What the hell are we doing giving out subsidy to prepaid?

Born during the mid-1990s in western Europe, the prepaid model has had an unprecedented impact on subscriber growth wherever it has been introduced. In most emerging markets prepaid subscriptions make up 90% or more of total mobile subscriptions.

This growth has two main consequences: a) it allows mobile telephony to surpass fixed-line telephony in penetration levels and b) it forces a decrease in fixed-line telephony tariffs. By making the services available to and accessible by all segments of the economy, mobile telephony moves from being a luxury item to being considered a commodity or even a basic service. As a result, prepaid service is a key component of mobile service providers’ portfolio.

Unfortunately, prepaid’s “golden age” is approaching its end in most of the markets. This doesn’t mean that prepaid is no longer a valid proposition, but mobile operators cannot continue to follow a market strategy purely based on aggressive customer acquisition to build critical mass without adopting some measures to qualify new users. The reality in many emerging markets is now a shrinking pool of potential customers, increasing operator debt levels, limited available vendor financing, an overabundant number of mobile service providers, a decrease in voice rates, and new subscription plans that negatively impact the operators’ profit margins. This is forcing operators to look for new revenue streams that could counteract the decrease in subscribers’ ARPU levels while considering subsidy strategies across segments to trap valuable clients as long as possible.

Since the nature of prepaid wireless service revolves around the lack of commitment involved, it makes sense that operators don’t offer much of a subsidy, if any, for prepaid subscribers. Much of the time, this means customers are paying full retail price for a phone, which can now get up into the $300 and $400 rage for the top models. The operators’ logic is that they don’t want to give out a subsidy only to have you break away from their service in three months. This becomes a larger issue with the prevalence of phone unlocking and reprogramming services. Since there’s no way to penalize a prepaid user (since they never agreed to a length of term) there’s no way to recoup that subsidy. Hence, there is none, for the most part.

The best offer in this regard from many companies comes in the form of a packaged prepaid phone and service card, which you can buy at direct (own shops) or indirect channels (distributors, retail outlets, points of sales, etc). The downside is that these are older, often flimsy phones. The upside is that you can get one for usually around $20.

So why do prepaid companies offer a subsidy in this form? The client’s tenure aka, the age of the phone, has something to do with it. Typically, it would be harder to sell such phones to postpaid customers. Since they get a subsidy, they’re looking for better phones. Most times, subsidized “free phone” that comes when you sign a contract is superior to the models you’ll find in prepaid packages.

Second, the prepaid carriers are betting that most customers will eventually buy enough airtime to cover the lost cost of the packaged phone. The problem is that they have no control over the situation. You could go and buy one of those phones and never activate it. This puts the operator out a sum of money though they would have been out the entire cost of the phone had it not been purchased in the first place. So in a way, it’s a cutting of losses, with the hopes that they can recover those costs through airtime.

This is also why many retailers limit the number of prepaid phones you can buy. You might get a number of reasons from retail employees as to why this is policy at most stores. But the real reason is that they lose money on the initial transaction alone. In order to make money, they need you to activate and use the phone. As a result, most stores won’t sell you more than two prepaid phones, which is a huge downer for someone (you know, consultants like us ;)) who want to conduct advisory to address the potential of future (or existing) prepaid customers.

This is precisely the case of the following slides prepared by two of our consultants (Nacho and David – good work gents!): a detailed tenure and CLTV analysis of the prepaid segment of a mobile operator, splitting the SIM-only vs PACK cases to fully understand the profitability of such prepaid products and most importantly, react upon subsidy inefficiencies making our client’s SAC rocket every month. If you ever wondered why prepaid is normally not subsidized, please take 10 minutes to read the case.

Feel free to share your thoughts on this! Enjoy your reading.
Best regards,
CVA