MVNO 2.0. The Resurgence of MVNOs in the US

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1 MVNO 2.0 The Resurgence of MVNOs in the US By Charles Crandon and Eric Holzhauer A new wave of MVNOs is emerging in the US, bringing innovative technologies and business models to enable flexible, low-cost wireless service. Though new solutions are still nascent and only beginning to mature, signs suggest that several of these MVNOs will achieve modest success. Particularly compelling MVNO 2.0 examples illustrate how a variety of segments and use cases can be better addressed and highlight potential long-term shifts in consumer expectations and demands. March 2013

2 Introducing MVNO 2.0 Mobile Virtual Network Operators (MVNOs) are beginning to reemerge in the US. Rather than owning their own network, these wireless carriers buy wholesale access from Mobile Network Operators (MNOs) and resell service to consumers. In the US, this has historically been a difficult business model, as the wholesale rates offered by MNOs can often make it difficult to compete on price. This dynamic drove many new entrants out of business during the first MVNO wave in the mid-2000s. The new MVNO 2.0 wave may stand a better chance. By developing new technologies and business models, new MVNOs may be able to achieve more traction and differentiation than their MVNO 1.0 counterparts. Figure 1: Example Companies in the Emerging US MVNO 2.0 Ecosystem The first wave of US MVNOs arose to serve a market segment not well addressed by Tier 1 carriers: consumers demanding low-cost, prepaid service. The success of companies like TracFone at addressing these untapped consumers fueled interest in a vast array of market segmentation strategies for new MVNOs. Though some followed the pure low-cost, prepaid approach, many attempted to differentiate by targeting particular demographics (especially ethnic segments, age groups, and immigrant populations) or interest groups (often tied to consumer brands for example, Disney and ESPN). However, due to lack of differentiation, market saturation, and unsustainable business plans, most MVNOs from this first wave no longer exist. Many new entrants failed, while several of the more successful players were acquired by their host MNOs (e.g., Boost and Virgin). Copyright 2014 The Management Network Group, Inc. d/b/a Cartesian. All rights reserved. 1

3 MVNOs in other regions have enjoyed considerably more success. Europe is a prime example: MVNOs account for as much as 20% of wireless subscribers in some European countries. 1 Several factors contribute to this positive MVNO climate. European regulators have taken a more proactive approach to MVNOs than those in the US, mandating wholesale access for MVNOs in some countries while suggesting that MNOs be more willing to provide access in others. Many European countries also have substantial immigrant populations that MVNOs have targeted for their specific language and ILD needs. Additionally, the popularity of multi-sim usage (especially by certain ethnic and youth segments) has made European subscribers more willing to try alternative carriers and the predominance of prepaid in contrast to the US makes the typical MVNO model more familiar. In the US, market conditions have changed significantly since the mid-2000s, and recent trends have helped facilitate the resurgence of MVNOs. The growing dominance of market leaders Verizon and AT&T has marginalized other MNOs to some degree; both Sprint and T-Mobile have become more receptive to MVNOs as an alternative growth strategy. The cost of launching an MVNO is now lower than ever, especially with the benefits of Sprint s advanced MVNO enablement platform, customizable Android phones, cloudbased Mobile Virtual Network Enablers (MVNEs), and Mobile Virtual Network Aggregators (MVNAs). Estimates suggest that it can cost $1M or less to launch an MVNO, 2 and using an MVNE/A can reduce costs even further. Additionally, many of the traditional barriers of brick-and-mortar retail have been broken: online-only distribution is becoming increasingly viable, and consumers are more accustomed to receiving support online rather than in person or over the phone. The retail prices of the leading MNOs have also spurred the emergence of MVNOs by restricting consumer choice to some degree particularly with the recent shift to shared data plans and data-centric pricing that requires subscribers to pay for unlimited voice and messaging. New MVNOs are attempting to address this perceived pricing issue with innovative technologies and pricing, and much of their marketing and press coverage has focused on this differentiation relative to the leading MNOs. Despite these positive trends, MVNOs still face a number of challenges to success: The market is very competitive, with many similar MVNOs attempting to take share from MNOs. Most MVNOs lack the highest speed networks (e.g., LTE) and the newest, top-tier smartphones. Recent changes at Sprint (e.g., Clearwire and Softbank) may impact its wholesale strategy. MVNOs may struggle to scale, given their business models, pricing plans, and cost structures. Many MVNO platforms and technologies (e.g., billing platforms, call quality) are still in development. Nevertheless, some of the recently-launched MVNOs have the potential to achieve at least modest success, and have already begun to gain traction. Below, we detail a few of the most interesting players. 1 Ofcom, The International Communications Market 2011, Figure 6.42, Dec Based on GSM Nation reports of $700K seed funding plus retail profits necessary to launch an MVNO. Khattak, Ahmed, from GigaOM, Meet GSM Nation, an MVNO selling any smartphone you desire, 15 Jun Copyright 2014 The Management Network Group, Inc. d/b/a Cartesian. All rights reserved. 2

4 Technology Innovation: Republic Wireless Republic Wireless, a division of enterprise voice over IP (VoIP) service provider Bandwidth.com, offers unlimited mobile voice, messaging, and data for $19 per month. It is able to maintain this price by offloading usage including calls to Wi-Fi whenever possible. When subscribers are not in range of Wi-Fi, the service falls back onto Sprint s 3G network. This Wi-Fi first strategy can substantially reduce costs by leveraging fixed network infrastructure; consumers typically already have paid broadband at home and work that Republic Wireless can piggy-back on without additional cost. The company is also able to support its low price point by reducing other typical costs. Distribution is entirely online, most customer service is provided via a community forum, and the company does not subsidize devices. (However, Republic did recently announce an option where customers can pay a reduced up-front device fee in exchange for a higher monthly price.) Reliance on Wi-Fi offload is potentially a risky strategy for Republic. Users may choose to turn off their Wi- Fi radios and always use the cellular network, driving up Republic s wholesale network costs and making the $19 price point unsustainable. Though explicitly forbidden in their Terms of Service, 3 it is unclear how much Republic could do to prevent this sort of usage pattern. Despite this risk, Republic claims to be performing well. They garnered a lot of attention with the launch of their private beta in late 2011, achieving over 100k customer registrations in 24 hours. 4 The company shifted to a mass-market public beta in late 2012, and the CEO hopes to sign up as many as 350,000 subscribers by early Furthermore, the company claims to be profitable; though some users could drive up costs by only using the cellular network, enough customers proactively offload onto Wi-Fi to even out total network costs. (Currently, average Wi-Fi offload for voice minutes across the Republic community is above 50%. 6 ) But the Wi-Fi-based mobile service doesn t quite match the quality of Tier 1 cellular yet, based on the experience of two Cartesian employees who signed up for Republic in mid Though data over Wi-Fi works well, VoIP quality is not always great. More often than not, our employees had no problems, but occasional clicks, delays, and echoes were enough to hinder the overall experience. Alternatively, the phone can be switched to cellular (with a hard handoff) at any time if Wi-Fi calling quality is poor. Another potential drawback is the device portfolio. The built-in Wi-Fi prioritization requires specialized phones, and the only device currently available is a mid-range smartphone running an outdated version of Android. Additionally, not all standard functionality is available (for example, Republic does not support MMS). Our employees also experienced a number of notable, though relatively minor, issues and malfunctions. One of our employees did not have cellular access for several days due to a malfunction during setup. His device required a factory reset. He also once received a bill mistakenly branded Phonebooth, another Bandwidth.com division. The other employee occasionally receives calls for the former owner of a masked 3 Republic Wireless Terms of Service, Retrieved 4 Mar Republic Wireless Company Timeline, Retrieved 28 Feb WRAL Tech Wire, Don't count out Bandwidth (David) in battle with wireless Goliaths, 10 Dec Republic Wireless My Account Portal, Retrieved 28 Feb Copyright 2014 The Management Network Group, Inc. d/b/a Cartesian. All rights reserved. 3

5 Sprint phone number assigned to his device (it appears an underlying Sprint number is necessary to facilitate cellular service) and has experienced other calling difficulties (including being accidentally connected to someone else s call). Though we are doubtful that these sorts of issues are pervasive, they do suggest that there are a number of kinks that Republic Wireless needs to work out before it is ready for prime time. Despite this, both employees remain fans of Republic Wireless due to the compelling offer: $19 per month for unlimited everything. Though the user experience is not always ideal, Republic can be a good option for consumers who are not very quality-sensitive. Moreover, if Republic is able to solve some of these problems and improve user experience as they maintain they are working to do they will likely be able to increase their traction in the market. Pricing Innovation: Ting Ting takes a different approach to achieving low-cost service: completely unbundled, pay-per-use pricing. The company is a division of Tucows, a domain name registrar and web services company, and launched on the Sprint network in February It has gotten a lot of attention for its innovative pricing scheme, which separates the cost of voice, data, and SMS, and charges subscribers on a tiered basis for how much of each they actually use. Additionally, services can be shared across devices, and each device on an account costs a mere $6 per month. This value proposition of simple, flexible, and easy-to-use service is bolstered by premium customer support: Ting guarantees human customer service agents and no hold time. The pricing flexibility Ting offers can save consumers a substantial amount of money. Ting estimates that 98% of US mobile phone accounts could reduce costs by switching to Ting, with average annual savings in the range of $ for accounts with one to ten devices. 7 However, there appear to be some use cases where Ting would be sub-optimal, specifically for high-end users. For example, 3GB of data would cost about $60 per month on Ting, versus $30 on AT&T (though this would only cover one device). Despite the many benefits, growth has been slow. After over a year, Ting has more than 10,000 user accounts with over 15,000 devices. 8 The high cost of unsubsidized devices and the threat of early termination fees (ETFs) appear to make consumers hesitant to switch from their existing carriers. Ting has taken steps to mitigate these issues by allowing subscribers to bring their own devices from Sprint and recently launching a promotion to refund ETFs for new customers. And they seem to be performing well even with slow growth, reporting 40-45% gross margins and a cost per gross add (CPGA) well below $ Distribution Innovation: Solavei What makes Solavei innovative is not its pricing or network: it offers $49 for unlimited everything, including access to T-Mobile s 4G network. It s very similar to a plan offered by Boost Mobile. The innovation comes in the distribution model: Solavei employs a multi-level marketing (MLM) strategy, in which subscribers are paid for referring Trios, or groups of 3 new subs, to the service. Subscribers earn a recurring $20 per month 7 Ting Blog, Validas study and Ting Savings, 21 Jan Noss, Elliott, from Tucows (TCX) Q earnings call, 13 Feb Noss, Elliott, from Tucows (TCX) Q earnings call, 13 Feb Copyright 2014 The Management Network Group, Inc. d/b/a Cartesian. All rights reserved. 4

6 for each Trio they enroll, as well as for any Trios enrolled by their referrals. Additionally, subscribers earn compensation based on a complex tiered system for referrals beyond those directly attributable and onceremoved. While MLM strategies can be incredibly profitable, they also carry a risk of overcompensating participants at the expense of company profitability. Though Solavei has structured their compensation plan to minimize the potential of significant payouts, some risk still remains. The MVNO is growing rapidly it achieved 100,000 subscribers in just three months, 10 and had paid out over $4.1M after only five months. 11 This would suggest that Solavei CPGA is very low (approximately $40 or less) and that risk of large payouts is limited. However, the complex structure of the compensation plan obfuscates the economics of Solavei s business model. A large portion of payouts could recur monthly, which may put pressure the traditionally thin margins of an MVNO. Solavei has been fairly successful in the short time since launch in terms of both subscriber growth and cost structure, and we believe Solavei will continue to be successful in near term. The cost of referral commissions does represent a danger to long-term profitability, especially when combined with the inherent risk of offering unlimited services to users while paying what are typically per-unit wholesale costs to the MNO. On the other hand, by relying on multi-level marketing and not subsidizing handsets the MVNO avoids most traditional customer acquisition costs. Could Wireless Service be Free? As mobile communications apps and public Wi-Fi hotspots become more prevalent, free wireless service begins to look like a real possibility for consumers. However, many limitations remain: mobile apps often only offer free voice and messaging to other app users, Wi-Fi is certainly not ubiquitous, and consumers typically have to juggle multiple phone numbers. These limitations may not be as insurmountable as they seem, though; by combining a handful of alternative communications solutions, a dedicated consumer could build their own mobile service including voice, messaging, and data for free. One Cartesian employee tried to do just that. First, he ported his personal phone number to Google Voice. This ensured that he could send and receive calls and SMS from the same number across multiple devices and also provided domestic calling and messaging for free. Next, he downloaded GrooVe IP, a mobile VoIP client that integrates with Google Voice, to an old Android phone without a cellular connection. By changing a few settings on Google Voice, calls to his personal number could now be routed to this Android device but only when it was connected to Wi-Fi. Enter: FreedomPop, a mobile broadband MVNO offering 500MB of free wireless data every month (with the aim of monetizing paid tiers and value-added services). With the purchase of an $89 mobile hotspot, our employee now had free wireless data access on his Android while mobile. Additionally, with GrooVe IP, the 500MB could be translated to just over 400 voice minutes that could be used anytime, anywhere for free. Of course, such a cobbled-together solution is not suitable for the majority of consumers. (Furthermore, the call quality leaves a lot to be desired.) Regardless, the fact that MVNOs and other alternative vendors provide avenues for hobbyists to break traditional business models is perhaps a sign of things to come. 10 Solavei Press Release, 20 Dec GigaOM, Solavei selling first BlackBerry Z10 phones in US, just $999 each, 11 Feb Copyright 2014 The Management Network Group, Inc. d/b/a Cartesian. All rights reserved. 5

7 International Insights Despite fundamental differences in market structure and typical business models, a new wave of MVNOs appear to be emerging in Europe and other regions in parallel with the US. Though few international MVNOs leverage new technology, many are experimenting with new business models: GiffGaff offers UK consumers rewards for providing support on their web forum, which reduces support costs and encourages community engagement. Bliep, in the Netherlands, allows users to pay by the day: 1 or less per day depending on outgoing voice and data usage, and free if you re only receiving calls and SMS. Samba and Ovivo are experimenting with ad-supported models in the UK, where subs earn credits for watching ads. These current international examples as well as historical MVNO success stories like Virgin, Lebara, and Tesco can provide valuable insights for the US MVNO market. They illustrate the value of offers that target particular segments and use cases, and can provide guidance for business models in the US. That said, it is important to keep in mind how differences between the US and international markets can impact MVNO business models. Bliep s business model is viable in part due to calling-party pays regulation which is not present in the US, and GiffGaff and other low-cost MVNOs benefit from the prevalence of prepaid and lower dependence on subsidies than in the US. Implications of the MVNO 2.0 Trend New MVNOs are unlikely to substantially disrupt the US wireless market in the near term, as most companies still have a number of issues to resolve. Republic is still nominally in beta, and it shows Wi-Fi calling is not optimal, and many other issues hinder user experience. Ting and Solavei do not have complex new technology to contend with, but may experience difficulties scaling low-cost business models that count community and customer experience as paramount. Even with generous estimates for subscribers today, these three MVNOs represent less than 0.2% of US wireless subscribers, while MVNOs overall hold less than 10% market share. 12 Figure 2: Estimated Innovative MVNO Subscribers and Total US Market 12 Cartesian Estimates, Mar Copyright 2014 The Management Network Group, Inc. d/b/a Cartesian. All rights reserved. 6

8 These carriers do not need to revolutionize the market to be successful, though. As the CEO of Tucows (the Ting parent company) recently remarked, any of us [Ting, Republic Wireless, and FreedomPop] can really make great businesses out of what would, relatively speaking, be very, very small market shares. 13 If anything, emerging MVNOs can be highly complementary to major carriers by offering differentiated feature sets, addressing divergent segments, and enabling wholesalers to monetize subscribers they would otherwise be unable to reach (see Figure 3). Though these new business models could be much more disruptive with the support of major technology players (e.g., Google or Apple), without such support it is likely that new MVNOs will remain focused on select market niches. Figure 3: Relative Qualities of US Mobile Operators Though new MVNOs may not be revolutionary, they do suggest an evolutionary shift in consumer demand. Growing adoption of new services like Republic, Ting, and Solavei as well as the substantial press they ve received illustrates that consumer preferences are beginning to diverge. We anticipate that some consumers will continue to focus on high quality of service, which the MNOs can provide with high speed 4G LTE and HD voice. On the other hand, we believe some consumers will become more content with service that is good enough, and will be most concerned with price, simplicity, flexibility, and support. New MVNOs are experimenting with business models that could successfully address these emerging demands, and are likely to achieve modest success over the next several years. 13 Noss, Eliott, from GigaOM Mobilize panel discussion, 21 Sep Copyright 2014 The Management Network Group, Inc. d/b/a Cartesian. All rights reserved. 7

9 Cartesian is a specialist consulting firm of industry experts, focused exclusively on the communications, technology and digital media sector. For over 20 years, Cartesian has advised clients in strategy development and assisted them in execution against their goals. Our unique portfolio of professional services and managed solutions are tailored to the specific challenges faced by executives in these fastmoving industries. Combining strategic thinking and practical experience, we deliver superior results. Cartesian has deep experience in assisting MNOs, MVNOs, and regulators achieve their objectives. We have worked on over 40 MVNO engagements globally and can support across a number of areas, including: Strategy and business case support, including detailed cost and revenue modeling Negotiation support for contracts and commercial terms Securing funding Vendor and partner identification, evaluation, selection, and negotiation support Assessment of MVNO policy, regulation and market impact For further information, please contact us at cartesian@cartesian.com