Lessons learned from handset subsidy cuts in Spain, one year on
Last year we reported on the removal of handset subsidies, notably in Spain, and the impact this phenomenon could have on mobile operator market shares and profitability. One year on, what are the lessons we can learn from this brave operator experiment?
Deteriorating macro-economic conditions in Spain have been in the spotlight over the past 12 months with the country’s mobile operators feeling the impact on their bottom lines. According to the OECD, GDP in Spain was falling more than twice as fast as the European average by mid-2012 with unemployment reaching 25% and inflation rising faster than the eurozone average.
Amid these challenging conditions, market-leader Telefonica Movistar replaced its handset subsidies with a ‘pay-by-installments’ facility a year ago – a bold move that risked leaving the firm vulnerable to cost-conscious subscribers churning to rivals. Yet the operator managed to sustain its customer market share at around 38% during 2012, while the removal of handset subsidies to new customers also led to “significant savings in commercial costs”.
Based on Telefonica’s experience, the first lesson to learn is that removing handset subsidies comes with a short term sacrifice. Telefonica’s revenue from handsets in Spain halved between January and September 2012 (to EUR149 million) while its mobile data revenues dropped by EUR13 million over the same period (to EUR400 million). Yet, despite this short term hit, the operator’s OIBDA margin increased from 42.8% in Q1 2012 to 47.5% in Q3 2012 as its recurring mobile revenues increased by 4.8% between January and September 2012 to EUR1.4 billion.
Telefónica’s COO, José María Álvarez-Pallete stated that “we are basically out of subsidies in Germany, the Czech Republic and in Spain and it has not been affecting our contract commercial activity”.
The second lesson is that the removal of handset subsidies should be paired with a robust contingency plan to manage subscriber acquisition and retention. Telefonica concentrated on convergent offerings – introducing its Fusión product last October that bundles its fixed, broadband, TV and mobile services at competitive prices under a single monthly bill. The service topped 430,000 customers in its first month.
Finally, any operator entirely removing handset subsidies should not assume that competitors will follow suit. In a recent report, Vodafone CEO Vittorio Colao stated that, in Spain, “there was a lot of excitement about elimination of subsidies. We followed. Clearly not the whole market followed and it didn’t really work”. This is in contrast to comments by Telefonica Europe CEO, Eva Castillo, who recently claimed that “[competitors] are not so much using the subsidy in handsets anymore”.
Last summer, Vodafone actually re-introduced handset subsidies on a promotional basis, which helped to regain momentum in customer acquisition and brought their market share of net additions to 104% in Q3 2012, compared to 50% at Movistar, and -18% and -36% respectively at Orange and Yoigo. Nevertheless, the operator’s Spanish mobile service revenue has been falling on a quarterly basis over the past 12 months (albeit stabilising in Q3 2012) while customer costs increased to one third of total revenue in Vodafone's FY2011/12 (up from 30% a year ago). This served to further eat into the EBITDA margin, which has fallen from 30% to 25% over the last two financial years.
Despite Vodafone Spain unveiling its own version of Fusión just a week after the Telefonica product was launched, the operator has said that “the real issue in Spain” is consumer pricing and the best approach is to replicate the tariffs introduced in the US aimed at encouraging data use and stablising ARPU.
“This is about clearly providing customers with unlimited voice and unlimited SMS,” claimed Colao, while allowing consumers to identify “what price is for the service and what price is for the handset or what is the intrinsic cost of the handset” while giving larger data allowances and freeing up usage.
According to Vodafone, “it’s more about the choice and the pricing levels than an ideology of taking out or leaving in subsidies”.
The Spanish situation highlights the issues that can arise when one operator withdraws subsidies and others do not. Generous subsidies may weigh heavily on operating costs but they are always a useful tool for building market share and stimulating data revenue growth. By not re-implementing subsidies (as Vodafone has done), Telefonica appears comfortable in trading improved profitability at the expense of handset and data revenue.
For European incumbent telcos struggling with large debts such as Telefonica this makes a lot of sense, but it leaves the door open for domestic competitors to make an impact if they can get their tariff offerings right.
Spain: revenue, recurring and % non-voice revenue
Source: GSMA Intelligence