As the wireless penetration increases, greater attention is needed in the areas of customer segmentation and service quality

Bob Metcalf, the inventor of the Ethernet, espoused in the 1970’s that the value of a network is proportional to the square of the number of its participants.

This “law” is actually more a simple observation in combinatorial math than a rigorously proven theorem. Yet, astonishingly, the blind application of such an uncomplicated result has led to widespread chaos in the mobile telecommunications industry.

The difficulty in interpreting this law has centered on the notion of the network’s value. Metcalf originally used it to refer to the number of possible interconnections the network’s constituents could make. Over time, mobile operators have repeatedly used value to serve as a proxy for the revenue that the network generates, i.e. if there are twice as many users, the network will generate four times more revenue.

The marginal revenue (revenue resulting from each incremental user) from the network is thus proportional to the size of the existing user base — i.e. bigger is much much better. If the cost of introducing additional users (marginal cost) to the network can be reduced to a relatively small constant, the (marginal) profits will appear like windfall gains.

This result is not exactly obvious. Clearly, larger networks do have more revenue potential —but, if the above analysis is to be believed, diminishing returns never seem to kick in. Additionally, it implies that a larger network will always win over a smaller one — even if the smaller one has a large initial value (due to some special benefit or concession). Growth of subscribers at any cost will be justified in the long run, it seems.

Unfortunately, the real world is vastly different from this simplistic mathematical view. On the revenue side of the equation, it is not really the number of interconnections in the cellular network that drive the top line — only usage can accomplish that. The value mentioned in Metcalf’s law therefore really refers to potential revenues, not actual ones.

Moreover, if each incumbent blindly applies Metcalf’s law and starts building larger networks, the excess bandwidth available will drive down prices, pushing revenues south. As an illustration, in the US the average wireless user talked 50 per cent more in 2001 than in 2000, but paid only 5 per cent more for that privilege.

On the other side of the equation, costs are not easy to control either. Marginal costs include expenses incurred in marketing, distribution and discounting to influence the increasingly savvy potential customer.

While marginal costs can be brought down with increased scale, this requires building vast networks capable of handling large call volumes — a capital-intensive task which bloats the fixed cost base. Capital expenditures are often considered free investments, but in the real world there is no place to hide costs.

Marginal profits must exceed the fixed cost base before any real profits materialise. It doesn’t help if billions of dollars are added to the fixed cost for the purchase of additional (3G) licenses, even before a single connection has been established.

What lessons from these experiences can be applied to the Indian context? Is the impressive growth of India’s wireless industry sustainable? Does the Indian cellular revolution run the risk of running out of steam?

India’s cellular market is relatively new; the first license for mobile operations was issued barely seven years ago. Prior to this, telecommunications infrastructure (mainly wire-line) was provided solely by the state. Since the late 19th century, the state-run telephone monopoly has managed to install about 30 million telephone connections (for a population of 1 billion residing in 180 million households). In comparison, private cable TV operators have installed over 40 million cable connections in just the past 10 years.

Indian mobile operators have not had to kick-off their operations in a mature telecom market. Users had to undergo long waits and painful experiences just to get a wire-line phone installed, only to see it remain out of order for days on end. Customer service and network maintenance have all been virtually absent from the state’s telecommunications operations. In such an environment, the cellular phone has emerged not as a luxury, but as more of a convenient alternative to the landline.

The lack of adequate telecommunications infrastructure in the country has allowed additional room for growth for the mobile operators. Wireless operators only started experiencing pain in the West once adoption rates had hit 40-50 per cent. This high level of cellular adoption in the presence of well-developed terrestrial networks resulted in the slowing of revenue growth.

Mobile operators failed in their attempts to trade expensive investment programmes and new products for additional revenue. With the Indian penetration of landline and wireless phones still in single digits, local cellular operators can expect robust growth rates in connections for some time to come. It seems that the scale at which Metcalf’s law starts disintegrating has not yet been reached.

The Internet revolution still remains elusive in India (Internet penetration remains less than 2 per cent). No ISP has gained a strong foothold in the country, mainly due to the uncompetitive costs of the underlying communications infrastructure and the Indian user’s price sensitivity.

While the dotcom boom has spawned indigenous replicas of e-bay and Amazon, no one has stepped up to develop the expensive infrastructure required to carry content to the end-user. Hence, getting the customer to use a cellular product does not require peeling his attention away from a multitude of digital options, making wireless adoption and increased usage a slightly easier proposition.

Cellular operators earn their revenues in local currency whereas setting up infrastructure requires paying international prices. This tension in supply and demand of capital automatically puts a restriction on its availability — an essential ingredient for inducting discipline in capex programmes.

As a consequence, while we do see a rapid expansion in the Indian cellular footprint, there are already instances of infrastructure sharing between operators in parts of the country (Escotel and Airtel in Haryana and Western UP). Some lessons in controlling capital expenses seem to have been learnt from the West.

Recently, Indian cellular operators have initiated structural price wars to attract more users to their networks. Certain categories of incoming calls are now free, and roaming facilities cost much less. As a consequence, the existing cellular tariffs are close to the lowest in the world. Falling prices combined with the recent drive to popularise prepaid cards in an attempt to attract more users has resulted in a steady decline of the ARPU (from Rs 1,200 in 1999 to Rs. 900 in 2001).

A fourth cellular operator in the metros will further divide the user base and adversely impact operator revenues (nearly half of operator revenue comes from the metro areas). In this scenario, the exaggerated dependence on increasing revenue potential just by adding more customers must end soon.

There is enough scope for employing creative marketing strategies to capture a larger portion of the consumer’s wallet. Today there is little difference between ARPUs across operators, indicating a market with largely standardised products. Quality of service too, is fairly standard for all customers regardless of usage.

Only 5-6 per cent of operator revenues are generated from value added services such as roaming and SMS. The time has come to combine business expansion with business basics. Now that the wireless revolution has achieved critical mass, customer segmentation, cost management, product design and service quality require increased attention.

(The author is with Booz Allen Hamilton’s Information Technology Practice in London. The views presented are purely personal)