Kaetzer Mastin 1 The National Market for Cellular Phone Service Tim Kaetzer and Dana Mastin Econ 200 Fall 2004 The national cellular market is undoubtedly one of the nation s most expansive markets. In 2003, wireless revenues totaled to over $100 Billion; nearly one percent of the United States GDP. Since wireless has emerged, the typical buyer has expanded from the average middle/upper-class adult to teenagers, elderly, and business consumers. 20% of American teenagers own cell phones, explaining why Virgin Mobile was founded to specifically target young consumers 1. There is certainly a large market for business consumers, as many carriers advertise business solutions even in retail outlets. Altogether, it s estimated that 50% of Americans own cell phones, yielding a consumer base of approximately 147 Million customers 2. Although there are over 300 registered national wireless firms, there are only a select few that compete in the entire national market 3. The industry s largest corporation is Verizon Wireless with a 2003 annual revenue of $22.5 Billion and a base of 40.4 Million customers. Sprint PCS, T-Mobile, and Nextel also have growing nationwide networks. Many competitors, although well known, only have coverage areas in sections of the United States. Alltel, for example, only offers service in the south and midwest. Until recently, Cingular had coverage areas in only the southeast and western parts of the United States. Its recent merge with AT&T wireless, though, will expanded its network to what some speculate will become the largest nationwide network. Since we are considering the market for national cellular service, we will consider only the ones with complete nationwide service: Verizon Wireless, Sprint PCS, T- 1 Brome 2 Brian and Tyson 3 Wireless Advisor
Kaetzer Mastin 2 Mobile, Nextel, and Cingular/AT&T. Figure A shows a distribution of revenue among these five corporations in 2003. Figure A 2003 Revenue Distribution Corporation Revenue Revenue (Billions of dollars) Share Verizon 22.5 32.2% Sprint 12.7 18.2% Cingular 15.4 22.1% Nextel 10.8 15.5% T-Mobile 8.4 12.0% Total 69.8 Nextel 15% Cingular 22% T-Mobile 12% Sprint 18% Verizon 33% General Market Structure: The product distribution structure for cell phone carriers is somewhat atypical. It is important to note that the individual carriers have no contribution in the manufacturing of phones. All carriers have contracts with manufacturing firms that produce phones to primarily operate only on each of their respective networks. Motorola and Sony Erickson are major manufacturers for Verizon Wireless, while Samsung and Sanyo are two of Sprint PCS s manufacturers. Interestingly, it is common for manufactures to produce phones for more than one competing carrier. Verizon Wireless, Sprint PCS, and T-Mobile sell Samsung made phones often which are essentially the same models. This introduces an interesting principle regarding patents. It is difficult for a carrier to develop or hold a patent on a phone related feature such as an implemented camera feature or voice command technology because the property rights reside with the actual manufacturing companies. If a carrier wanted to be the only competitor to offer a specific phone feature, it would have to negotiate an agreement with the manufacturer. This sometimes happens for new features, though in general, this trend with carriers and manufacturers makes it difficult for firms to develop a highly differentiated product.
Kaetzer Mastin 3 The retail process for cell phones is also quite unique. Practically all cell phone carriers make sales through their own retail stores as well as through third party retailers such as Best Buy and Radio Shack. The firms use of third party distributors is critical for their revenue because cellular is a relatively new large market only about a decade and half old while general electronics is well established. Verizon Wireless, for example, has only approximately 1200 stores and kiosks nationwide 4. Yet, their agreement with the Radio Shack Corporation expands their outlets to 7,000 more stores nationwide 5. This generally makes Verizon s marginal costs higher, rather than their fixed costs. As Verizon grows and builds more outlets, though, they will increase their fixed costs to effectively reduce their marginal costs. Accordingly, as Verizon seeks increasing sales as well as increasing economies of scale, they will generate more output from proprietary retail stores and less from third party distributors. The same holds true for practically all other carriers and their associated retailers. The national wireless carrier industry can be best understood as an oligopoly. This is first true because only a few major firms compete at a national level. A new aspiring cellular company would have many obstacles hindering entry to the market such as spectrum property rights, extensive network construction costs, manufacturing contracts, and retail/advertising methods. Obtaining frequency spectrum rights is extremely costly. In 1993, the FCC implemented a distribution model of auctioning frequencies of the electromagnetic spectrum. Winning prices are often in the billion dollar range; The Congressional Budge Office estimates that income from spectrum auctions in 2003 2005 will total to about $24 Billion 6. Spectrum rights alone greatly expand costs, and combined with other costs constitute a high minimum efficient scale. This explains why there are relatively few firms in the cell phone market. 4 Verizon Wireless 5 Radio Shack 6 Taylor
Kaetzer Mastin 4 The cellular service market is also understood as an oligopoly because the industry exemplifies a product/service with little product differentiation. Most consumers purchase a cell phone for the fundamental use of correspondence away from home, which all firms products offer. There is some variety with add-on services that different firms offer as well as service integrity in various areas. With add on services, firms don t have a particular service for long before other firms follow with comparable and competing services. Sprint PCS was the first corporation to introduce picture messaging, but Verizon and T-Mobile quickly followed. Similar trends also occurred with wireless internet, email, and ring tone purchasing. Thus, add-on services don t necessarily differentiate products for a long period of time. As for coverage integrity, all national carriers offer adequate reception in centralized cities. In some rural areas, though, it is often possible that only one or two carriers offer sufficient reception. Still, firms have become very competitive and strategic with network strengths, especially firms with national coverage. Although there are in fact short periods of time or areas where the national cellular market may appear as a monopolistic competition, long run considerations indicate that market is most like an oligopoly. Price Behavior: The vast majority of cellular phone sales are based on 2-year and sometimes 1-year agreements. In general, customers choose a plan that gives them their desired amount of minutes per month and sign a contract for the plan often with about a $ 35 activation fee. Carriers bill their customers every month for their selected monthly price. If a customer decides to break their contract (to change carriers, for example) they are obligated to pay an early termination fee. These are often in the $150 dollar range, making it difficult for the customer to leave the carrier.
Kaetzer Mastin 5 If the consumers exceed their allotted minutes for any given month they are charged extra minute fees which tend to be approximately 7 times greater than the plan price per minute. A customer is roaming if they happen to travel to an area where their carrier doesn t provide coverage. If a customer makes a phone call while roaming, they often pay extra because they are using a tower and network owned by a carrier other than their contracted service provider. Firms in the industry negotiate these prices according to deals with other firms; Verizon has a set roaming fee of $0.69 while T-Mobile has a roaming fee that varies with location. Nextel and Cingular advertise no roaming charges on their plans, and Sprint and Verizon offer upgraded plans with no roaming charges. Table 1 shows a comparison of carrier price plans closest to 1200 minutes a month. Table 1 Plans Closest to 1200 Minutes Minutes Monthly Price Price per Minute Carrier Plan Name T-Mobile Get More Plus 1000 $ 59.99 $ 0.060 $ 35.00 $ 0.40 (varies) $ 200.00 Yes Yes Nextel National Power 1200 $ 69.99 $ 0.058 $ 35.00 $ 0.40 (none) $ 200.00 Yes Yes Sprint PCS Free and Clear 1100 $ 65.00 $ 0.059 $ 36.00 $ 0.40 $ 0.50 $ 150.00 No Yes Cingular Nation 1250 1250 $ 79.99 $ 0.064 $ 36.00 $ 0.30 (none) (varies) Yes Yes Verizon America's Choice 1200 $ 79.99 $ 0.067 $ 35.00 $ 0.35 $ 0.69 $ 175.00 Yes Yes Activation Fee Extra Minute Charge Roaming Charge (per minute) Early Termination Fee Free intra- carrier calling Free Nights and Weekends Price Discrimination: Average: $ 0.062 $ 35.40 $ 0.37 $ 0.60 $ 181.25 Cellular providers all display a lucid trend of price discrimination with their plans. Most firms offer monthly plans that typically range from 400 minutes to 2000 minutes, with increasing prices according to how many minutes are purchased per month. Calculating the price per minute for a given company s plans practically shows a textbook example of quantity price discrimination. Figure B shows a breakdown of Verizon s America s Choice National Plans. It
Kaetzer Mastin 6 is clear that as more minutes are purchased, the price per minute reduces significantly. In fact, those who purchased 2000 minutes or more pay exactly half as those who purchase 400 or 500 minutes. Price discrimination also occurs with family plans. This is true not only with minute prices, but with phone prices. It is quite common for firms to give discounts on phone prices when more than one is purchased at one time. For example, T-Mobile offers a promotion where customers can purchase a Motorola V300 for $199.99 with a family plan and get another one for free. Minute prices for family plans typically allow customers to share minutes for a lower total price, meaning they pay less than they would have if they had purchased the plans separately for the same net amount of minutes. Figure B Monthly Alloted Price per Plan Price Minutes Minute $ 39.99 400 $ 0.10 $ 49.99 500 $ 0.10 $ 59.99 800 $ 0.07 $ 79.99 1200 $ 0.07 $ 99.99 2000 $ 0.05 $ 149.99 3000 $ 0.05 $ 199.99 4000 $ 0.05 $ 299.99 6000 $ 0.05 Price per minute $0.11 $0.10 $0.09 $0.08 $0.07 $0.06 $0.05 $0.04 $0.03 Price Discrimination: Verizon's America's Choice National Plans 0 1000 2000 3000 4000 5000 6000 7000 Minutes puchased per month Price discrimination also occurs according to location. All carriers ask for zip codes when customers wish to view their plans online, allowing them to charge different prices in different locations. Similarly, they print different fliers and advertise varied promotions across the country. For example, Nextel offers a plan found in some areas called the Nextel $99.99 unlimited plan which offers unlimited anytime minutes, unlimited nights and weekends, and unlimited intra-carrier calling. Although this is a national plan, it is only offered to those who
Kaetzer Mastin 7 live in some cities such as Houston (area code 77201) and Chicago (area code 60652). This plan is not offered in other large cities such as San Diego (92124), Los Angeles (90065), and Phoenix (85033). There are many potential reasons for this type of discrimination, and this has implications about demand elasticity. In all markets, firms tend to charge higher prices to areas with low elasticity because setting a higher price will result in only a small loss of customers. The opposite is true for areas with high elasticity, as customers will easily decide not to purchase according to price. Thus, it is possible that areas such as Houston and Chicago have relatively large demand elasticity s as opposed to Phoenix, where the $99.99 Nextel plan only offers 2,000 minutes. Another possible explanation for this discrimination is that Nextel is piloting this plan in some areas before making it nationally available. Differentiation of Products As previously noted, there is generally not enough product differentiation between firms to indicate that the market is anything other than an oligopoly. There are, however, various aspects that can differentiate products in the short run and in certain instances. Communications technology is not as big an issue now as it was in the late 90s, but it can make a difference to some customers. When cell phone networks were first established, everything was based on analog technology. This is also known as AMPS (Advanced Mobile Phone System). Analog technology is the most basic type of wireless communications, and compared to digital technology, has various drawbacks such as weak signal integrity, poorer clarity, and lack of encryption. Analog service quality is comparable to the VHS video cassette standard. Cricket, although not a national carrier, is an example of a firm that solely uses analog technology. Over the last few years, most firms (including all of the national firms that we consider) have moved
Kaetzer Mastin 8 towards digital technology. Digital technology is basically the DVD quality technology for wireless communications. There are two types of digital technology, Digital Service and PCS. Digital Service is essentially a hybrid between analog and digital technology because it uses towers originally designed for AMPS for digital communications. PCS, in contrast, is a standard fundamentally designed for digital service. Where Digital Service offers more clarity and privacy than AMPS, PCS rises above Digital Service with encryption algorithms and errorcorrecting codes providing superior service. Sprint s entire network is PCS, while Nextel s network uses mainly Digital Service. Verizon s network employs both PCS and Digital Service standards 7. Aside from Verizon, most carriers networks use Digital Service and AMPS or PCS and AMPS. AMPS is now used as a backup standard for cellular communications that many firms offer. Many phones are designed to operate in AMPS where digital technology isn t available. Interestingly, not all phones sold by a given carrier offer the same technology capabilities. Some phones support only one digital frequency, while others can operate on numerous digital frequencies (Dual Band), or even numerous digital frequencies as well as AMPS (Dual Mode). The Samsung SPH-A740 sold by Sprint, for example, supports two digital frequencies (CDMA 800 and CDMA 1900) as well as analog (AMPS 800). The LG VX-6000 sold by Verizon on the other hand only has two digital frequencies (CDMA 800 and CDMA 1900) 8. The majority of customers know little about technology. Still, some customers do pay attention to frequency capabilities and buy accordingly. Market Shock 7 Bryan and Tyson 8 Brome
Kaetzer Mastin 9 In 2003, the Federal Communications Commission passed legislation that required firms to allow phone number porting between carriers. Before the legislation was passed, a customer changing carriers had to sacrifice their old number and receive a new one from their new carrier. This legislation obviously made consumers less obligated to their carriers than they were before, and sought to eliminate the externality of friends and family hassle to keep up with new contact information. The effects of this were not like a price or demand shock because the net revenue of the industry didn t necessarily change. Rather, customers changed carriers within the industry, resulting in an increase in sales for some companies, and a decrease for others. Eric Burden, a Sales Associate in Glendale, AZ with more than four years of experience noted that A lot of people moved from T-Mobile and ATT to larger companies such as Verizon. This certainly makes sense, as customers with inferior service could easily move to carriers with larger networks. Most importantly, the legislation made the cellular service industry much more competitive. Because the legislation made it harder for carriers to hold on to customers, firms came out with an array of promotions and deals to attract and maintain customers. Mr. Burden emphasized that [carriers] made sure their prices were more competitive, and became more concerned about contracts. [It] gave people a lot more freedom and brought down prices on the service plans and phones. After the legislation was passed, Sprint began offering plans with free nights starting at 7pm instead of 9pm. Also, practically all firms began offering free in carrier calling (when a Verizon customer calls another Verizon customer for example, the call is not charged to their monthly minutes). Altogether, the legislation mostly benefited the customers, as it made the market more competitive, and provided a slight degree of product differentiation allowing customers the convenience of choosing features to best suit them.
Kaetzer Mastin 10 Conclusion The effects of the phone number porting legislation as well as the oligopoly market structure show the overall behavior and state of the market: firms work with a mainly undifferentiated product and are always seeking ways to gain an edge on the market. Due to the manufacturing patent situation, it is continually hard for carriers to develop any significant feature to rise above others. Carriers ultimately resort to a price setting game in effort to attract customers from other carriers and maintain current customers. Additionally, firms continually expand their networks to gain market edge with coverage. This explains why many carriers have sought to merge as Cingular and AT&T did. Recent news explains that Sprint and Nextel are seeking to merge, which would similarly make a larger and more competitive network. It is unlikely that there will be many more large merges due to FCC regulations, which will prevent the market from approaching a monopoly. Ultimately having less firms in the market will benefit consumers with network coverage, but will likely lead to higher prices with less competition. Still, there is a large number of small carriers that could potentially merge or grow to enter the national scope of cellular service.
Kaetzer Mastin 11 Works Cited Brome, Richard A. Phonescoop. <http://www.phonescoop.com/>. Burden, Eric. Personal interview. 6 Dec. 2004. Cingular. <http://www.cingular.com/>. Leslie Cauley, and Paul Davidson. Cingular, AT&T deal gets an OK from Justice. USA Today Oct. 2004: Money, Pg. 03b. Marshall Brian and Jeff Tyson. How Cell Phones Work. Article. <http://electronics.howstuffworks.com/cell-phone.htm/printable>. Nextel. <http://www.nextel.com>. T-Mobile. <http://www.tmobile.com/>. Taylor, John B. Economics. Boston: Houghton, 2004 RadioShack. <http://www.radioshack.com/>. Sprint PCS. <http://www.sprintpcs.com/>. Verizon Wireless. <http://www.verizonwireless.com/b2c/index.jsp>. What is the difference between analog and digital cell phones? Article. <http://electronics.howstuffworks.com/question31.htm>. Wireless Advisor. <http://www.wirelessadvisor.com/>. Yahoo Finance. <http://finance.yahoo.com/>.