All, Prudential Director>
Capacity of Wireless Systems: Will the Real Cost Per
Minute of CDMA and GSM Systems Please Stand Up?
by Michael Elling, Managing Director, Prudential Securities,
Investment Banking Group
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As relates to cost, it is now becoming accepted fact that inexpensive wireless minutes
stimulate substantial usage by consumers, who spread such usage across a good portion
of the day, all across a given system. We have explored this in a report entitled the
"ABC's of PCS Pricing" in which we also proposed our own virtual wireless local loop
offering called PoWeR. Usage also increases if the user has faith in the system coverage,
both in-building and geographic. The latter we documented in a report entitled "All POPs
Are Not Created Equal." Finally, if the call is reasonably clear, the user will likely become
accustomed to using the wireless phone as a preferred access device (PAD). In a report
entitled "We Can Hear The Future" we found that digital was approaching wireline in
quality, CDMA was the best digital format, and pure digital was better than overlay
digital.
Since most people are awake about 25,000 minutes a month, and since our Creator gave
us two feet, a mouth and two ears (making us highly mobile and communicative), it is
likely that people will talk a lot more than they do today, if given the chance. Should the
above three C's of wireless be satisfied, it is likely that usage will jump from the 100-200
minute levels experienced on average worldwide to 700-1000 minutes. At such usage
levels, capacity has to be looked at in a entirely different light, namely not just in terms of
minutes consumed in the peak busy hour, but rather the relationship between total minute
production and the number of billed revenue minutes, or consumption.
We challenge any system owner, engineer or accountant to calculate just how many
minutes a typical wireless system in a given market produces between 5 AM and 1 AM
(20 hours), 6 days a week, across an average month. Then calculate how many billed
minutes are consumed. This capacity utilization measure should provide the best measure
of capital turnover. Our estimation is that in a typical cellular system that level is
somewhere around 15% (remember, free off-peak minutes are not counted). In a digital
system with large bundled minute plans this number is likely to be 20% or better.
Regardless, these represent some of the worst capacity utilization numbers in American
industry. The return on capital would be significantly higher if capacity utilization were
between 25%-50%.
Another way of looking at this relationship is that one customer at 800 minutes is worth a
lot more than eight customers at 100 minutes. First of all, it is spectrally a lot more
efficient. Secondly, it amortizes the cost of getting, keeping and stimulating the customer's
demand across a greater minute base, thereby lowering the effective cost (price) per
minute. This is the paradox of digital wireless systems, which the market is only now
beginning to figure out. Digital systems, while costing more, have significantly greater
capacity, which should lead to lower, not higher, prices per minute. This is antithetical to
most analyst and company forecasts, because the presumption is that individuals will not
consume more minutes. As a result, most analysts have average revenue per user (ARPU)
declining over the life of their models, rather than increasing, which is what occurred as
long-distance networks digitized and dropped their price per minute.
So just what does a minute of capacity cost? The answer can be arrived at by looking at a
couple of supply (network) issues and demand issues. From a supply perspective, the key
variables are amount of frequency, cost of radios and infrastructure, cost of backhaul,
maintenance costs, and reuse and other capacity factors. In our model we have as
constants a market of 1 million people (POPs) with 15 MHz of spectrum. The only
constraint is to build a digital minute factory for $60 million. We then calculate the cost of
a minute of capacity, under various utilization levels for CDMA and GSM, which excludes
interconnection costs. Assuming most of the general technical and cost distinctions hold
between the two formats, then the total minute production for the CDMA system is 950
million minutes and that for GSM is 425 million minutes. At 1000 minutes per month, per
user, and assuming all production is consumed, then equilibrium costs of CDMA are
$0.0011 per minute and for GSM are $0.0031 per minute. By the way, usage spread
evenly over 20 hours per day equates to 5% of traffic in the peak busy hour. That works
out to roughly $2 per user per month.
No network can ever be run at peak efficiency; however, marketing and billing algorithms
can be constructed that channel usage to between 25%-50%. At 50%, the cost per
minute rises to $0.002 and $0.006 per minute, for CDMA and GSM respectively. At
25% utilization, a more meaningful number, the cost rises to $0.004 and $0.012 per
minute respectively for CDMA and GSM. This in turn works out to $8 per user per
month.
The real distinction between CDMA and GSM is not therefore on the price per minute,
but rather the total minutes that can be produced for a given spectrum or dollar amount. In
our example, total users for CDMA are 880,000 and for GSM 390,000 at peak loading.
The fixed costs of running the wireless system, namely umbrella marketing, G&A and
customer support costs, are, therefore, amortized over a wider base for the CDMA
system.
If the reader is wondering what sort of billing and marketing algorithms exist that efficiently
match supply and demand, look no farther than Prudential's PoWeR pricing plan. The
latter is a combination of the eat-what-you want (EWYW) bucket plans that are prevalent
in the US today, and zone-based billing algorithms that borrow from successful
long-distance marketing plans like Friends & Family, The Dime Lady and Friday's Free.
In conclusion, why then, is cellular pricing, and even PCS pricing so high? Because the
cost of getting, keeping and stimulating a customer's demand is so high. Yet, in part it is
high because carriers do not fully appreciate the underlying capacity cost per minute. They
would rather let the minute of production evaporate, or go unsold (which is the most
expensive minute in our book), or worse give it away for free, than lower the price of the
peak minute. If, on the other hand, the user begins to appreciate the value, or low-cost of
wireless, particularly within the user's time budget (25,000 waking minutes) and financial
budget (measured against all other consumption, not just fixed telecom), then a win/win
situation can develop for both the consumer and the carrier where demand more
effectively soaks up supply.
Michael Elling, Managing Director, Prudential Securities, Investment Banking Group can
be reached at (212) 778-4768 or michael_elling@ccmail.prusec.com.
July 1998 | October 1997 | CDG Home Page
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