To be a major competing force in the wireless industry, or to be a national wireless carrier an extremely costly infrastructure of wireless towers and cellular sites must be built across the country. Cellular towers can cost in the range of $3250,000 to $500,000 apiece, and thousands can be used in an urban city, 10’s to 100’s of thousand across the country.

Towers are initially built taller to allow for more coverage, and then as customers are added to a network the heights of the towers must come down and more towers built to accommodate the need for more capacity. Of course the towers are just the physical infra-structure, there is also a requirement for the costly invisible asset of purchasing the rights to use frequency or spectrum. Typically each of these two, the physical network and the licensing of spectrum, can be a upwards of $3 billion for each of these, creating a cost of entry into this market in the range of $6 billion.

The variable costs include sales, customer service, engineering, human resources, and other operational departments. In an effort to reduce variable costs and create a more fixed cost structure and reduce expenses many wireless companies started to outsource customer service to other countries such as India, but quickly realized that relying to heavily the impact on foreign lower cost customer care at times has a negative effect on customer service ratings and churn (loss of a wireless subscriber) was costing them money. Outsourcing of Site Development, Engineering, and other non-core functions have been employed to assist carriers in stabilizing costs.

The marginal cost curve is U-Shaped for this industry because there is a cost associated with each new customer acquired that typically ranges from $200 to $450 dollars. Companies make their money on the CLV (Customer Lifetime Value). Every time a customer purchases a new advanced Smart-phone, a large part of the cost of the device is subsidized by the carrier. The data access plans increases ARPU (Average Revenue Per Subscriber), but a carrier still must keep a customer for as many as 22 months to start making a profit.

If a customer leaves the carrier it is referred to as churn. Carriers are highly focused on retaining customers as it typically cost three times as much to acquire a new customer as it does to retain an existing customer. As users of Smart-phones drive more data usage carriers Operating Expenses (Opex) have increased and their EBITDA has decreased due to the higher subsidy costs of smart-phones, and higher customer retention costs related to upgrading smart-phones.

ANALYSIS OF COMPETITIVE FORCES (PORTERS FIVE FORCES)

The threat of entry by new competitors

The threat of new entrants into the telecommunications is moderate.  “Entering this market requires a substantial amount of capital to be able build an infrastructure that covers most of the geographical area of the country. Companies presenting such business model benefit from large scale operations and may be difficult to compete with as they offer lower prices to their customers; a more cost effective option for new entrants may be the acquiring a company that already has network in place (“Wireless Telecommunications” 2009).

The intensity of rivalry among existing competitors

Exit barriers are not insurmountable for a strongly diversified telecoms company, as it could exit the wireless market while continuing to operate in fixed-line and related (or unrelated) business. Such move would mean forsaking the potential revenues from a market than continues to grow strongly (“Wireless Telecommunications” 2009).  If the market continues with higher saturation of providers, competition will eventually turned to strong. In order to stay competitive Sprint created Boost mobile; is a prepaid  version of nearly the same services provided by Sprint but often at a lower prices. Both Sprint and T-Mobile have put downward pressure on pricing while also putting pressure to increase services, features of the wireless products, and content and applications.

The bargaining power of suppliers

The government is also an important player in the supplier power. Federal Communications Commissions (FCC) is the only provider of frequency bandwidth in the United States,  it gives permission to wireless companies to communicate using particular parts of electromagnetic spectrum; the companies have to win the highest bid in order to be able to use specific radio frequency bands (spectrum). As an example, in 2006 T-Mobile paid to the FCC more than $4 billion to have access to this service.

CONCLUSION

The wireless industry is highly competitive, with high barriers to entry, consistent growth, and profitability that has been almost untouched by the last couple recessions. Entering this market might not be profitable for another wireless carrier, but there are enough profits to be shared for those that would want to get their share of profits as an MVNO. Industry regulations, and availability of frequency spectrum are just two more reasons that entry into this market would be best served as an MVNO.

The current oligopoly threatens profitability with fierce competition and the existence of a kinked demand curve model. Further, the talks Sprint was rumored to be having with T-Mobile to negotiate a merger of the two smaller of the top four wireless carriers would have created a carrier that was nearly equal in size to the other top two carriers was derailed when AT&T made a hostile $39 billion bid for T-Mobile.  This threatens to return the wireless industry to the prior 1984 status where the Bell companies have a duopoly over the entire wireless industry. This in turn will stifle competition, raise prices, and lessen the choices that consumers have.

With such a merger the low pressure from substitute products, decreased bargaining power of buyers, and decreased bargaining power of suppliers we contend that such a merger would create a duopoly and is not in the best interest of consumers and a competitive market place where competition is fair, and equal.  Such a merger would create a duopoly that would hurt consumers, stifle competition, and ultimate have a comparatively negative impact on the economic structure of the US economy.

REFERENCES

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This paper was written as a course term paper for Economics 6351 by David J. Roy and Brenda Sandoval. All comments and opinions regarding the Merger are those of David Roy and Brenda Sandoval in the context of Industry Analysis for course Economics 6351 at University of Houston – Victoria with INSTRUCTOR:  Dr. Chien-Ping Chen.