Myth #2: Carriers are gouging consumers and enriching themselves with the profits.

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Myth

Compared to other countries, Americans are paying more for slower speeds.  Carriers are using the profits to enrich their shareholders, not improve their services or invest in infrastructure.

Where this notion comes from

Americans recall the antitrust action against AT&T where it was shown that AT&T had overcharged consumers and blocked competitors. For 10 years, AT&T had to report to the courts about their activities.  Today their market power is sufficiently tamed by other competitors.  Susan Crawford alludes to the 19th century robber barons in the oil and railroad industries in her book and likens this to the telecom industry today in her book.

Possible explanation

People may confuse revenue with profit.  There is no doubt  that large telcos such as AT&T earn a lot of cash. With millions of customers and businesses as subscribers, they raked in $127 billion in 2012.  However, they also have operating costs of more than $114 billion, as well as the cost of rolling out an LTE network across the USA.  Things add up when you are running a global operation of 241,000 employees.   As for 2012, AT&T ended up with a gross profit of around 5%.  That’s an awful lot of work for such a tight profit margin, and there are other investments where one could find with a better return.

It is easy to use the internet to check list prices for broadband internet in other countries, but without proper adjustment, these numbers do not make a fair ”apples-to-apples” comparison.

Being on the internet, people are habituated to things being ”free”. For example, free calling on Skype and free searches on Google.  People deduce that internet connections should be free, without understanding that these services require investment in real equipment and infrastructure. Moreover the so called free services on the internet may entail tradeoffs in privacy.

Facts

  • Americans pay more for mobile service than European (an average of $69 in the USA versus $39 in Europe), but they use five times as many voice minutes and twice as much data. (GSM Study)
  • Entry-level pricing for American broadband is the second lowest in the OECD, behind Israel. (OECD, Berkmann)
  • American cable companies had 82% more additions in Q1 of 2013 than in 2012  (Leichtman)
  • American DSL companies had 99% more additions between the same two periods (Leichtman)
  • American carriers are generally less profitable than European. (Bloomberg, Bank of America Merrill Lynch)

Analysis

While the telecom industry has been on a seven year decline globally for returns on invested capital (ROIC) and average revenue per user (ARPU), the characterization about too high prices and profits persists.  Financial analysts have an opposite view of the situation, owing to increased competition and deregulation. ”Operators have to invest in their networks or they’ll disappear — competition is too cut-throat not to,” notes Stéphane Téral, principal analyst for mobile infrastructure at Infonetics Research.

Comparing prices for telecommunications services across countries is a slippery slope.  The market price of two different countries may not reflect the same inputs.  The price can vary for many reasons including the network type, the network speed, the type of subscriber (individual, business, company etc), whether the item is sold in bundle, whether the subscriber has a certain exemption, taxes, and other factors.  Economists and financial analysts who study prices have to build dynamic models to reflect these factors.  It is a quite a different matter than simply checking the internet for a carrier in another country and making a meaningful comparison.

While many may mention low prices in Japan and South Korea, the reality is that consumers there actually pay for their broadband three times:   once with their taxes (broadband networks are subsidized), once through their rent (landlords required to pay for upgrades), and once on their broadband bill.  Compared to US which is mainly a private carrier-funded market, Americans only have to pay once, and they pay what it costs.  So Americans who don’t want to connect to the internet, don’t have to pay for it at all.

Consider it another way. There is nothing wrong with paying more for something that is faster and better.  Cars cost more today than they did 10 years ago, but we don’t complain because we get more value.

As cursory comparison on cable prices between America and Europe shows that  Americans typically get more channels and content than their European counterparts.[1] Plus many European countries impose taxes as high as 25% on telecom and cable services.  Don’t forget that television in Europe was largely public until twenty years ago. There was one station, the public TV channel, and that was paid for through taxes.

To get a sense of this, read the GSM study on mobile, and see how Americans get more value for money.  As for mobile prices, in the last ten years we have had nothing less than a 6 million fold improvement in mobile broadband prices.  In 2003 a mobile broadband data plan cost $1.75/MB.  It took 150 hours (about a week) and $1200 to download a CD worth of music.  Today we can get 5 GB of mobile broadband on a 4G with speeds of 20 Mbps or higher.  To stimulate adoption of new LTE networks, providers offer LTE at the same price as 3G; consumers are therefore getting tomorrow’s technology at today’s prices.

The bottom line is that American broadband scales with usage.  Americans who want an entry level internet connection can only  get it cheaper in 2 countries.  Thereafter, if they want faster speeds, they pay for it.  That is only fair.  This means that for as little as $20, people can be assured bandwidth to do essential email and web browsing for job applications, online banking, and so forth.  Having access to real time entertainment is not a human right, and it is not fair that other network users should subsidize bandwidth so others can watch movies.

As for high speed broadband which customers spend upwards of $60-$100 per month, those prices are not out of line with a daily Starbucks beverage.  What is the value of all that content?  Certainly as much as a latte.

As for carriers that take risks in investing in new technologies, it is also fair that they should receive a return on their investment.  Shareholders won’t invest in a company otherwise. The telecom industry invests upwards of 13% of sales back into their infrastructure, significantly higher than other equipment industries.  In some years, American carriers have invested even more.

At the end of the day, people would not buy subscriptions if they felt that broadband packages were too highly priced and/or not worthwhile. The fact of the matter is that the number of new broadband subscriptions is increasing year or year.  More people are getting broadband, not less. Some 800,000 new cable subscriptions came on line just in the first quarter of this year. As for DSL, some 315,000. Read the Leitchman report to learn more.

Data

  • Read the study on mobile at GSM
  • The OECD broadband portal has the most comprehensive study of prices across the world.
  • Yochai Benkler of Harvard’s Berkmann Center made a definitive study of broadband policy globally.  He observed that American entry level prices for broadband are some of the lowest.  See page 59.
  • Merrill Lynch Bank of America has a department dedicated to the analysis of the global telecommunications industry. They collect all the available public information on the telecom industry and collate it into a massive database. Their position is that the long term profitability of telecommunications is declining on account of competition, regulation, and regulatory uncertainly.
  • Valueline makes a survey of return on capital (ROC) of 120 industries and 25,000 firms globally. In 201 it listed the global telecommunication industry with an ROIC of 12.65%. Computer software (e.g. companies such as Microsoft) had the highest ROC of 43%; internet companies are 21.54%, and entertainment technology, 19.51%  Telecom services fall in the lower bottom half of all global industries,  13.66% in ROC, placing it just above the publishing industry.
  • The Leitchman Research Group publishes quarterly data on broadband subscriptions.

Reality

Consumers can get broadband internet packages at all budget levels. Financial returns of American carriers are in line with the rest of the world. Globally the telecom industry faces downward trends of profitability, return on capital, and annual revenue per user (ARPU).



[1] http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2258747