European operators look to cut smartphone subsidies to preserve data gains - Vodafone hitting the 'sweet spot' on data pricing but acquisition/retention costs still hurting bottom line

Stabilising prices mean that data revenues are beginning to offset voice revenue declines in certain European countries, but the cost of attracting new mobile internet subscribers and keeping hold of existing ones continues to eat into operator profits. As a result, operators in mature markets are looking to reduce the high level of subsidies they currently offer to new and upgrading smartphone customers. In Spain, where the level of mobile churn is second only to the UK in Western Europe, number-two player Vodafone this week announced that it was ending the practice of subsidising smartphones for new customers, following a similar announcement by market-leader Movistar (Telefónica) earlier in the month. Vodafone Spain, which recorded customer costs in the year to Q3 2011 of £2.1 billion - equivalent to almost half its revenue, will instead offer free finance programmes for the purchase of new handsets and introduce a scheme to buy back old phones from upgrading customers.

Mobile data costs have fallen dramatically in Western Europe in recent years, a phenomenon clearly demonstrated by Vodafone's UK arm. The operator observed in a 2010 white paper that in 2005, shortly after its WCDMA network launched, mobile data in the UK typically cost around £7.50 per MB. After seven years of declining data costs for users due to all-you-can-eat packages, Vodafone today offers, for example, a 2GB allowance for £15 per month. While this means that the operator has effectively dropped its price per megabyte more than one-thousand-fold, increased usage means that it is finally beginning to see data revenue compensate for the long-standing decline in voice returns. Data revenue at the operator jumped by 20.3% during 2011, from £715 million to £860 million, offsetting a £128 million decline on the voice side. Total UK service revenue during the year was up 2.6% to £4.9 billion, with data now accounting for 17.2% of the total, up from 14.7% in 2010.

The company’s German operation is showing similarly encouraging trends in mobile broadband usage, with data revenue up 25% (£295 million) during 2011 to hit £1.5 billion. While this did not entirely compensate for a £401 million drop in voice revenue, total service revenue was up 1.3% to £7.6 billion, with data as a percentage rising to 19.4% from 15.8% in 2010. Vodafone’s operations in Spain and Italy also witnessed strong data growth in 2011, up 19.8% and 18.2% respectively, although again these were not sufficient to offset declines in voice revenue during the year.

Across Vodafone’s European operation as a whole, data now makes up 15% of service revenue, up from 12.2% in 2010. The operator reported that 32% of all handset sales during Q4 2011 were smartphones, and that smartphone penetration now stands at 24% of the customer base, up from 17% in 2010. In the UK, this figure is considerably higher at 39%, and the operator currently offers a choice of more than 20 different smartphone models alongside its ‘Data Test Drive’ promotion, launched in Q4 2011. This offer allows all new and upgrading customers unlimited data use across any number of devices for a period of three months, essentially allowing users to test the limits of the network before Vodafone recommends a suitable data plan for the remainder of their contract. Although customers are not obliged to accept the recommendation, the operator hopes that after the unlimited period they will be inclined to sign up for one of its higher value tariffs.

Yet this kind of promotional activity - combined with the high level of smartphone subsidies that have been commonplace in Western European markets – is in danger of wiping out the gains made in terms of data revenue growth, with subscriber acquisition and retention costs rising across the region. Vodafone’s latest available Opex figures (for the year to Q3 2011) show that while other expenses lessened, ‘acquisition and retention costs’ were up 12.4% on the same period in 2010 which – as revenue growth was flat – led to an unhealthy 3.2% decline in EBITDA.

This phenomenon is also affecting Vodafone’s European competitors; subscriber acquisition costs at Orange France and Orange Spain rose by 2.5% and 11.7%, respectively, during 2011, while retention costs increased by 5.6% in France and 1.5% in Spain. Deutsche Telekom’s T-Mobile, meanwhile, fared better in controlling its acquisition costs during the year, but still saw subscriber retention costs up by 16.2% in the UK and 7.1% in the Netherlands.

Calum Dewar, Analyst, GSMA Intelligence:

Our report published last month, The effect of mobile broadband on operator revenue, described how operators have been able to effectively monetise 3G networks to compensate for declining voice revenue. By assessing the difference in blended ARPU between mobile broadband operators and those operators that do not provide mobile broadband services we observed that the latter group have seen their average blended ARPU decrease at twice the rate of that of the former over the past five years. This phenomenon is linked to a gradual stabilisation in data pricing, with unlimited data tariffs invariably being phased out in mature markets, as well as a significant rise in smartphone ownership, with penetration at greater than 30% for operators like Vodafone in markets such as Spain and the UK. As smartphone ARPU is typically double that of non-smartphone users, Vodafone (like many operators) has inevitably been tempted to go all out to put smartphones in the hands of both new and existing customers by offering high levels of subsidies. However, the operator has now decided that having almost half of its revenue in Spain swallowed up by customer costs is clearly unsustainable, and its move to cut smartphone subsidies should lead to a considerable reduction in these expenses – albeit leaving itself (along with Telefónica) vulnerable to subscribers churning to rivals Orange and Yoigo in the short term. Nevertheless, we have already seen this type of pay-by-instalment smartphone purchase model employed in France with the recently-launched Free Mobile, and can expect other operators across Europe to follow suit as they too attempt to prevent acquisition and retention costs spiralling out of control.

Vodafone: Operational and financial data, selected Western European markets, FY 2011
Source: GSMA Intelligence

¹ Year to Q3 2011, latest figures available
² Q3 2011, latest figure available