Business Week reported that at&t may be considering reducing its current $30 per month data plan to $20/month for new iPhone subscribers. at&t already subsidizes the price of iPhone up to $200 and currently require iPhone subscribers to pay a minimum of $30 per month for the data plan. The service is offered only as a bundle – getting the data plan is required to activate iPhone. Should at&t reduce its price by $10? What is the impact on its current subscribers? How should they do this so the incremental profit from this price reduction is greater than their current profit? Let us do this by looking at why they are doing this, industry cost structure, competition and customer perceptions.
US Mobile phone penetration is more than 90% and a service provider can grow its subscriber base only by stealing market share. As the Business Week story reports most customers in the high income bracket with a higher willingness to pay for data service are already taken either by at&t or by Verizon. The current churn rate (% of subscriber base that switch service) is about 1.1% for at&t, this means an average at&t subscriber stays with them for 8 years.
A service provider’s network costs are mostly sunk and even the ongoing maintenance costs are fixed its marginal cost to serve a customer is $0 – so it makes sense to add as many new subscribers as possible to amortize the fixed costs and deliver profit. So no surprise that at&t wants to grow its current subscriber base. The only relevant cost is the customer acquisition cost which is about $200 (including iPhone rebate) to customers.
Given these numbers, the lifetime value of a iPhone subscriber over 8 years (at 10% discount rate) is $4400. So adding every subscriber and keeping them longer adds directly to their bottom line.
Despite reporting strong profit and increase in number of iPhone subscribers, at&t added fewer subscribers than Verizon wireless who beat out at&t with its portfolio of devices. at&t has not said explicitly how many unique iPhone subscribers it has. One source is to find from Apple’s earnings statement but ArsTechnica summarizes the number of iPhone activations that it culled from at&t quarterly earnings report. The total iPhone activations since it was introduced is 8 million, of which 2.1 million were pre-3G. If we assume 50% of the pre-3G iPhone subscribers upgraded to 3G the number of unique iPhone subscribers is about 7 million.
If at&t simply reduced the pricing by $10 its current 7 million subscribers are not going to be happy. Like the iPhone price drop outcry that happened when Apple dropped the price of its iPhone by $100, there is bound to be customer demand to reduce their pricing. This means a total monthly loss of $70 million. So just to get back to its profit levels before the price drop at&t should acquire 1.16 million new iPhone subscribers. Note that this 1.16 million is above and beyond its current subscriber growth rate which is 1.6 million new subscribers per quarter. Since the competition is not going to stand still it is going to be a tall order.
So at&t will definitely introduce versioning and introduce the low priced plan with service restrictions/impairment. While it helps to avoid the need to reduce the fee across the board it does introduce two new problems. First, some of its current subscribers will switch over to the lower priced plan and second, majority percentage of its new subscribers will pick the lower priced plan. If we assume a 50% downgrade and 100% pick $60 plan, then the new break-even number of new subscribers is 580,000. This is still a high number.
So should at&t reduce its price? I think it should not to keep its profit at current levels.