Jason Devitt

This is the second in a series of posts analyzing what forces might break the hold that carriers have on the mobile market. Part I is here.

(3) Subsidies Lose Their Power

Almost 90% of people in the US buy their mobile phones from their carriers; now almost 50% of people in the UK do the same. This allows the carriers to control what people can do with their phones.

So why don’t more people buy mobile phones and wireless service separately, the way they buy PCs and Internet service? Because carriers subsidize the cost of handsets, cutting $100 to $300 off the retail price of a new phone, provided that you sign a two-year contract.

(Why don’t regular ISPs do this? I know of one that tried during the dot-com boom: Gobi. But the math doesn’t work. A broadband ISP would have to keep you as a customer for four years just to earn back the cost of an entry-level Windows PC. A wireless carrier can earn back the cost of a free RAZR in four months.)

There are three ways that subsidies could go away. The first is regulatory change, but I’ll leave regulations until a later post.

The second is that a carrier could decide to abandon subsidies and use the savings to slash the cost of service, betting on consumers switching to their network and bringing their old phone with them. A new European MVNO, Blyk, is taking this idea to the extreme: no phone, but completely free wireless service - in exchange for receiving ads.

The third possibility is that phones will become cheap enough to make carrier subsidies irrelevant.

We almost got to that point in 2000. Every new phone seemed to cost less than $50, and pumping up the price took upholstery or goldplating. Then came color screens and games and internet access and cameras and music players, and average prices began to climb again.

I believe that some time in the next five years we will reach another plateau, similar to where the phone market was five years ago and where the PC market is today: smaller, lighter, prettier, cheaper, please, but no new features. The price of new mobile phones will head back towards zero without a subsidy, and carriers will lose their power.

(4) Operator Overload

With great power comes great responsibility. By insisting on controlling all the services that pass through your phone, operators take on huge costs and uncertain legal liability.

Imagine if Dell or AOL were to insist on approving every web site in the world before it went live: content, usability, features, legal compliance, everything. This is the one of the implications of a ‘walled garden,’ and some wireless carriers are still trying to do this. It is not possible. You can let everything through and caveat emptor; you can let almost nothing through and make no money from data; or you can burn millions of dollars searching for a technical solution, a third way that doesn’t exist.

Recognizing this, some operators have begun to allow consumers unrestricted access to the Internet. They still put their own sites and ‘approved’ partners out front, but for how much longer? 74% of Americans already go straight to the mobile site of their favorite portal.

What do I mean by unknown liability? Assume that you are Verizon: Are you responsible for faulty merchandise sold by a mobile commerce site? If you have to approve every site on your deck, how do you offer adult content? If someone downloads an mp3 over your network, are you liable for copyright infringement? The solution is the same for wireless operators as it was for wireline ISPs - become a bit-pipe and disclaim all responsibility for what passes over your network.

(5) Flat-rate Pricing

A lot of people seem to think that operators are bound to move to flat-rate pricing for data, and that this will lead to unrestricted Internet access. Yes to the first part, no to the second.

Over time, all communication technologies seem to move towards simplified pricing, such as flat-rate pricing for mobile data. Note that ’simpler’ doesn’t necessarily mean ‘lower.’ Consumers often pay a premium for simplicity.

But switching to a flat rate for data doesn’t make your carrier indifferent to how you use the network. If you pay by the kilobyte, they want to maximize the amount of bandwidth that you use: streaming video, music downloads, multiplayer games. If you pay a flat rate, they want to minimize the amount that you use. Only when it becomes cheap to deliver all kinds of content do they cease to care.

UK operator "3" announced flat-rate pricing for data services a few weeks ago and were greeted as messiahs. I am reserving judgment until I hear what the flat-rate price is, what the usage restrictions are, and why a company that is promising unfettered access to the Internet still needs a partnership with Yahoo. (And since 3 has only 5 million subs, I still won’t care.)

Another week, another laughable announcement from a major carrier: I will be able to watch a handful of videos from YouTube on my Verizon phone. Videos carefully screened by Verizon. If I sign up for their $15 per month VCast service. Wonderful. Meanwhile carriers have made it even harder to do something as simple as forwarding email alerts to your own employees via SMS, even if your company is paying for the phones.

Imagine if there were only four major Internet Service Providers in the US. Now suppose that most of the time you had to buy your PC from your ISP - even if you were General Motors or McDonalds or the US government. What kind of PCs would you expect your ISP to offer? What kind of services? And at what price?

The correct answers are ‘crippled’, ‘Soviet’, and ‘too much.’  It would be infuriating. But this is precisely how the market for mobile phones operates in the US and Japan today, and the rest of the world is not much better off.

What will it take to break the carriers’ hold on the market?

Most of my peers believe in some form of technological Manifest Destiny: that change is inevitable, that carriers will see the light or be swept away, that the brave warriors Linux and Ajax will march around the Walled Gardens seven times blowing their trumpets and lo, the mobile Internet shall be ours.

For my business, I care about when and if this is really going to happen, and so I am trying to think about the market forces that may lead to it. I’ll break this up into several posts. Thoughts and comments very welcome.

(1) More Competitors. Please.

The more carriers the better. Competition has driven the cost of long-distance phone calls in the US to near zero. But that took a hundred years and unlike Skype two guys in a garage cannot launch a nationwide wireless network good enough to compete with a Cingular or Vodafone or KDDI.

‘Mobile Virtual Network Operators’ or MVNOs help a little. These are companies like Amp’d and Virgin that lease carrier networks and sell services under their own brands. They have shamed the larger carriers into improving services and trimming prices. But starting an MVNO is like sub-letting your apartment; tenants may prefer dealing with you but you will never put your landlord out of business this way. ESPN and easyMobile have already given up.

New technologies can enable new entrants. There are two WiMax networks planned in the US, but one of those is Sprint’s, so that means net one new entrant this decade. (Estimated cost of building a nationwide WiMax network: $5 billion.)

WiFi? No one can live on WiFi alone. As Roger Entner from Ovum says in this New York Times article, “Everybody who tries a Wi-Fi phone will get down on their knees and thank the wireless phone people for the good job they’ve done on coverage.” As well as spotty coverage and calls that drop even when you are stationary, WiFi drains batteries faster. Hybrid WiFi/cellular handsets actually help the carriers - they get to offer better coverage indoors without building any new towers and they can shift traffic off their own networks. The best we can hope for hope is that customers in turn will shift to lower-priced plans, squeezing carrier revenues.

(2) Market Saturation

The good news is that even without any new competitors, there can still be increased competition.

For twenty years, mobile operators enjoyed continual growth; prices fell every year, but this drew so many new first-time customers that total revenue kept going up. Investing in the network and keeping suppliers and vendors in their proper place was never a problem. Carriers that were modestly successful got bought by carriers that excelled. Failure was rare. 

Now in most developed countries there are at least seven mobile phones for every ten people, which means that pretty much every adult has a phone. In countries like Taiwan the ratio exceeds 100% - almost everyone has a phone and many have two.

This raises the cost of a marginal subscriber; operators have to steal customers from each other or persuade their current customers to stick around and buy more services.

Anything that cuts into revenues or margins forces carriers to rely more on their partners - handset vendors, software companies, content providers, Google. And that is good for all of us.

More to come … stay tuned.

Apparently there is a crisis in the world of venture capital. Those who write about it see two distinct problems, one on the way in and one on the way out. Technology has so lowered the cost of starting a business that traditional VCs are no longer needed; on the way out the number of IPOs and big-ticket acquisitions has obviously dwindled, MySpace and YouTube and maybe Facebook being the exceptions. Some entrepreneurs seem quite smug about VC troubles. I think that the ‘crisis’ is largely confined to consumer Internet services, and that it is more of a crisis for entrepreneurs than it is for VCs.

True, part of the problem on the IPO side has nothing to do with technology or VCs. It’s a piece of over-zealous legislation called Sarbanes-Oxley that has raised the cost of going public. Personally I think the way to prevent corporate crimes is not to make companies swear to their accountants that they are really really not lying about their EBITDA, but to make them disclose as much information as possible to investors. SarbOx didn’t reveal that dozens of corporate executives had back-dated options; it was Erik Lie, a finance professor from the University of Iowa who crunched numbers that were publicly available.

But mostly the problem is that while the technology and the concepts behind Web 2.0 are exciting and important, the companies that embody them just aren’t very valuable. Pioneering sites like Flickr and delicious sold for less than $50 million each, and even YouTube and MySpace didn’t think that they could survive as independent companies. In total it’s just not enough money to get venture investors excited.

No problem, we are told, since cheap Intel boxes and Amazon S3 and Ruby on Rails and the rest of it mean that you can launch a company with $6,000 and a bowl of ramen.

Wait a minute. All over this country, across every sector, small business owners use an average of $10,000 to start their businesses. Even for this year’s Inc 500, a list of the 500 fastest-growing companies in America over the last four years, the median amount of start-up capital was only $75,000.

The key word is small. Like their peers in construction and retail and transportation, most of the consumer-facing Web 2.0 businesses are small today and will stay small. What is different is that most of the founders of the Web 2.0 companies believe that they are destined to be big.

VCs are adjusting to the fact that just like railroads, automobiles, fast food, bowling alleys, wall-to-wall carpet, fabless semiconductors, and personal computers in days gone by, the consumer Internet market has begun to mature and no longer presents many interesting opportunities for venture returns. (Yes, there will be exceptions; but every so often there is still an opportunity for a venture-backed retail franchise.)

A lot of the entrepreneurs that I meet have not made that adjustment. That’s the crisis.

The Carnival of the Mobilists is a weekly roundup of the best writing online about the mobile data market. Each week it’s hosted at a different site - like a traveling carnival. Thanks to C. Enrique Oritz for including my post "Content is the Cup Holder" in this week’s Carnival. If you follow the mobile market, you should definitely read some of the other pieces, particularly Andreas Constantinou on operator strategy.

Photo by markisevil

Why do carriers care about content for mobile phones?

As eMarketer pointed out in an article last month, mobile content is a $20 billion niche in a trillion-dollar industry. That is more than enough to get entrepreneurs and investors excited, and a lot of people have already gotten rich selling ringtones and games. But from the carriers’ perspective, it is 2%.

True, the market for mobile content grew by one third last year. At that rate it might get to be 10% of carrier revenue five years from now, depending on how quickly voice revenue declines. How much time do you spend thinking about products that might represent 10% of your revenue in 2011?

“I thought that mobile data revenue was already much higher than that,” you protest. Yes, but:

mobile data = content + messaging + internet access

Messaging includes SMS (text), MMS (pictures), IM, email, video calls, and whatever is to come; internet access means means wireless connections for laptop computers. Right now messaging brings in three times more revenue than content and still has plenty of room to grow. 3G modems for laptop internet access are very new but the coverage is so much better than WiFi that some people have ditched WiFi altogether. Messaging and internet access explain how mobile data got to be 14.1% of total revenue at Verizon Wireless. Messaging alone explains how the Philippines just became the first country in the world to see data revenue overtake revenue from voice.

Mobile content (games, ringtones, TV, maps, music, location-based services, and everything else) is much less important. Moreover, content must be sourced; dozens of technologies are involved and hundreds of business relationships must be managed; and everyone wants a cut. That makes content far less profitable than messaging or access, for which marginal costs are negligible. So why do carriers care about content at all?

One reason often given is that some category of content is going to break out and generate a hundred billion dollars in revenue. Before the telecom bubble burst in 2000, this was how European carriers explained the prices that they paid for 3G spectrum. But those investments have long since been written off and forecasts for mobile content are today quite modest. Carriers no longer have to be seen putting a lot of effort into content in order to justify their stock prices.

In my view the real reason that carriers care about content is that content is to mobile phones as cup holders are to new cars.

27% of car buyers in America would consider switching make or model to get the perfect cupholder. And no, it’s not just Americans anymore.

This is rational behavior. Once you’ve decided that you want, say, a two-seater car for the city or an SUV, there’s very little to choose between the dozen models available except for details like cup holders, keyless entry, a telescoping steering column, or a power outlet on the center console.

Consumers choosing a wireless carrier care most about price, handsets, and in the US, coverage. But in most countries there is very little to separate the leading carriers. Enter mobile content. When a customer is standing in Radio Shack or Carphone Warehouse trying to choose a new carrier, one rock star, one new game, one favorite TV show might make a difference. Carriers use content to sell voice.

Why is this important? Because if you are in the business of developing content for mobile phones, this explains a lot of carrier behavior that otherwise seems irrational or unsustainable.

• They don’t pay attention when you say that you can increase their ARPU, because you can’t

• They will market a category - say games - but over time they have no interest in helping you to sell your content, because the success of your business can never make a difference to theirs
• They care about brand-name content, even if the application sucks
• Brands like American Idol and Disney pose no threat to the carriers’ business; brands like Google do
• A three-month exclusive may be worth more than three years of revenue from non-exclusive content
• If they marketed games last quarter, they will not market games this quarter; they need something new
• A third-rate app that allows them to claim parity with a competitor is a higher priority than a first-rate app that customers might actually buy
• If you do start making money, they will cut your revenue share; allowing a content vendor to get powerful isn’t worth the risk
• Categories of content that are actually hard to add or might generate negative publicity are at the bottom of the list - think location-based services
• Mobile search is now necessary to help new customers find the content that made them buy the phone in the first place; having the best possible mobile search is not interesting
• Mobile advertising will be a bone thrown to content providers; it can’t possibly help carriers to sell phones