Competitive industries and the telecom sector
The classical definition of competitive price are those where price equal cost. The thought being, if a producer pushes their price above this line, they will not be able to capture customers, and if they lower their prices, they will not be able to cover their cost. We often think of cost as the money one spend to produce an item, but it includes more; there is there also the cost of managing the firm, and importantly it includes the minimum level of profit the firm must return to be attractive to investors and thus have capital inflows.
Honesty is often in short supply is Washington, but earlier this month, two telecom investment advisers who spoke on a panel at the Pheonix Center’s Annual Telecoms Symposium. In the recently posted video, Michael Rollins, Managing Director of Citi Investment Research and Analysis, and Chris Gleason from Alyeska Investment Group, articulate from an investors perspective some of the features of the telecom market, the most important of which is the historically low return on investment and the similarly low revenue growth. Rollins explained,
The return on gross invested capital is not very strong on an industry perspective. I think the biggest issue and challenge for the industry if we look at it in total is revenue growth, or lack thereof… If you look at telecom revenue growth, [Citi’s] estimation of the last nine years is an average industry revenue growth rate per year of about 1.8 percent. Over that period of time, nominal GDP is growing around 4 percent.
Rollins is suggesting exactly that which neoclassical economics offers up as evidence for competition. Revenue is at the level to attract capital, but comparative to other industries, low. A couple of headwinds are holding the industry back. Regime uncertainty is at the top of the list of issues. Without a spectrum bill and a pro-growth plan forward, investors are rightly taking to the sidelines. Then there is the issue of product substitution. To consumers, VOIP has become functionally equivalent to wireless phone, and so they are using both to make calls. Similarly, broadband data over the spectrum serves many of the same uses as boadband over the line, and thus the two have come into direct competition. All of this is to say that investors in telecom are citing as problems the exact same issues that we often describe of the industry, which seem to fall unto deaf ears at the agencies.
There are many other factors that go into competition analysis, but combined with the FCC’s admission in the Wireless Competition Report that prices are falling with a steady advancement in quality, the industry looks to be intensely competitive.
Clearly, the utility for customers is growing faster than 2 percent per year, but carriers have yet to capture it. It is, as Gleason noted, unsustainable in the long term, “We will probably face over the next ten years, a massive realignment in terms of business models as people try to address this [problem].”
It has often been said that if you want to know the weather, you should go outside. I would implore the FTC, FCC and DOJ to talk to some investors before they decide to proffer on this industry.
First published Jan 11, 2012