RESEARCH NOTE 4
JUNE 2006
The Competitiveness of the SA Mobile Market Will the entry of Virgin Mobile increase competition?
The question that will be addressed
in this Research Note is how the
entry of Virgin Mobile will affect
competitiveness and prices in the
South African Mobile market.
Nicola Theron
1.Introduction
Much has been written on mobile prices
in South Africa and the reasons for the
persistence of high prices. This research
note gives a short description of the
economic structure of the SA mobile
market. It is argued that the current
oligopolistic structure of the market,
with Vodacom and MTN controlling
approximately 90% of the market, is not
conducive to competition.
In July 2005 ICASA published a discussion
document on mobile prices in which it
asked why the entrance of Cell C in the
mobile market has not reduced call costs
and whether there is sufficient competition
in the mobile market. Some reasons why
the entrance of Cell C in 2001, has not
brought sufficient competitive pressure to
bring true competition to this market will
be examined
On the 24th of June 2006, Virgin mobile
launched a SA virtual mobile offering
– a 50/50 partnership with Cell C. The
question that will asked is whether Virgin
Mobile would be more successful in
providing some competitive pressure to
the incumbents, and whether this will
translate into lower overall prices for the
consumer.
2. Structure of the SA mobile
market – an economic analysis
This section will give a brief overview of
the SA mobile market from a competition
economics perspective. In order to address
the question of persistent high prices, the
relevant market has to be defined and
market shares calculated in order to be
able to investigate issues of market and
pricing power.
2.1 Relevant market for competition purposes
When applying the traditional SSNIP1
test to the market for mobile services,
the relevant question is whether fixed
line services are substitutable for mobile
services. The literature provides several
reasons why fixed line services should
not be included in the market for mobile
services. These are mainly:
•
Mobile and fixed line services are fundamentally different. Mobile phones have the distinct functional advantage of portability;
•
Prices for mobile telephony services are significantly higher than fixed line services; and
•
Competition authorities in both the US and EU have ruled that mobile and fixed line telephony services constitute two distinct markets.
In the words of the EU Commission2:
“As regards mobile communications,
the Commission has found that, from
a demand-side point of view, mobile
services and fixed telephony services
constitute separate markets”. According
to ComReg (2004:18): “The difference
1. Small but significant non-transitory increase in price
2. European Commission (2001). “Proposed New Regulatory Framework for Electronic Communications Networks and Services”.
RESEARCH NOTE 4 - APRIL 2006
in price between fixed and mobile retail
services combined with the inability
of other firms, such as fixed operators,
to switch to providing mobile services
indicate that mobile services are in a
separate market to fixed services”.
The general conclusion is therefore that
fixed line services can not be substituted
for mobile services, because of the
difference in the nature of the service
to the consumer, but also because of
the price difference. Viewed from the
demand-side, fixed and mobile services
can not be considered as substitutes,
mainly because of the price difference.
It is true that in a converged environment,
mobile voice services will not be the
exclusive right of mobile operators as
mobile voice services will also be offered
over other platforms such as mobile voice
over IP. In the future the mobile voice
market will have to be expanded to
include all mobile voice offerings and not
just the traditional cellular networks.
2.2 Market structure
The mobile phone market is a textbook
example of what is termed a ‘network’
industry. Network industries are a large
part of the world economy, and these
industries often provide necessities, which
usually necessitate regulation to guarantee
optimal supply.
Where the average cost curve in a
traditional market declines over time and
reaches a point where it starts to rise
again, in network industries the average
cost might be declining over a very long
period as network effects are realized. The
initial capital costs are very high, but will
be retrieved over time. High initial costs in
the mobile industry often mean that firms
only become profitable after 6-8 years.
The following graph shows the percentage
of MTN’s debt to EBITDA (Earnings
before interest, taxes, depreciation and
amortization) between 2000-2005.
Figure 1 – MTN : Nett (includes cash) Debt to EBITDA (2000-2005) – MTN Total
EBITDA is a good indicator of profitability
and the graph above shows that until
2003/2004, MTN’s ratio of nett debt to
EBITDA was positive indicating that a
long period is needed before companies
in this industry becomes profitable.
2.3 Oligopoly/ Duopoly
Up to the recent entrance of Virgin Mobile,
the South African mobile market could
have been classified as an oligopoly, or
even a duopoly, with two firms, Vodacom
and MTN of more or less the same size
dominating the market.
Both Vodacom and MTN have market
shares of at least 35%. This implies that
both firms can be classified as ‘dominant’
i.t.o. the Competition Act. It is also
important to note that the combined
market share of the two large players is
approximately 90% which should be
an indication of their collective market
power. Where two large companies
control a market (duopoly) and they
have similar cost and pricing strategies,
competition levels may not be optimal.
Companies in the mobile sector are
interdependent as they have structural links
with each other in the form of cooperation
agreements, such as termination of voice
and data traffic and roaming relationships.
This type of interdependence is a wellknown characteristic of oligopoly (and
duopoly) markets. An oligopolistic market
is more likely to have a structure which
is conducive to coordinated effects,
because firms are likely to become
aware of their common interests and
to anticipate one another’s behaviour.
Interdependence among the competing
firms in an oligopoly (or a duopoly) can
give rise to coordinated effects.
The following table lists the characteristics
of an oligopoly market that can indicate
that competition levels are not optimal:
Source: MTN annual reports
3. This approach is also used in the USA. In “Department of Justice vs. Bell Atlantic Corporation, July 1999”, it was stated that: “Wireless mobile telephone service is a relevant product market. There are
no cost-effective alternatives to wireless mobile telephone services for those customers using these services. If the price of wireless mobile services were to increase by a small but significant amount, there
would not be a sufficient number of customers that would switch away from wireless mobile telephone services to make that price increase unprofitable. Wireless mobile telephone service is therefore a
relevant product market, and a line of commerce within the meaning of Section 7 of the Clayton Act”.
RESEARCH NOTE 4 - JUNE 2006
Table 1: Mobile oligopoly market in SA
Theory
South African market
Degree of market concentration
Highly concentrated market (HHI=4 3504);
it might be able to erode it to a certain
degree. However, it does not seem that
Cell C’s entry has increased competition
and reduced prices sufficiently. Reasons
for this will be explored below.
Few firms in an oligopoly
Vodacom & MTN have a collective
market share of approximately 90%;
2.4 Market shares and market power
The market shares are relatively symmetric
Vodacom (55%) and MTN (35%) dominate;
High barriers to entry
License needed under regulatory regime;
Lack of countervailing power
Consumers not well organized
Economies of scale and scope
Large sunk costs favour early entrants –
Vodacom & MTN
The figure below shows that both MTN
and Vodacom have market shares equal
to or exceeding 35%. Cell C has managed
to grow its market share to 10% since its
entry in 2001.
Figure 2: Mobile market share in terms
of subscribers (2005)5
The table illustrates that all the theoretical
factors listed in the first column are evident
in the South African mobile market. The
market is highly concentrated, there are
only three firms, the market shares of the
two large firms are relatively symmetric
(and have become more symmetric
over time) and there are few potential
market constraints. The most important
disciplining factor in such a market, is
actual or potential competitors (market
constraints). In theory, even a smaller
‘fringe’ competitor should be able to exert
enough competitive pressure to change
the behaviour of the larger firms in an
oligopoly. While a competitive fringe
firm may not be able to eliminate market
power of the larger firms completely,
Source: Company annual reports, and ICASA
3. New entrants –
Figure 3 below shows a comparison of
Cell C and Vodacom and MTN tariffs
when Cell C entered the market during
2001. At the time of Cell C’s entry, their
tariffs were cheaper for all the product
classes in the standard pre-paid category.
the case of Cell C
Cell C entered the market in 2001 and
has gained some market share since then.
However the ICASA discussion document
on mobile pricing (ICASA, July 2005)
stated that Cell C’s entry has not led to
a reduction in mobile tariffs, as might be
expected with more competition. “At a
general level, the Authority is of the view
that the overall picture pertaining to call
rates in the country is not encouraging.
The reality of the situation is that lowincome consumers are subjected to much
higher prices. Contract or post-paid users
on the higher end tariff plans are charged
lower rates in contrast to those who
are on the lower end tariff plans. The
fact that handsets for contract customers
are subsidized and the usage rates are
lower raises concerns that pre-paid users
may potentially be subsidizing post-paid
users”.
Figure 3: Pre-paid standard plans at the time of Cell C’s launch.
4. Own Calculation
5. The market shares are based on the number of subscribers. The number of Vodacom subscribers, however, may be inflated as the Vodacom
figure includes subscribers inactive for the past 7 months, as opposed to the normal allowed inactive period of 3 months
RESEARCH NOTE 4 - JUNE 2006
The same was not true for Cell C’s offering
in the contract categories. In the contract
categories, comparison of call charges
are more complex, as these offerings
typically bundle usage (i.e. call minutes)
as part of the subscription charges. As far
as subscription charges were concerned
at the time of Cell C’s entry, these were all
below Vodacom and MTN levels across
the range of contract offerings. However,
Cell C’s tariffs were not necessarily cheaper
on the contract offerings. It seemed that
initially Cell C targeted the pre-paid
market, but more recently (2005) it has
increased its share of the contract market
to 15% (2005). Cell C’s share of the prepaid market was 9% in 2005, giving it
a total market share of 10% (2005). The
pre-paid market is the largest part of the
market with a ratio of pre-paid to contract
for the entire SA mobile market of 85:15
(AMPS, 2005). However, average revenue
per user (ARPU) is much lower in the prepaid than in the contract sector.
Cell C also had a ‘late mover’ disadvantage,
having entered the market place
considerably later than its competitors.
The earlier entrants had time to establish
subscriber bases and to reduce unit costs
(see figure 1 above). The current ‘deep
pockets’ of Vodacom and MTN constitute
a significant competitive advantage over
Cell C, specifically i.t.o. advertising and
all forms of promotion. Cell C also has the
added cost of the roaming agreement with
Vodacom, to achieve the same coverage
as its competitors.
However, to understand why Cell C has
not made significant inroads into the
market shares of Vodacom and MTN
issues at the interconnection level become
important.
Mobile customers make different types
of calls, including calls on the same
network (e.g. calls between two Vodacom
subscribers) and calls to customers of
other networks (e.g. calls between one
MTN and one Vodacom subscriber).
For the latter, call costs are influenced
(among other things) by interconnection
fees charged by the other network for
terminating the call. In South Africa, recent
studies have shown that interconnection
rates are excessively high and do not
adhere to the regulatory requirement that
interconnection fees should be cost-based
(South Africa Foundation, 2005: 17). While
all three of the mobile operators may be
charging these high interconnection fees,
these fees may significantly reduce the
competitiveness of Cell C. Because of its
small size relative to Vodacom and MTN,
Cell C subscribers are likely to make a
large number of calls to Vodacom and
MTN subscribers. The high cost of the
interconnection may therefore serve as
an incentive for potential customers to
subscribe to one of the larger networks
(rather than Cell C).
4. Mobile virtual network
operators (MVNOs), number
portability and Virgin Mobile
The section above has explored several
reasons why Cell C has not managed
to grow a larger market share since its
entry in 2001. Although even a fringe
competitor might be able to reduce overall
price levels, this did not seem to happen
in the SA market (although there have
been some recent price reductions).
Virgin Mobile has entered the SA mobile
market as a MVNO. An MVNO does not
own a network infrastructure but buys
network time from traditional mobile
companies, brands it and sells it to its
customers. Although an MVNO can also
be described as an ‘enhanced service
provider’, it is usually seen as competing
more with traditional mobile companies
than with traditional service providers.
Virgin Mobile can therefore be described
as a ‘fourth mobile operator’ in the SA
market.
According to Virgin Mobile they will
offer innovative products and the same
tariff will be offered to pre-paid and
contract customers. This will certainly
bring competitive pressure to a tightly
controlled market that has always
offered differential prices for pre-paid
and contract customers. Although Virgin
Mobile will use Cell C’s infrastructure,
it will operate as a completely separate
brand, in competition also with Cell C.
According to press reports Virgin will
aim to capture 10% market share within
the next 3-5 years. The success of this
strategy will be heavily dependent on
the successful introduction of number
portability6.
International experience shows that
in markets where MVNOs have been
introduced, they have helped to drive
down prices and reduce profit margins.
Virgin Mobile as a virtual operator does not
face the same late-comer disadvantages as
Cell C, and hopefully the entry of Virgin
Mobile will provide enough competitive
pressure to the current oligopoly to finally
force down mobile prices.
6. Number portability is the ability of a subscriber to retain his number while switching between network operators, between geographic
locations, or between services (e.g. fixed to mobile). Many countries have now mandated number portability as a pro-competitive measure.
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