Would Telephony Bring Cheper Rates in India

Mobile Telephony in India... Ref. No.: ME0007

On August 23rd 1995, Jyoti Basu, the then Chief Minister of West Bengal, made India’s first cellular phone call to Telecom Minister, Sukh Ram, from Kolkata on Modi Telstra network at INR 16/minute. Initially, Indian government imposed a heavy license fee for providing mobile services. To recover such huge license fee, mobile operators had no choice but to keep very high tariff rates. Thus, the growth of cell phone services was sluggish in the first few years due to high price of handsets and high tariff structure. An average handset was costing around INR 15,000; outgoing and incoming call rates were INR 16/minute and INR 8/minute respectively. Because of these reasons very few customers at that time were willing to jump on to a new revolution, called the mobile telephony. Up to mid1990s mobile phones were used only by the affluent. Only 3,000 people possessed mobile phones in 1995–96 (Exhibit I). Even 4 years later, when the Government planned to introduce a new telecom policy called NTP 99, mobile subscribers in India numbered less than 2 million. The mobile phone industry was in heavy losses.

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“India welcomes 2009 with 346.9Mn mobile subscribers”, India+Welcomes+2009+With+3469Mn+Mobile+Subscribers.aspx, January 28th 2009

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In 1999, with the introduction of a new telecom policy by the Government of India, the telecom industry moved to a revenue sharing regime. The license fee was reduced, which helped in the reduction of call rates by 60%. More importantly, incoming calls were made free. The fall in call rates increased the number of mobile subscribers in the following years. The mobile subscriber base in India has risen from less than 2 million to 90 million within a span of 7 years from 1999–2006 (Exhibit I). An estimate at the end of 2008 shows the mobile subscriber base in India at 346.9 million.1

This case study was written by Hepsi Swarna under the direction of Akshaya Kumar Jena, IBSCDC. It is intended to be used as the basis for class discussion rather than to illustrate either effective or ineffective handling of a management situation. The case was compiled from published sources. © 2009, IBSCDC. No part of this publication may be copied, stored, transmitted, reproduced or distributed in any form or medium whatsoever without the permission of the copyright owner. Background Reading: Chapter 4, “Applications of Supply and Demand”, Economics (Paul A. Samuelson and William D. Nordhaus)

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Mobile Telephony in India: Would Cheaper Rates Bring More Profits?

http://www.itu.int/ITU-D/ict/newslog/

Mobile Telephony in India...

Exhibit I Growth in Mobile Subscriber Base in India

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Source: Singh K. Sanjay, “The Diffusion of Mobile Phones in India”, http://home.iitk.ac.in/~sanjay/skspresentation.ppt, page 3

Elasticity of Demand and Mobile Services in India
Indian customers are price sensitive. As the tariffs were slashed, the subscriber base increased (Exhibit II).

Exhibit II Increasing Mobile Subscriber Base due to Decreasing Tariffs (1998–2007) minute Do

Source: Brahmadhandi Vivek and Soans John, “Indian Telecom Industry”, http://d.scribd.com/docs/ u5l1dzmf24gok0by150.pdf, page 24

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Exhibit III Minutes of Usage per Month (2008)
US India China Russia 88 303

Source: Brahmadhandi Vivek and Soans John, “Indian Telecom Industry”, http://d.scribd.com/docs/ u5l1dzmf24gok0by150.pdf, page 9

An estimate by Vodafone Public Policy series in January 2009 revealed that demand for mobile phones is highly sensitive to price with a negative relationship. “The own-price-elasticity of mobile phones is minus 2.12, which implies that a 10% price increase would reduce demand by roughly 21%.”4 Price elasticity of demand is a negative number because of inverse relationship between price and quantity demanded. The above Vodafone estimate also showed that demand for mobile phones in India is positively correlated with increase in income. The income elasticity of demand for mobile phones is estimated to be 2.455 and this makes mobile a luxury in the technical sense of economics. A study using household sample survey data from Karnataka, a state in South India has, however, found out that “a

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Mani Sunil, “Growth of India’s telecom Services (1991-2007): can it lead to emergence of a Manufacturing Hub?”, http:// poverty.developmentgateway.org/uploads/media/poverty/Griowth%20of%20India’s%20Telecom%20Services.pdf, page 45 India Welcomes 2009 with 346.9 Million Mobile Subscribers”, http://wirelessfederation.com/news/14151-indiawelcomes-2009-with-3469mn-mobile-subscribers/, January 22nd 2009 “India:The Impact of Mobile Phones”, http://72.14.235.132/search?q=cache:iIcMvHoqhCgJ:www.vodafone.com/ e t c / m e d i a l i b / p u b l i c _ p o l i c y _ s e r i e s . P a r . 5 6 5 7 2 . F i l e . d a t / public_policy_series_9.pdf+india,+impact+of+mobile+phones&cd=1&hl=en&ct=clnk&gl=in, January 2009, page 16 Ibid., page 17

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The fall in prices of mobile handsets also contributed to the increase in mobile usage. In 2005, 32 million handsets were sold in India, as handsets were available for as low as INR 2,000. It was reported that from July 2006 onwards 5 million handsets2 were sold monthly and in 2008, India stood as the second largest market for handsets in the world, when handsets were available for even INR 1,000. In March 2008, India had the second highest minutes of usage per month, only next to US (Exhibit III). Thus, the mobile phone, which once was a rich man’s toy became affordable even by the common man. International Telecommunications Union opines, “The ever-growing rate of subscriber base in India is driven by cheap call rates, low-end handsets and network expansion spree.”3

Mobile Telephony in India...

rise in monthly income of households by 5% increases mobile phone services to the extent of 0.638%”6, which makes mobile a normal necessity rather than a luxury good. With the rise in their income, by the beginning of 2005 the Indian customers started demanding for stylish phones.The trend continued over the years and in 2008, it was reported that Indians with income patterns rising, were increasingly wishing to be seen with smart mobile handsets. As mobile service providers turned innovative, offering tariff plans like lifetime validity pre-paid cards (aimed at low-income group), cheap handsets with loads of features, internet and online payment facilities, more and more Indians started demanding more and more mobiles. The tremendous growth of mobile phones has adversely affected the subscriber base of fixed phones in India. Fixed phones per mobile decreased from 5.87 in 2001–2002 to 0.25 in 2006–2007 (Exhibit IV).

Exhibit IV Fixed Phones per Mobile Phones in India (2001–2007)

Source: Narayana Ranganathan Muttur, “Substituability between Mobile and Fixed Telephones: Evidence and Implications for India”, http://www.e.u-tokyo.ac.jp/cirje/research/dp/2008/2008cf550.pdf, March 2008, page 21

On the count of access price, the magnitude of cross price elasticity is, however, very small – implying that the prices of fixed phones do not have much impact on the demand for mobile phones.
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Narayana Ranganathan Muttur, “Substitutability between Mobile and Fixed Telephones: Evidence and Implications for India”, http://www.e.u-tokyo.ac.jp/cirje/research/dp/2008/2008cf550.pdf, March 2008, page 14 “India:The Impact of Mobile Phones”, op.cit., page 16 Access price comprises onetime installation charges and monthly rentals. Usage price refers to the call rates.

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A study7 using household sample survey data from Karnataka estimated that an increase in access price8 of fixed phones by 5% would increase subscriptions for mobiles phones by about 0.3% while increase in usage price9 of fixed phones by equivalent percentage would increase subscriptions by 10.6%. Thus, the increase in usage price of fixed phone has a larger impact than the increase in access price. The cross price elasticity between fixed and mobile phones is positive, implying substitutability.

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Price Elasticity of Demand for Mobile Phones and Revenue

Source: Brahmadhandi Vivek and Soans John, “Indian Telecom Industry”, http://d.scribd.com/docs/ u5l1dzmf24gok0by150.pdf, page 35
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“Mobile Phones India”, http://www.factsaboutindia.org/mobile-phones-india.htm Gopalan Krishna, “Action hotting up once again in Indian telecom”, http://www1.economictimes.indiatimes.com/ articleshow/msid-3606382,prtpage-1.cms, October 17th 2008

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But in spite of decreasing ARPU, the telecom service sector in India generated total revenue of INR 867.2 billion in 2004–2005, an increase of revenue by 21% from 2003–2004.10 Manoj Kohli, joint managing director, Bharti Airtel opines, “At a tariff of one-and-half cents per minute, it offers a reasonable margin, which has flabbergasted the world.”11 The falling tariffs of SMS have increased the SMS volumes in India from 12.3 billion in 2004 to 89.4 billion in 2008 (Exhibit V). It is being predicted for 2009 and 2010 that SMS volumes will continue this increasing trend and rake in increased revenue.

Exhibit V SMS Volumes in India (2004–2010)

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Demand for mobile phones in India is price-elastic as a 10% price increase is found to have reduced demand for it by roughly 21%. When mobile service was introduced in India, only the affluent could afford it, owing to high call rates. All the mobile players were incurring huge losses, and then it became very clear that volumes only could bring profitability. And volumes in a price conscious country like India could be achieved by reducing the call rates. Gradually mobile carriers started shifting their focus to mass markets by reducing the tariffs by around 93%. A call that used to cost INR 16/minute now costs INR 1/minute and sometimes even less than that. This has resulted in decreasing Average Revenue Per User (ARPU) for the companies.

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Demand for mobile phones is thus almost independent of fixed phone prices. There are many reasons for this. It is very easy to get a mobile connection. More importantly, one can be contacted anytime, anywhere. Airtel, India’s largest mobile service provider, underscored this point by flashing an advertisement where a girl’s plane crashes in a jungle; and when she thinks there is no way of contacting anybody, she looks at her mobile, sees Airtel signal still strong and then makes the life saving call. Mobile comes with loads of features, which an ordinary fixed phone does not have.

Mobile Telephony in India...

Exhibit VI Declining ARPU (March 2007–March 2008)

September 2007

March 2007

Source: Brahmadhandi Vivek and Soans John, “Indian Telecom Industry”, http://d.scribd.com/docs/ u5l1dzmf24gok0by150.pdf, page 9

Whether further lowering of call rates will ring profits for the mobile telephone sector of India remains an open-ended issue. While the key to understanding this issue lies in measuring the elasticity of demand and probing its relationship with the revenue, this is often forgotten, leading to faulty reasoning and false debates.

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December 2007

March 2008

June 2007

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CDMA

ARPU (USD/month

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GSM

With falling call rates, the subscriber base has increased exponentially. This has given the carriers the benefits of economies of scale and ensured them profits. Still a large part of India’s consuming power, like the rural areas remain untapped. The declining ARPU during the period March 2007– March 2008 indicates that India is tapping a large market of low-income households by reducing the tariffs (Exhibit VI).