There were rumors today – not for the first time – that Sprint might be interested in making a bid for T-Mobile. This is not all that surprising given recent remarks from T-Mobile execs and Dan Hesse that they would be open to a merger. But there’s been a predictable outcry about the possibility of the US’s three major carriers being whittled down to two, and especially about the presumed loss of T-Mobile’s recent disruptive approach to the industry.
There are several good reasons to take this view:
- T-Mobile has indeed been disruptive, and has caused real change in the industry. Its shift away from 2-year contracts and towards easier, more frequent upgrades sparked the other major carriers to follow suit. It has won subscribers from Sprint and AT&T in particular as a result.
- There’s an instinctive reaction to a reduction in the number of players in any industry, and it would follow years of consolidation in the US wireless market. It’s easy to argue that a market dominated by three players would be less competitive than one with four major players.
- The US has a huge population, and it seems like it ought to be able to support four or more players without too many problems, given that there are other markets around the world with more players and much smaller populations.
- The two carriers use incompatible network technologies. After Sprint has worked so hard to eliminate iDEN and WiMAX and focus on its core CDMA, EVDO and LTE networks, it would be a shame to complicate things by adding T-Mobile’s GSM-based networks to the mix. Given the focus on LTE this might be less complicated than it once was, but it’s still a non-trivial issue.
However, I think this knee-jerk reaction opposing any consolidation among the big four may be misguided, and here are the reasons.
T-Mobile’s strategy is a price war wrapped up in clever marketing
Yes, T-Mobile has been disruptive, and some of its moves really have shaken things up, but its strategy largely amounts to a price war, which is unsustainable over the long term. It’s also likely to run out of significantly disruptive things to do pretty soon, leaving it with much more marginal moves which will have far less impact. (this was the subject of an earlier post). Other than these moves, it’s upgrading its network rapidly to LTE, but still suffers overall from poor coverage and significant gaps. And it’s doing very little to capture new opportunities in mobile services, from M2M to advanced content services to home automation.
Sprint is in rebuilding mode and has fallen back this year
Like a struggling major league baseball franchise, Sprint is in rebuilding mode this year. It is taking some much needed actions enabled by the investment from SoftBank to set its network house in order and build a foundation for growth. Unfortunately, the “dust” stirred up by its construction work has caused customer service issues and at least temporarily undone some of the great work it’s done over the last several years overcoming its reputation for poor network quality. This is a real shame, because it’s come a long way, but is hopefully temporary and it should resume its progress in 2014. But while it’s focused on these major network upgrades, it’s suffered from the same problem as T-Mobile in achieving success beyond traditional consumer services.
Verizon Wireless and AT&T are lengthening their lead
Verizon Wireless and AT&T are fighting it out for first place in the network coverage and reliability stakes, with the two largest LTE networks and fastest, most consistent speeds. But neither is relying solely on network investment to drive either competitiveness or future growth. AT&T in particular is driving several potential multi-billion-dollar opportunities off the back of its network, including its Digital Life home automation and security business, the connected car business, the broader M2M space and others. Verizon is pursuing some of the same opportunities, albeit less aggressively.
Relative scale makes or breaks companies in mobile
Having said all that, the biggest driver behind the logic of a Sprint-T-Mobile merger is scale. AT&T and Verizon Wireless are so far ahead in the US market that Sprint and T-Mobile are perennially at a huge disadvantage. The chart below shows wireless revenue for the big four (this excludes the massive revenues AT&T and Verizon generate from wireline services).
There are several key areas where scale plays a huge role:
- Advertising – advertising is an enormous component of success for wireless carriers, and AT&T and Verizon are able to outspend Sprint and T-Mobile significantly. AT&T and Verizon spent $1.6 billion and $1.4 billion respectively on advertising in the US in 2012, as the two largest advertisers in any industry. Meanwhile, T-Mobile spent $800 million and Sprint spent $600 million, far less, at a time when they arguably need to be spending far more to catch up with their bigger rivals. When you’re much smaller, and when you’re far less profitable, you simply can’t afford to spend at the same levels, and that hurts both companies. A merger would help with both scale and profitability, boosting the combined company’s ability to spend.
- Retail – over 50% of device sales go through carrier retail stores, and a far higher percentage of carrier subscriptions are sold through their own retail stores, making this another critical component of competing effectively. Running a network of retail stores has a certain fixed cost that has to be spread over however many subscribers you have. The more subscribers you have, the fewer dollars per subscriber a national retail presence costs.
- Network – perhaps the biggest scale efficiency comes on the network side, where roughly the same number of total base stations may be required to cater to vastly different numbers of subscribers, and the incremental costs of carrying additional traffic are small in relative terms. Again, running a network that generates business from over 100,000 subscribers is going to be much more cost-effective than running a similar network that carries just 40,000 subscribers.
- Buying scale and other factors – there are lots of other economies of scale, including buying at greater scale for both network infrastructure and devices, and all the other standard economies of scale that apply in any industry. On all these counts, Sprint and T-Mobile significantly lag AT&T and Verizon, and a merger would close the gap significantly, though far from entirely.
There are no other ways to overcome these scale challenges
There are other ways to overcome network-related scale issues – network sharing has become popular in some European markets, and might work to some extent, though given Sprint’s network upheaval and the incompatibility between the two core network technologies the companies use, it wouldn’t be as straightforward as in those markets. But the vast majority of these challenges cannot be overcome without increasing scale significantly.
No ideal scenario exists
None of this is to say that a merger is a no-brainer or that it would be straightforward or instantly solve all the issues the two smaller companies face. Mergers are disruptive and time-consuming and require synergies to produce a return on investment, which means there will be cuts and changes that may impact performance too, especially during the approval process and in the year or so following. But these may all be worthwhile if the benefits detailed above are achieved.
I’d love to see both Sprint and T-Mobile pursue their current strategies and ultimately become successful in their own rights. If they really can achieve that, then that would be a great outcome for both companies and for consumers. But if they continue to struggle as they have in the face of these massive scale disadvantages, then a merger may be the only way to ensure that these entities to survive as meaningful forces in the US carrier landscape. Insisting that they remain separate may ultimately be self-defeating if they continue to weaken rather than strengthening, and fall further behind the big two. We’re definitely better served by three strong competitors than two.
One final thought
For all that a merger would benefit Sprint and T-Mobile in achieving scale in wireless services, it would leave them without a significant presence in consumer wireline services. Though the world is forever going more mobile, wireline services still have a huge place both in providing high-speed, reliable, inexpensive broadband and the TV and video services Americans spend so much time consuming. Verizon and AT&T benefit not just from scale but from synergies and bundling across wireless and wireline. Content is moving towards subscriptions, and those subscriptions are increasingly cross-platform, and without a wireline business, neither Sprint nor T-Mobile is participating in that area, relegating both to providers of connectivity and communications without a content play.
As such, I wonder if Masayoshi Son’s big vision goes beyond just combining these two carriers and includes an acquisition (or two) of wireline assets too, so as to create a true rival to AT&T and Verizon. Centurylink would be the obvious property to go after there, with a significant footprint across much of the middle of the United States, and a growing presence in enterprise services too. A Sprint-T-Mobile-Centurylink merger with significant backing from SoftBank could be really powerful.