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August 24, 2012

Telcos Need Redesigned Supply Chains to Compete

By Gary Kim, Contributing Editor

Dominant and highly profitable suppliers who lead their markets frequently find that the very profitability of those markets attracts competition, especially from competitors who incorporate a “low price” feature.

Just what a market leader can do when such challenges arise is debatable. Some might suggest buying out the competition early, before the attacker can gain a serious foothold.

But many would suggest that tactic does not generally work forever. If buying the competition to essentially remove it does not work, some would suggest a dominant supplier has to restructure in ways that lower its cost to compete, since such suppliers have to expect gross retail prices to drop strategically.

 That tends to imply that a redesigned supply chain is required. Some might even point to Apple (News - Alert) as an example of a market leader that has focused strategically on its supply chain to provide a competitive cost advantage.

You might argue a similar process is at work in the fixed network telecom business. Incumbent telcos virtually always are the highest cost suppliers, have been the market leaders, but are losing customers, market share and gross revenue to cable companies and competitive suppliers including competitive local exchange carriers, for example.

It being too late to prevent lower-cost providers from gaining a foothold in the market, incumbents now must, among other tactics, work to change their cost profiles.

In part, that is necessary to meet competitor prices. But there are other issues. A business with high fixed costs always experiences difficulty when growth stops, since any significant customer attrition means those fixed costs must be recovered from a smaller base of customers.

The process is most clear in the voice business, where telcos once had 90 percent or higher share of consumer and small business voice accounts, and now have perhaps 60 percent to 40 percent. All other things being equal, that means the sunk costs and overhead supporting the voice network have to be spread over a smaller base of customers.

Thus begins a vicious cycle. Telcos might have to raise prices to cover overhead. Higher prices then drive customers off the network. That means overhead per remaining customer gets higher. So prices have to be increased, which causes more customers to flee, and so on. To be sure, all other things are not equal. Telcos are creating new products to replace lost revenue.

As the U.S. Federation Communications Commission takes a look at special access prices, one wonders how big a deal that might be. In principle, incumbent telcos have lost significant numbers of consumer and small business customers that fixed costs have to be amortized over a smaller subscriber base.

Much of a telephone network’s costs are joint and common, and recovery of those costs is shared across the full range of services the network provides.

As the contribution margin from residential phone service falls, then other services on the network, including special access services, must carry an ever-increasing share of the joint and common costs, some would argue. Oddly, special access prices might now be “too low.”

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Edited by Brooke Neuman
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