Party Crashing T-Mobile

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Colin here. In Cell Phone Bastards I wrote about how you could build all of the cell towers in the entire United States for $30 Billion, or about one month’s income for the cellular industry. I also talked about how the cost of renting tower sites, connecting them, and on-site service amounted to under 2% of revenues. Much of what you are really paying for with Verizon and AT&T is a vastly bloated bureaucracy with lots and lots of executives. The CEO of Verizon only makes $20 Million a year, but it’s not just how salary alone.

But there is a surprise twist in this story and it is T-Mobile.

Many people will think that T-Mobile’s recent un-carrier crazy CEO John Legere’s simple choice pricing plan was the essence of their strategy to buy back customers. But it is more clever than just that.

About 18 months ago T-Mobile sold off almost all of its real-estate holdings to an unrelated company called Crown Castle, and received $2.4 Billion in cash in the process. They were criticized at the time for not re-investing this money immediately into towers and instead using it to pay down debt. But T-Mobile was actually launching a devilishly clever strategy.

Let me go back to the year 1915 and quote the founder of the Bell System, Theodore Newton Vail: “Don’t steal your competitors customers. Steal their capital.” This was the most fundamental strategy that the Bell System used to expand throughout the United States. I think T-Mobile must have been reading some old Bell System history books.

You see, by “un-carrier” T-Mobile means that it doesn’t own any towers. It leases capacity and leases equipment space which it shares. T-Mobile is, quite simply, not a carrier any more in the sense that Verizon or AT&T is. They are out of the tower real-estate business.

This means that their business is suddenly much less capital intensive. It also means that they don’t have as much debt load (remember, they paid much of that down). They are just a marketing middleman. That’s a great spot to be when your suppliers can’t cut you off and when prices are falling.

The game works like this: Verizon and AT&T have massive amounts of debt load. They must service this debt monthly or else their are in dire trouble. When prices drop, this comes straight off the bottom line. And, what was a ridiculously profitable business suddenly becomes burdened with paying off debt which is nothing more than a ball and chain.

T-Mobile can drive prices down like crazy because it doesn’t have the same debt load and it is running a non-capital intensive un-carrier business. Because they are the last-place major carrier, price drops affect them the least.

T-Mobile seems to acutely understand strategy and it is applying enormous pressure on Verizon and AT&T. In fact, I am certain this is why T-Mobile is bundling free international roaming with its current plans: T-Mobile doesn’t have a lot of roaming income, it is the single most profitable product by margin percentage for the two biggies. By crashing the price of this cash cow it is ripping the core business model away from Verizon and AT&T without costing T-Mobile much.

In fact, free international data is probably still profitable for T-mobile since they are billing $50 a month for something which they are buying wholesale for basically the same price that they pay domestically. If tower-time in Shenzhen China costs the same as tower-time in Austin Texas, then what do you care which tower a customer uses? What you don’t want is for the customer to suspend their service for a month while they go to China. t-Mobile gets that. Their un-carrier strategy allows them to view a tower in Shenzhen China no differently than a tower in Austin.

Now the math should become pretty clear: If T-Mobile can pick up 1-million customers this is about $500 Million a year of moolah. Because they operate a variable cost business it’s hugely profitable for them and allows them to lease more and more towers as they grow.

The same revenue is displaced from Verizon and AT&T (because cellular is increasingly a zero-sum game). Those companies are essentially fixed-overhead businesses who will be unable to service their debt load.

Let me provide some relevant context by telling a story from a few decades ago in my own career.

We were a young start-up selling some pretty high-tech stuff against a well established and hugely dominant company. They touted their thousands of sales people, massive headquarters resources, and their history. They had  recently built a new headquarters palace and we discovered that they had leased all of their furniture and equipment. Basically, they had built a high fixed cost business that demanded cash every month.

We entered the market with a vastly superior product. We decided to price the subscription-based product identically to our behemoth competitor. Then, we offered the product on a special price on a per customer basis. Every customer had some reason given to them for the special price (educational discount, industry discount, end-of-month-sale, or whatever). But the bottom line is that we basically gave our product away for the first year, but in a way that didn’t establish the sale price as the forever subscription price.

When we started we had zero customers. Within two years we had 495 of the fortune 500. Everybody decided to switch to our (relatively free) product, knowing that the special price was only for one year. But the industry switch was massive and in our favor.

Punch line: our competitor found its cash flow dried up when all of the customers decided to “just try” our free product. Our product was great, and the customers never left us, even after we started charging. But more importantly: it took under six months for our giant, decades old, behemoth competitor to declare bankruptcy. You see, they were utterly unable to service their debt load or to carry their business for a year until our free promotion stopped.

I believe that T-Mobile’s John Legere knows exactly what he is doing. He’s playing the same strategic game with Verizon and AT&T. He is one smart devil as I see it. And, Verizon’s and AT&T’s CEOs must be hoping that John has a bad accident some day.

The un-carrier strategy is much more than ending service contracts and lowering prices. It is about fundamentally changing the cell phone business in America for the better. It’s profoundly ironic that both AT&T and Verizon’s roots go back to Theodore Newton Vail and the Bell System and that they are being killed by their own founder’s strategy.

Colin Berkshire