Price wars threaten survival of Kenya’s mobile phone industry

In March 2010, Sunil Bharti Mittal sealed a deal that earned him a place on the list of India’s business stars, among them Ratan Tata of the House of Tata, the Ambani brothers, and Lakhmi Mittal of steel giant Acelor Mittal. All the men had sealed transformative merger and acquisition deals that symbolised India’s coming of age in a new world order.

Backed by a $10 billion loan arranged by his bankers at Standard Chartered and Barclays Capital, Sunil became the third owner of Zain’s mobile phone business in 14 African markets.

Starting with Kenya, Sunil waged a devastating price war that has affected the other operators. The price war has not only been waged on the streets of Nairobi, it has spilled onto the corridors of power in Parliament, drawing President Kibaki and Prime Minister Raila Odinga into the fray.

As the Communications Commission of Kenya’s (CCK) sits to deliberate on major regulatory issues later this month, the Business Daily’s Okuttah Mark brings you the inside story — in three parts — of the high-stakes games to wrest the control of the mobile phone market from dominant market leader Safaricom.

--------------------------------------

Two years since mobile phone operator Airtel stormed the Kenyan market, the voice business is a wreck and the losses are mounting. What happened?

On August 18, 2010 the Indian firm shocked the local telecoms industry by cutting its calling rates by 75 per cent, in what has turned into a two-year bloody and gruelling price war that has reverberated across the country.

A day later, Yu, a mobile brand owned by Essar — a conglomerate from India — cut its tariffs by 75 per cent too.

Overnight, Airtel, which was still trading as Zain, dropped its calling rates from Sh8 per minute for calls within its network to Sh3, those outsides its network were reduced from Sh12 to Sh3.

READ: Zain explains strategy behind deep tariff cuts

The price cut was heavily advertised in both print and broadcast media featuring comedian Likobe (Aurelian Mwalukumbi).

At one point Airtel took to the streets; sponsoring a promotion that featured a truck carrying provocatively dressed young dancers swinging their hips to Field Mob’s hit rap song Baby Bend Over.

The truck made an abrasive stop outside Safaricom House, immediately hitting a chord with the talkative social media.

While to consumers the price cut was seen as a brave move; dwarf Airtel taking on giant Safaricom, to industry insiders the move was both an act of sheer bravado and a big gamble that threatened to jeopardise the future of the industry.

The move would lead to unexpected painful consequences on the industry over the next year.

An industry report released by CCK in October 2011 indicates that in 2010, the average revenue per user (ARPU) per month went down to Sh348.94 from Sh389 in 2009, which was attributed to lower calling tariffs. ARPU is revenue from services provided divided by the number of users buying the services.

ARPU is important because it provides a breakdown of what is driving revenue growth, and it also gives some indications of what is driving margins.

Increasing revenue

Growing by increasing revenue from users tends to be better for margins than increasing revenue by raising the user base, as the latter incurs additional costs.

Mr Danson Njue, a research analyst with Informa Telecom and Media said that the price war has benefited consumers but cast a dark shadow on the sustainability of the low-cost model in a market like Kenya that has a low population.

“The price war saw a sharp reduction in call tariffs, increasing affordability among consumers,” said Mr Njue.

He, however, added that “the price war also saw a sharp decline in operators’ blended ARPU and revenue, which directly translated to a reduction in the tax paid to the government.”

For instance, while Airtel and Yu played out the price cuts as 75 per cent and 50 per cent reduction on their voice products respectively, the real story that portrays the desperation and gamble taken by the two operators is captured in a statistic referred to as gross margin in the telecoms industry.

This is the net revenue that an operator receives per minute after factoring in top-up charges that belong to other people like the government and regulators, including value added and excise tax, and the cost of connecting a customer to complete a call on a rival’s network.

The later is known as interconnection fees. Gross margins are expected to cover most of the other costs of doing business ranging from marketing and debt service costs to cleaning the office.

On August 17, Airtel and Yu were making a gross margin of 34 cents per minute on a call placed through a rival operator, two days later the two operators were ready to make their fortunes based on a 17 cent net tariff.

For calls made within the networks, the tariffs were as low as Sh1. Yu still allows its customers to call for free at night.

These prices did not reflect the true cost of doing business if the loss the industry continues to rake up is anything to go by, said analysts.

Safaricom and Telkom Kenya were also forced to cut their prices. For instance, Safaricom cut its call rate from Sh8 per minute on its network to Sh3 to match Airtel, and from Sh12 off network to Sh4.

In terms of gross margins, Safaricom moved from making Sh5.10 per call to 96 cents. Telkom’s mobile business, Orange, moved from Sh1.93 to 96 cents per minute.

“A low-cost business model may not be very viable in markets like Kenya due to the relatively low population. The model could work in countries such as India and China that have huge populations. However, the model could work in certain cases where an operator is the market leader, commanding a considerable number of subscribers,’’ said Mr Njue.

ALSO READ: Tariff wars eat into telecom revenues

“Low tariffs should not be used as the only factor in initiating competition, especially in cases where operators cannot realise any returns on the investments made.”

Low tariffs

Despite the low calling rates, minutes of usage (MoU) among consumers have been on the decline, which CCK and analysts attribute to the large increase in the total number of mobile subscribers.

“In Kenya, high net worth subscribers generally account for 20 per cent of the total users but contribute up to 80 per cent of the revenues,” said Muriuki Mureithi, the chief executive of Summit Strategies.

“Low tariffs do not necessary translate into increased minutes of usage, as the minutes are restricted by the importance of the message to be passed across,” said Mr Mureithi.

The low tariffs have enabled younger operators to increase their market share by subscriber base over the years. However, Safaricom still commands the lions share of the voice traffic market.

Safaricom has 77.3 per cent market share of voice traffic compared to 65.3 per cent share of subscriber base. Airtel has 13.2 per cent market share by voice traffic compared to 15.3 per cent it holds on subscriber base.

Yu and Orange have 8.7 per cent and 0.8 per cent market share of voice traffic respectively, while on subscriber base Orange has 10.6 per cent while YU trails the market with 8.7 per cent.

Mr Mureithi said that the cost of acquiring new subscribers had gone up compared to that of maintaining older ones due to the increased competition, adding that the rivalry had resulted in a big headache for operators which are yet to break even.

This, he said, may lead to a cut on investments and expansion of networks which in turn would compromise the quality of services to consumers.

The burning questions are:

• For how long are Airtel and Yu willing to bleed as they wage this devastating price war?
• What strategies will industry players employ to cover up the heavily eroded margins in the voice business?
• How will the regulator, CCK, react to all these?

Observing the cutthroat price war has been like watching a complex game of chess — at a high cost to the players.

[email protected]