Where Do Service Providers Actually Make Their Profits?

By Gary Kim May 22, 2012
One of the truths about virtually every business is that 80 percent of the profits will tend to come from about 20 percent of the activities people at those businesses conduct. In the communications business, profit historically was generated by business customers, who provided the surplus required to run the money-losing rural parts of the business, and later the break-even suburban residential business. 

Those realities are changing with the advent of mobile service and broadband, though on a global basis voice services--both mobile and fixed--continue to generate as much as 70 percent of gross revenue. In the U.S. and other developed markets, voice is down to 60 percent or less (including both mobile and fixed revenue).

One way of characterizing matters is to say that narrowband services--voice and text messaging--often continue to drive the highest margins for retail service providers, as well as representing a crucial, if not dominant revenue source. 

That is not true for the entire business, though. In the long-haul markets, voice traffic is a miniscule part of the overall traffic. So much so that today’s networks are designed around the ability to carry IP traffic, not voice. 

In fact, long haul networks are ideal illustrations of the dumb pipe metaphor, as much as executives in that segment would claim otherwise. There’s a reason that segment of the business deals with “capacity.” 

By some estimates, gross profit margins averaged 86.51 percent for the telecommunications industry in 2010. Net margin was only about 10.99 percent, on average. Assuming industry-average expenses, a reasonable profit margin would be anything between 10 and 15 percent.Of course, little in the telecom business is “average.” Without various subsidies, small rural telcos would consistently lose money, overall. 

Also, profit margins vary dramatically by product. Text messaging margins are almost arbitrary, and can in principle feature margins of 80 percent, though margin is dropping. 

Now, as communications is a multi-product business, including mobile voice, texting, mobile broadband, machine-to-machine services, fixed network broadband, voice, video entertainment and business services, with important new lines of business being built in other areas, executives and managers must contend with many lines of business, each with a different gross revenue contribution and profit margin. 

And many of the sources have variable margins depending on penetration rate. As profitable as voice has been, the fixed network business grows more tenuous as the amount of stranded assets grows.

That is highly significant for retail providers, who make most of their money on selling “lines,” not selling minutes of use. In the capacity business, usage is key, even though there is some revenue earned by fixed charges rather than variable usage. 

The point is that casual observation can miss the discrete margin contribution of various services and applications, as well as the importance of legacy services, even as newer lines of business are added.

Those calculations always are difficult for the tier-one service providers, where so much of the network “cost” is sunk. In such scenarios, the attribution of “variable” cost is an accounting issue. In other words, it is quite hard to determine what the profit margin is for many services.

In a multi-product business, those determinations are crucial.

Edited by Brooke Neuman

Contributing Editor

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