The economics of a mature market

Has the wireless market in the U.S. finally hit its saturation point? Have we finally “matured” so much that every subscriber add is a steal from someone else’s network and the few remaining souls without a cellphone are just too plain stubborn to not bother with? Do we have to look elsewhere for growth? There are plenty of signs pointing to just that.

A new report from Bernstein Research points out that Q1 net subscriber adds dropped 23% year-over-year, and overall subscriber numbers have fallen from 11.5% to 7.9% in the same period. Further, the NPD Group found that handsets sales volumes dropped 22% in Q1 compared to the same quarter in 2007. It’s eerie how those two percentages match up. Sure, we’re still growing, but the boom days are long gone.

What’s most interesting about this trend, however, is how it will change the fundamental business of wireless. The industry will have to transition from one where growth is spurred by new subs to one that  grows its revenue per sub. And since the amount of money that can be squeezed out of a minute of voice is rapidly shrinking to zero, that growth will have to come from data services. At first glance, the industry seems well-prepared to make that transition. At the top two operators, data ARPU is already well over 20% of total revenues, and AT&T and Verizon are rapidly increasing those numbers. But further analysis shows the industry may not be quite as ready to make that transition as you think.

According to the Bernstein report, 90% of AT&T and Verizon Wireless’ revenue growth came from subscriber adds in Q1. Though their data growth numbers are popping off the charts as percentages, in terms of overall additional revenues, they’re not making much of an impact because a) data revenues are still only a percentage of overall revenues and b) much of the gains in data ARPU are being offset by decline voice ARPU. Furthermore, Verizon and AT&T are benefiting from Sprint’s misfortunes: When Sprint gets its act together, those 1.5-to-2-million subscriber quarters are probably going to end.

Bernstein concludes that we will begin to see a “U-shaped” growth trajectory in U.S. wireless revenues as data ARPU growth fails to keep up with the slowing pace of new subscriber adds. At the end of the “U” growth will pick up albeit from a much lower base (i.e. it’s easier to accelerate once you’ve decelerated). While SMS and incremental wireless content sales will have their place, Bernstein expects data ARPU increases to be driven by data subscriptions, a guaranteed monthly pay out. With data subscriptions on only 7% of the wireless plans today, Bernstein projects penetration to rise to between 30% and 35% by 2012, which is coincidentally when 4G networks will most likely achieve enough scale to affect overall revenue numbers. That still leaves four awfully cold years in between, according Bernstein’s calculations.

There’s some hope in the numbers, though. According to NPD’s study, 17% of all phones sold in Q1 were smartphones (compared to 7% a year earlier) and formelry niche player Research in Motion entered the top five in handset volumes shipped with a 5% market share. Smartphones, particularly e-mail focused gadgets like the BlackBerry, are proven APRU drivers. At just over 5 million phones, that volume is still too small to have any real effect on an industry with 260 million connections, but at least we’re on the right track.

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