Dilemma of pre-paid: up to 80% of total sales

Sérgio Damasceno Silva

Mobile service providers in Brazil are facing a dilemma: in order to continue expanding they must increasingly invest in selling to low-income consumers, but these consumers can only afford to buy pre-paid service and most operators reported a fall in profitability in 1999 due in large measure to pre-paid.

Another serious problem, which is linked to the low profitability of pre-paid, is complete lack of knowledge about customers, who are not obliged to identify themselves when they buy pre-paid service. In some cases, pre-paid service accounts for as much as 80% of total sales (see table) and has created a vast mass of unknown users. Here the problem is how to build customer loyalty and ensure repeat sales so as to raise average revenue per user (ARPU).

Managers are worried about these two factors - low profit margins and lack of customer information. To make matters worse, operators subsidize the handsets they sell with pre-paid service agreements and sell refill cards for 10 reals (less than 6 dollars). All these factors combined explain the low margins and are considered a short-term challenge.

Júlio Ziegelmann, director of equity markets at BankBoston Asset Management, expects sales of pre-paid to continue forging ahead. "Pre-paid service was introduced as a loss leader, quite deliberately," he notes. "It's an aggressive strategy to grow market share." However, he points out, if margins remain very low investors will start to complain and management should now reconsider this strategy of expanding at any cost.

The vast majority of mobile providers sell a great deal of pre-paid service. One of the very few exceptions is Global Telecom, the B-band operator for Paraná and Santa Catarina, but it too is beginning to conclude that staying out of the pre-paid segment is not a good strategy and is studying the viability of introducing pre-paid service. "Pre-paid sells all too well. The problem is low profitability. We're proceeding very cautiously with an analysis of other operators' financial statements," says Sávio Bloonfield, director of marketing at Global Telecom.

At the opposite extreme is ATL, the B-band operator for Rio de Janeiro and Espírito Santo. As soon as it began operating, ATL took an aggressive marketing stance by offering pre-paid plans as the basic form of access to mobile service. Pre-paid customers now account for 80% of the total.

"Pre-paid is a pricing plan," says Carlos Henrique Moreira, president of ATL. Customers start with pre-paid because it is cheaper and can migrate to post-paid later on without having to change their phone number. This is easily done thanks to integrated systems, but in reality the statistics show that most ATL customers have so far preferred to stay with pre-paid.

Mr Moreira acknowledges that average revenue per user is lower in the pre-paid segment but he argues that pre-paid plans enable low-income consumers to acquire mobile phones, which they cannot afford in the post-paid segment, where a monthly bill averages 70 to 80 reals (about 40-45 dollars). This problem reflects Brazil's acute income inequality, he notes.

However, pre-paid is advantageous only when it costs at most 50 reals per month (about 29 dollars). A pre-paid customer of ATL currently pays 30 reals for a handset (in several monthly installments) and a minimum of 10 reals for a calling card. But there is nothing to prevent a customer from never using the phone to make calls and only receiving calls for four months. This gives a running cost of 2.50 reals per month once the handset is paid for. A pager costs at least 19.90 reals per month, and cellular mobile telephony evidently offers more features than paging.

Challenges

For Ricardo Rubini, marketing director of Americel, the B-band provider for the Center-West region, operators face two challenges: boosting revenue and profit margins in the pre-paid segment, and stemming the fall in sales of post-paid service. "In order to increase ARPU, we must target current upper-income users of A band while at the same time raising average revenue from our existing customer base," he says.

Mr Rubini says this could be done by cutting per-minute calling rates for pre-paid users, which are currently three times higher than post-paid rates. A special plan with a 50% discount on nighttime calls has boosted Americel's traffic by 120%. Another solution would be what he calls a scoring program whereby customers are rewarded in proportion to usage. He also has faith in value-added services but says care must be taken to ensure they are affordable, again by reducing prices in proportion to usage.

The absence of direct contact with pre-paid users leaves operators completely in the dark. Carlos Henrique Moreira says ATL knows its pre-paid users in Rio de Janeiro thanks to state legislation making consumer identification obligatory whenever services are sold. "We communicate with customers via short messages," he explains.

Americel is based in Brasília, where no such legislation exists. It is forced to use expensive prime-time TV commercials to publicize changes in pre-paid service such as discounts or promotions. "In that space you're competing eyeball to eyeball with the big corporations, so it works out very costly," Ricardo Rubini notes.

European operators in are pursuing ways of enabling their operators to establish links with pre-paid users. One way being tried in Italy and Portugal, for example, is to offer credit in the hope this will retain users and turn them effectively into customers. The difference between the two markets, according to Mr Rubini, is that Europeans choose pre-paid for convenience while low purchasing power gives Brazilians little choice.

Moreover, pre-paid users in Brazil are atypical in their habits. The majority only receive calls or call collect (reversing the charge). Acel, the national association of cellular mobile providers, has lodged a formal complaint with Anatel, the telecoms regulator, asking for a reformulation of the rules so that pre-paid handsets cannot be used to call collect.

This is in fact the position in most other countries. In Brazil, the mobile providers want to ban calling collect altogether or at least be allowed to charge for the privilege. "Users can call collect even when they run out of credit," complains Marcelo Almeida, sales manager of Maxitel, the B-band operator in Minas Gerais, Bahia and Sergipe.

History also plays a part, according to senior managers of B-band operators. When cellular was first introduced in Brazil, they note, high-income consumers (known in the jargon as "top top") were early adopters and necessarily acquired post-paid plans because no pre-paid alternative was available. These far more profitable consumers are still in the post-paid segment, and almost all subscribe to A-band operators, the incumbents originally implemented by Telebrás before privatization.

Middle- and low-income consumers could finally afford to acquire a mobile phone only when pre-paid services were launched. This is the heart of the paradox: the strategy of massifying pre-paid plans was successful insofar as it grew the overall customer base, but it has been disastrous for profitability. The reason is that upper-income consumers, who already had a post-paid account, took advantage of pre-paid offerings to acquire a second and in many cases a third mobile phone, mainly for teenage children so they could control the size of the monthly bill. And the middle- or low-income consumers who have flooded into the market thanks to pre-paid also prioritize the ease with which they can control the amount they spend on phone calls.

To make matters more complicated, the advent of PCS can only fuel competition in the mobile market. While it is important to invest in market share, as BankBoston's Júlio Ziegelmann argues, customer quality is equally critical to ensure an adequate return on investment. But the dilemma faced by operators is that if they eliminate pre-paid plans to boost ARPU they risk losing low-income customers to the competition. They also need a solution to lack of customer information.

While very few operators are prepared to blame low profitability in 1999 on the pre-paid segment, they know they must find a way around these problems, not least because their shareholders will be demanding an explanation and a solution. And they do not have much longer to make up their minds.