Chapter 5
CONSUMER DEMAND
The progression of this book has mimicked the top-down method of investing (detailed in Chapter 7). We began with the big picture (basics, history, and sector composition) and then moved on to drivers. The material so far should help investors decide whether to overweight or underweight the Telecom sector versus a benchmark for the next 12 to 18 months.
The purpose of the next two chapters is to facilitate both industry and stock-specific decisions. With economic, political, and sentiment drivers anchoring sector knowledge, you can sharpen your analysis by examining consumer demand trends in this chapter and the challenges and opportunities for Telecom firms in the next.
But this chapter isn’t a static template! The drivers for consumer demand are changing rapidly, so a good investor should regularly reassess the trends. Here, we’ll review some of today’s most influential developments to demonstrate how to identify new ones going forward.
The industrialization and urbanization taking place in emerging markets (EMs) like China are driving enormous economic growth and wealth creation. And there are still large rural populations that cell phone towers have yet to reach. Due to their growing economies and low user penetration rates, emerging markets represent a big growth opportunity for Telecom.
Disposable Income
Consumer demand for Telecom services can be heavily influenced by increases in disposable income—particularly in emerging markets. For example, someone in India with $812 of annual disposable income likely won’t spend all of it on an iPhone—never mind the accompanying voice and data plan. However, India has a population of 1.17 billion, so a nominal increase in disposable income could materially impact aggregate Telecom spending in that nation. To better gauge where opportunities may be, Table 5.1 lists populations and disposable incomes for the BRIC countries (Brazil, Russia, India, and China—the largest emerging economies) and the US (for context).
Table 5.1 2009 Populations and Disposable Income (US $)
Source: The Boston Consulting Group, “The Internet’s New Billion” (September 2010).
Low Penetration Rates
We know India has a huge population, but investors should focus on determining the real prospect for subscriber growth. In other words, what percent of the population already pays for Telecom services (i.e., the penetration rate), and what percent represents an opportunity? Relative to the developed world, a number of emerging countries have low penetration rates—meaning there are still millions of potential new Telecom customers. Table 5.2 shows penetration rates for the BRIC and the US.
Table 5.2 2009 Telecom Penetration Rates for the BRIC and the US
Source: The Boston Consulting Group, “The Internet’s New Billion” (September 2010).
Mobile phones have the highest penetration rates in BRIC countries compared to other technologies—not surprising considering how relatively cheap they are and the popularity of prepaid services. Prepaid services have enabled vast populations of low-income consumers to own phones because they can purchase as many minutes as they can afford. Prepaid cards can cost less than $1, and users can add value in increments as low as 30 cents.1 In fact, it’s estimated 72 percent of the world’s 4.6 billion mobile subscribers use prepaid services.2
Although certain mobile phones can be cheap and monthly costs negligible (if the phone is used sparingly), PCs are another story. PCs can be prohibitively expensive for most BRIC citizens, and this directly impacts Internet penetration rates too, which greatly lag mobile phones’ high penetration rates. However, in both India and China, Internet penetration rates are higher than PCs (see Table 5.2). In these countries (and many others), Internet cafes are still popular because they enable relatively cheap Internet use without the costs of PC ownership.
The lowest penetration rates across the board are in India. With such a large population, India is a great growth opportunity. However, the timing and pace of increased Telecom spending in India and other developing economies depends not only on the size of the population without a mobile phone, PC, or Internet connection, but on disposable income levels too.
Mobile Phone Usage
Like penetration rates, usage tends to vary by country and service. For instance, texts are wildly popular in China, but they’re not half as fashionable in India. Table 5.3 lists a variety of mobile phone activities and percentage usage in the BRIC and US.
Table 5.3 2009 Percentages of Phone Users Engaging in Mobile Activities
Source: The Boston Consulting Group, “The Internet’s New Billion” (September 2010).
Such information can help investors identify possible opportunities. For example, a telco offering mobile gaming services in China has the potential to do well because, at a 39 percent usage rate, it’s a popular activity with additional room to grow—but competition is likely high. However, using a mobile phone to make payments is less common in China than gaming—meaning there may be greater upside and less competition. Obviously, deeper research into each activity is required, but the illustration shows that user activity information can be useful in identifying consumer demand trends.
Wireline Usage
In general, wireline businesses are a relatively smaller portion of the emerging markets Telecom sector than wireless services (as discussed in Chapter 3). Mobile voice services are more abundant and usually more affordable than wireline voice services. However, since Internet penetration rates are relatively low in most major emerging markets, wireline businesses could benefit from greater Internet demand and therefore greater data consumption.
Similar to mobile usage, online activities vary by country too. While e-mail is common across the board, social networking is most popular in Brazil, job hunting is trendy in India, and the vast majority in China indulges in music. Depending on your outlook for these end markets, a telco delivering regionally popular services may be a relatively more attractive investment than one that doesn’t. Online activities are listed by country in Table 5.4. Note the differences among the EM countries—and also between them and the US.
Table 5.4 2009 Percentages of Internet Users Engaging in Online Activities
Source: The Boston Consulting Group, “The Internet’s New Billion” (September 2010).
Emerging markets generally have great growth potential based on new users, but are limited by average revenue per user (ARPU) due to low incomes. The developed market is the exact opposite. Penetration rates are high, so there are limited opportunities to add subscribers, but much higher incomes support much higher ARPUs.
These demographics have coincided with two major trends in developed markets. The first is a shift from wireline to wireless services. The second is a shift from voice to data subscriptions driving growth.
Wireline to Wireless
Wireline services have been hampered by falling prices and consumers switching to wireless services. In 2006 dollars, US Telecom firms’ wireline revenue per minute peaked at $4.27 in 1933 and has dropped to $0.07 in 2006—the 73-year decline is shown in Figure 5.1. As prices fell, consumers used more minutes, but even falling costs have done little to stem the tide of decreased wireline spending in US households. As shown in Figure 5.2, household wireline spending peaked in 1997 at $57 per month and has declined ever since.
Figure 5.1 US Average Revenue Per Minute for Interstate and International Calls
Source: Federal Communications Commission, “Trends in Telephone Service: 1930–2006” (August 2008), p.104.
Figure 5.2 Average US Monthly Household Telecommunication Expenditures
Source: Federal Communications Commission, “Trends in Telephone Service: 1995–2007” (August 2008), p. 29.
Wireless household spending stands in stark contrast to the decline in wireline spending. As shown in Figure 5.2, the growth in wireless spending has been strong enough to more than offset the decline in wireline spending and has powered aggregate Telecom spending higher.
In the mid-1990s, the initial rise in wireless spending was driven by early cell phone adopters—those willing to pay a premium for a service not yet widespread. However, as the mobile industry matured, the quality and affordability of wireless services led to more consumers not only buying cell phones, but also canceling their traditional wireline services.
Figure 5.2 provides an excellent look at household Telecom spending, but it’s also important to consider business spending. Unlike a home, it’s unlikely a business will cancel all wireline phones and just use cell phones. But even accounting for both homes and businesses, mobile revenue growth has still been astounding. In 1997, mobile accounted for just 22 percent of all OECD Telecom revenue—by 2007, it was 41 percent (the OECD is mainly developed countries, so it’s a fine proxy for the developed world even though it does contain some small non-BRIC EM countries). It’s likely this trend will continue, especially due to the growing popularity of smartphones.
Smartphones
The migration from wireline to wireless has been expedited by the popularity of smartphones, whose demand is growing six times faster than the overall mobile phone market.3 Whereas smartphones were an insignificant percent of wireless market share just a few years ago, in 2009, nearly 32 percent of AT&T’s postpaid (customers on contracts) mobile subscribers were using a smartphone.4 The growth has been fast—particularly for AT&T because of the popularity of the Apple iPhone. (AT&T had an edge in attracting new subscribers because it was the sole US provider of the iPhone when the phone launched in 2007. As of February 2011, however, AT&T lost exclusivity, and Verizon also began offering the iPhone.)
Figure 5.3 shows the growth of mobile subscribers in OECD countries. Because the figure shows growth only through 2007, it doesn’t reflect the more recent growth of the smartphone market, but it’s interesting to note the increasing popularity of prepaid phones. The economical attributes that make prepaid phones popular in emerging markets are attractive in developed countries too—segments like the youth market, families, and small business customers (who prefer to control usage or pay in advance) also favor prepaid subscriptions.
Figure 5.3 Cellular Mobile Subscribers in OECD Countries
Source: Organisation for Economic Co-operation and Development, “OECD Communications Outlook 2009.”
Voice to Data
As the price and importance of voice services have fallen for both wireline and wireless services, data services have filled the void and fueled growth. Data demand has been driven in wireline by broadband demand and in wireless by smartphones.
Although broadband prices have been falling—between 2005 and 2008, Digital Subscriber Line (DSL) prices fell in the OECD by 14 percent per year5—subscription growth has coincided with greater data demand. Due to consumers’ desire to participate in the numerous activities listed in Table 5.4, broadband has grown from 60 percent of OECD wireline Internet connections in 2005 to 90 percent in 2007.6
Web browsing, e-mailing, GPS maps, social networking, and the thousands of applications that can now be run on a smartphone have driven considerably more demand for mobile data. The significance of the growth can be exemplified by AT&T. Between 2006 and 2009, AT&T’s annual wireless data revenue grew 47 percent annually to $14.3 billion. Wireless data skyrocketed from only 4.6 percent of company revenue in 2006 to 11.5 percent in 2009. Smartphones have contributed to the growth of wireless not only through handset sales, but by driving increased demand for mobile data, which bolsters ARPUs.
Chapter Recap
The Telecom sector has undergone significant changes because of deregulation and new technologies. In order to increase the likelihood of identifying the investment opportunities that are created by change, it’s important to understand what’s driving consumer demand for Telecom services. Here are some of the most influential trends today:
- In numerous EMs, there are growth opportunities based on large populations with low penetration rates. Disposable incomes, however, are often low, which limits Telecom spending per person.
- In EMs, mobile and wireline usage differs regionally.
- In developed markets, there are few opportunities to add subscribers, but higher disposable income drives higher ARPUs.
- There have been two primary trends in developed markets: A transition from wireline to wireless services, and a shift from voice to data subscriptions driving growth.