High-cost smartphone subsidies impacting operator margins - Canadian operators ramp up acquisition and retention expenditure to support smartphones

Efforts by mobile operators to increase smartphone penetration levels are beginning to put pressure on margins and leading to higher operational costs. New GSMA Intelligence research has used Canada as a case study of a developed mobile market where smartphone users now account for roughly a third of total postpaid subscribers, a trend linked to the popularity of high-end devices such as the BlackBerry, Apple iPhone, and Android-based smartphones and tablets.

While rising smartphone penetration has led to higher ARPU and increased mobile data revenue at the three main Canadian operators (Bell Mobility, Telus Mobility and Rogers Wireless), our study found that, in most cases, operational expenses (Opex) have increased, resulting in a contraction of EBITDA margins. This is due to the increased handset subsidy costs involved in acquiring new customers and retaining existing ones (in the latter case, via smartphone upgrades).

Our research reveals that the cost of acquisition (COA) per subscriber at Bell rose 13.4 percent between 2009 and 2010 and by 3.9 percent at Telus over the same period (see chart). There were similar trends in retention spending, which (as a percentage of service revenue) increased by 2.4 percentage points at Bell and 0.7 percentage points at Telus year-on-year, and by 7 percentage points at Rogers in Q4 2010. Opex also increased at all three operators during the period.

Rogers Wireless
Rogers Wireless is Canada's largest mobile operator and had 9 million connections at the end of last year. It also has the highest proportion of smartphone users among the three operators; these users represented 41 percent of its postpaid customer base as at 31 December 2010, up from 31 percent a year earlier. The operator said it "activated or upgraded" 635,000 new smartphones in Q4 2010, a quarterly record for the firm. Data revenues grew 32 percent and now account for 31 percent of total mobile service revenue. However, this rapid move to smartphones has come at a cost. Rogers recorded a 90 percent year-on-year increase in smartphone upgrades in the quarter, which it said was the single largest factor for its increase in Opex. As a consequence, total retention spending in the quarter increased 76 percent year-on-year to C$269 million (US$280 million). Rogers also noted that a 3 percent drop in equipment sales between Q409 and Q410 was due to higher smartphone subsidy levels, which cancelled out the increase in smartphone activations.

Bell Mobility
Canada's second-largest operator had 7.2 million connections at the end of last year. Its smartphone subscriber base rose 82 percent year-on-year in 2010 and now accounts for 28 percent of its postpaid base. These users typically have an ARPU of over C$90 and were deemed responsible for a 41 percent uplift in data revenue year-on-year. But despite a 9.2 percent increase in service revenue, earnings (EBITDA) dropped 5 percent, which Bell attributed to "incremental acquisition and retention costs." These costs – in the form of handset subsidies for both new subscribers and upgrades – are set to rise further still as smartphone levels continue to rise. Bell expects to upgrade more than one million devices this year (2011) pushing retention spending as a percentage of mobile service revenue to grow to 8-9 percent – still below a market average of 9-10 percent.

Telus Mobility
Smartphone users represented 33 percent of Telus' 7 million total subscriber base at the end of last year, up from 20 percent a year earlier. Moreover, smartphones represented 46 percent of postpaid gross additions in the fourth quarter, up from 25 percent a year earlier, suggesting that smartphone penetration levels are rising fast at the market number-three. Data revenue rose 36 percent year-on-year as a result. However, Telus also saw corresponding increases in both COA and retention spend. COA increased by 3.9 percent to C$350 between 2009-10, which it attributed to a "higher per-unit subsidy largely caused by a higher smartphone mix." Meanwhile, retention spending increased by 28 percent to C$170 million due to "increased migrations to higher cost smartphones." This year, Telus expects its wireless EBITDA to be 6-11 percent higher despite the further anticipated impact on margins caused by increased investments in customer acquisition and retention.

Joss Gillet, Senior Analyst, GSMA Intelligence:

Handset subsidies have always been an industry paradox: increasing smartphone penetration on one hand, but pressuring margins on the other. But now that there is an urgent need for data revenue to counter the effects of declining voice revenue this issue has come to the forefront. In Canada, operators are seeing the benefits of higher sales and upgrade volumes largely wiped out by the impact of discounted handset pricing. Nevertheless, Canadian operators value these costs as positive investments since they help to acquire and retain higher ARPU, lower-churning customers on longer-term contracts. Typically, smartphone users commit to new multi-year-term contracts and generate ARPU nearly twice that of voice-only consumers. Such trends are not exclusive to Canada - which is 78 percent postpaid-based – and can be seen in most mature mobile markets worldwide. In Australia, for example, Vodafone Hutchison (VHA) recently reported that postpaid subsidies remained high through 2010 following the launch of the Apple iPhone 4 in July 2010 and a range of Android devices in the second half of the year. VHA also noted that smartphones are growing as a share of the prepaid base with devices available from just US$123. We expect more affordable smartphones – in the US$150-200 ASP price tier – to come to market this year and help operators to balance their smartphone portfolio mix and handset subsidies. Last November, both Portugal's TMN and Turkey's Turkcell launched their own-label low-cost Android touchscreen smartphones, Sapo a5 and Turkcell T10, priced at US$214 and US$232, respectively (half the average smartphone price in unsubsidised Turkey).

Canada: Mobile revenue, earnings and customer acquisition costs 2009/2010
Source: GSMA Intelligence, company data

¹ Cost of Acquisition, C$ per subscriber
² As a percentage of service revenue
³ Q4 2010 data