Are MVNOs a No-Go?

How Prepaid Plans and Young Subs Are Creating Challenges

With the high-profile bankruptcy of Amp’d Mobile and the news that Virgin Mobile USA is more than $500 million in debt after five years in business, the MVNO model has come under scrutiny. But many still believe this model can work.

The model is, on the surface, quite simple: take a brand, outsource operations and the network at a fixed monthly cost, and focus on attracting customers profitably — “profitably” being the operative word. In fact, Virgin reported that capex accounted for only 3 percent of its spending in 2006. With less overhead than the big guys, the idea is to be able to offer more personalized, tailored services than the mass-market wireless companies.

Amp’d Mobile is focused on hip branding

Unfortunately, it’s not quite so simple in reality. MVNOs must take other factors into account, such as handset subsidies and the delicate interplay of business metrics, like subscriber target base and size, ARPU, churn and customer acquisition costs. Add in expenses like marketing costs and distribution, and an industry average of only 30 percent margin to begin with, and you’re looking at something a bit more complicated than simply hawking a brand.

There’s also the question of being able to provide the basics. “Bottom line is that the majority of mobile subscribers in the U.S. seek quality of coverage and good value,” writes Jupiter Research’s Julie Ask, who acknowledges that MVNO prospects are not dead. “A handful want handset selection and will choose T-Mobile for the Sidekick or [AT&T Inc.] for the iPhone. It’s hard to beat the infrastructure owners [e.g., Verizon Communications Inc., AT&T] on any of these dimensions. This will evolve over time and more consumers will seek differentiators [e.g., entertainment offerings], but for now it’s more important that they are on their friends’ networks.”

And the other consideration is the branding itself. “A successful MVNO must have some brand recognition already with their target audience, or that large sucking sound you would otherwise hear is $100 million being flushed into the market to create awareness of a new brand,” says Dean Fresonke, CEO at ClearSky Mobile Media, which supports content for MVNOs. “Instead, the value proposition has to be a differentiated service to a distinguishable market.”

It’s worth taking a look at what knocked Amp’d out of the game. After 17 months of fast growth, Amp’d had 200,000 subscribers and an ARPU of around $100, putting it in position to satisfy its creditors — on paper. The problem came when bad debt skyrocketed at the postpaid provider, stemming from a lack of timely billing and lax credit checks in its quest for growth. What came to light in the court documents is that close to half its base (80,000 subs) were not paying.

Content and multimedia-focused Amp’d still owed about $33 million to underlying network provider Verizon Wireless, who was unwilling to extend any more deadlines for the startup. Combined with $16 million owed to handset partner Motorola Inc., and various sums to Universal, Best Buy and MTV, the amount for restructuring comes to more than $100 million in debt.

Conventional wisdom says Amp’d should have known that its target market of teens and young people wouldn’t typically be able to afford the high ARPU. Conventional wisdom also says this demographic is the least responsible in paying and staying within limits, and therefore the most likely to require a prepaid plan. “It turned out that that Amp’d’s target customer is the root of the company’s financial woes,” says Fedor Smith, an analyst at Atlantic-ACM. “The lack of sound credit exhibited by Amp’d customers, which is shared with several other prime MVNO targets, is exactly why they are not considered a premium target for traditional carriers.”

Amp’d isn’t the only one to get in trouble by not understanding all the facets of its target market. Mobile ESPN was the first big MVNO in the dead pool, going out of business after a marketing blitz and high-profile launch failed to yield subscribers in numbers. Fresonke blames the difficulty of branding the sports-oriented service, which offered exclusive replay clips, fantasy football leagues and other tailored value-adds. “Show me an existing ESPN customer,” he says. “There isn’t one — only cable customers who watch ESPN sometimes.”

Then there’s Helio, a joint venture between Korean operator SK Telecom and U.S. ISP EarthLink, which may be repeating the mistakes of its fallen peers (a from-scratch brand-building, narrow-market, postpaid model with high ARPU). EarthLink is targeting the high-end, technology-savvy, upper-income level younger consumer on a postpaid basis — similar to the Amp’d model. Insight research says the MVNO had about 100,000 subscribers at the end of 2006 and an ARPU of $100. Helio launched the $415 Ocean device in the spring, taking a $115 hit per subscriber to offer it at $299 for new users. “The company has adopted the unusual approach of distributing primarily through electronic game retail outlets, which is limiting its ability to attract a significant core customer base,” says Alexandra Rehak, research director at Insight. “Helio aims to have 250,000 subscribers by the end of 2007, but is reportedly running significant losses.”

For all the bad-news stories, no one seems to have completely given up on the model yet. Gartner Inc. has it slated for growth, saying that the stable of 40 MVNOs in the United States that serve up to 10 percent of U.S. subscribers today will expand to serve 25 percent in five years.

Indeed, there are still many signs of life. Virgin Mobile, which is in a quiet period and couldn’t comment for this story, still is planning to go ahead with its IPO, although that may be pushed back to later in the fall. Analysts and others have said the company’s future success can’t be judged by its current debt, particularly since the IPO should raise about $100 million and it’s running about $1 billion in annual revenue.

Virgin Mobile also is planning a series of enhanced services to make its proposition even more attractive to what is already a loyal customer base of 4.6 million youth users. For example, it just launched a service with online networking site Facebook to offer a new application called “My Mobile” on the new Facebook platform.

“Virgin used their brand to connect with the twentysomething market, but the real value proposition was to make prepaid service something cool and socially acceptable,” says Fresonke. “Before, [prepaid] had been a behind-the-counter offering from other carriers with an ‘if-you-have-to-use-prepaid-you-must-be-a-loser’ stigma.”

TracFone Wireless is the next biggest MVNO, which along with Virgin Mobile, accounted for a combined 5.3 percent share of U.S. cellular subscribers and almost 36 percent of all prepaid subscribers at the end of 2006, according to Rehak. Boost Mobile has a similar model.

Meanwhile, top MVNO enabler Telcordia Technologies Inc. continues to announce customers, most recently the North American venture of Japanese giant KDDI Corp., dubbed KDDI America Inc., and the tween-focused kajeet.

For its part, Disney Mobile has neglected to provide subscriber numbers, but all indicators point to a healthy service that makes use of the lessons learned in the above paragraphs: attractive low monthly subscription rate, prepaid service, tailored content and services for kids and parents, affordable handsets, low-key marketing efforts that rely in the power of the established Disney brand and a mass-market, every-kid appeal.

“Mass-market MVNOs with low-priced prepaid offerings have taken a notable share of the U.S. market, and have driven the growth of prepaid services,” says Rehak. But, she adds, a key challenge for mass-market MVNOs is maintaining ARPU levels and limiting churn. “Prepaid customers generate less ARPU than postpaid subscribers,” she says. “They also switch operators more often, and price tends to be the key factor in their choice. The average monthly ARPU for prepaid services in the U.S.A. is about $27. Maintaining high ARPUs is less critical for MVNOs because of lower capex requirements, but consistently declining ARPUs do not make for a sustainable business.”

Share this article: Email, Slashdot, Digg, Del.icio.us, Yahoo!MyWeb, Windows Live Favorites, Furl
Add this article feed to: RSS, My Yahoo, Newsgator, Bloglines