Is Time Up for Europe’s MVNOs?

Historically, many telecom operators have treated their business with mobile-virtual-network operators (MVNOs) as a free lunch. The free lunch, however, is not so free after all. In some markets, such as Spain, Germany, and Austria, mobile operators have paid—or are about to pay—a stiff price for their MVNO deals.

Mobile operators have sold wholesale mobile access to fixed operators and cable companies in order to generate fresh revenues. But by enabling cable and fiber attackers to embrace fixed-mobile convergence—and altering the overall game—some of these deals have let the fox into the henhouse. The resellers, wanting to hold onto their customers and generate additional sales, have priced the mobile portion of their fixed-mobile packages at or below cost, driving down overall market prices. Aggressive MVNO pricing accelerated market declines in Spain and is now destabilizing the market in Austria. Some mobile operators cannibalized themselves, with a disproportionate share of customers moving to their hosted MVNOs.

At the same time, the overall explosion in mobile data usage has started to hurt the economics of almost all MVNOs. Mobile operators have fixed-cost network economics, but MVNOs generally pay for usage à la carte, so their costs are rising rapidly.

It’s no wonder, therefore, that in recent investor conference calls with management, analysts have questioned the effect of MVNOs on the overall health of mobile operators and the impact of specific MVNO deals.

Mobile operators cannot legally walk away from their MVNO deals. And even if they could, regulators would not let them. Regulators in Europe view MVNOs as good for competition.

In approving M&A deals between mobile operators in Austria, Ireland, and Germany, the European Commission required the surviving entity to set aside as much as 30 percent of its capacity for MVNOs. In Germany and Ireland, the EC forced Telefónica Germany and Three Ireland (Hutchison), respectively, to sell that access at a fixed cost, creating so-called capacity MVNOs. These MVNOs essentially replicate the fixed-cost-network economics of mobile operators and—regulators hope—sustain market competition. (There is, of course, a difference between healthy competition and loss-leader pricing strategies that can depress long-term value creation for all operators. The jury is still out on the role these capacity MVNOs will play.)

Conventional Wisdom Is Wrong

The foundation of mobile operators’ MVNO business, in other words, is about to be shaken to its core. In particular, three frequently expressed core beliefs are out of date—or just wrong.

MVNOs Do Not Hurt Industry Profits. Ten years ago, MVNOs may have been marginal players whose market influence was hidden behind overall industry growth, but those days are over. Markets are saturated, revenues are under pressure, and mobile data and fixed-mobile packages have become commodity-like products in many cases. In this environment, conventional mobile operators are forced to react to price cuts and other MVNO tactics. It’s no accident that the overall profit pool in Spain, Germany, and Austria, where MVNOs are active and aggressive, has shrunk.

MVNO Revenues for Mobile Operators Come at 100 Percent Margin. Before the explosive growth of mobile data, operators could use MVNOs to soak up excess capacity, predominantly in voice but also in data. They also could avoid the trouble, expense, and bad debts of dealing directly with certain retail-customer segments. But the center of that high-margin business model could not hold strong in today’s data-hungry world. That model did not account for the capital costs that mobile operators incur when they are forced to upgrade their networks and buy expensive spectrum. In fact, some MVNOs are currently paying about one-third less than they would if mobile operators’ full costs were allocated properly. Additionally, the business case of many MVNO deals did not properly reflect the risks of cannibalization or new competitors.

If We Don’t Do an MVNO Deal, Our Competitors Will. Operators have rationalized their MVNO deals on the theory that they are at least winning the business at the expense of one of their competitors. The problem with this “prisoner’s dilemma” is that it is a false choice. In the classic formulation of the dilemma, the prisoner who takes the plea bargain receives a much better deal than his companion who does not. In reality, during negotiations, the MVNO plays mobile operators against one another across multiple rounds, creating a dynamic, multistage round of negotiations. The deal for the “winning” operator gets worse the longer negotiations drag on (and the more operators participate), and so do the competitive dynamics of the market.

The Right Way to Work with MVNOs

MVNOs are not going away, especially those that enjoy regulatory protection. Indeed, remedy-induced capacity MVNOs are in their infancy. How can operators work with all MVNOs in ways that make economic and strategic sense? Here are three commonsense approaches.

Do the math. Properly. When they negotiate with MVNOs, operators need to take into account all the costs and risks. These include, among others, the frequently “forgotten” capital costs of expanding and upgrading their networks and the risks of cannibalization and the emergence of new competitors. In the long run, operators will be stronger if they say no to deals that do not reflect the full costs and risks of providing service. In a sweet irony, equity analysts reward them for turning away the prospect of short-term gains.

Choose your partners carefully. When regulators impose MVNO-based remedies on M&A deals, operators should be especially careful in choosing partners. These deals could disadvantage mobile operators for many years and engender a new breed of powerful MVNOs whose economics are potentially superior to their hosts’.

In other deals, mobile operators should seek MVNO partners that will add value to the host as well as the overall markets by acting as more effective sales channels or tailoring services to the respective target segments. The obvious, history-based example: MVNOs that serve immigrant or ethnic segments with inexpensive calling services. Still, there are also opportunities to serve other segments, such as B2B audiences.

Make a difference by differentiating. Ultimately, mobile operators should resist the commoditization of mobile markets by creating packages of services that MVNOs cannot easily duplicate. For example, mobile operators might bundle mobile services with content, value-added services, and fixed-line products. They can create innovative handset business models such as U.S. mobile operators have done by increasing the frequency of upgrades and offering insurance for additional monthly fees. Or they can simply provide superior customer and network experiences.

We are entering a new era of MVNOs. Mobile operators are getting smarter about picking partners and negotiating or walking away from deals. The mobile data revolution is forcing the MVNOs themselves to reinvent their strategies—if they have not already done so. The result, if operators act with foresight, will be a tamer market based on fundamentals, rather than fantasy or short-term arbitrage.