Why Spend More Than $6.25 Billion on a Company that Primarily Resells Your Service?

  You might wonder why Verizon would pay a hefty premium to buy the U.S. wireless resale flavors of America Movil’s TracFone.  See  https://www.fool.com/investing/2020/09/14/verizon-buys-tracfone-from-america-movil-for-625-b/.  I’ll start with reference to the name of the acquired company.

Verizon gets more than a remarkably profitable revenue stream from TracFone’s 13+ million prepaid—presumably low margin--wireless subscribers. Verizon adds 13 million consumers whose commercial (and private) activities are increasingly subject to extensive surveillance.  Verizon’ ability to track the phones of 13+ million new customers has the potential for substantially adding revenue well beyond the relatively paltry monthly payments for resold cellphone service.

Perhaps belatedly, Verizon recognizes that it has less to gain in targeting and pitching the few higher margin, post-paid wireless subscribers than in acquiring a vast treasure trove of new consumers available for targeting and pitching lots of products and services.  Smartphones have become trackable devices for location-based marketing, data collection and mining and cross-promotion.

Verizon has implemented a part of Amazon’s strategic planning.  Amazon sells Kindles and Fire tablets, probably at a small loss.  The company easily recovers its investment as consumers owning Amazon devices typically become higher volume purchasers than consumers who interact with the company via other devices.

I learned the hard way about Amazon’s cross promotional strategies when I purchased an Insignia smart television set conveniently pre-loaded with a host of Amazon applications.  What I did not know was the miserly 4 Gigabyte memory capacity of the set, 75% of which Amazon occupied while denying set owners the ability to delete any of the pre-loaded apps.  Worse yet, Amazon prevents most competing and alternative apps from being downloaded to external memory inserted into a USB port.  How clever.  I inadvertently have become largely captive to Amazon content, or to ventures willing to pay Amazon for undeletable app installation.

Verizon realizes that it too can surveil (yes, another word for track) and relentlessly market to a captive customer base.  Better yet, Verizon—unlike Amazon—does not even have to discount the tracking device.  Cellphones monitor user locations so that subscribers can make and receive calls, etc. Additionally, this essential function of wireless service easily transitions to commercial surveillance and profitable marketing to third parties by wireless carriers. Bear in mind that the nonnegotiable, “take it or leave it” wireless service contract reserves for the carriers all sorts of subscriber data monetization options—at no additional compensation to the subscriber. 

Verizon gets two additional revenue streams from its TracFone acquisition: 1) cross promotion of its services to 13 million new subscribers and 2) revenues from third parties willing to pay for marketing access.  In a nutshell, Verizon has less interest in the monthly revenue stream from pre-paid wireless access than from the variety of additional revenue streams it can generate by having a large new customer base to surveil and market.

Heretofore Verizon appeared disinclined to promote resale for fear that it would cannibalize higher margin post-paid service, despite AT&T’s successful Cricket venture.  Verizon still may have limited interest in resale revenue streams, aside from the ample new ancillary revenues likely to accrue.

Make Versus Buy in Telecommunications—Verizon/Yahoo

        In a matter of days, Verizon will likely add to its inventory of content by acquiring much of Yahoo.  This deal and the earlier acquisition of America Online confirms the trend that deep-pocketed incumbents see the benefit in acquiring content, rather than growing their own.

            Many years ago, soon after divestiture from the Bell System several Regional Bello Operating Companies threw millions of dollars at becoming content creators, with little to show for it (pun intended).  Now incumbent telephone and cable television companies see the benefit in overnight vertical integration.  You can call it defensive, in light of declining margins and revenues for core, “legacy” business lines.  Alternatively, you can call it prudent recognition that in-house talent might not have necessary mindset and creative skills to flourish in Hollywood.

            The billions of dollars recently invested by companies such as Comcast, Verizon and AT&T confirm that regulatory uncertainty and the “scourge” of network neutrality have not and will not stop investment and capital expenditures.  No company will invest in content if its managers conclude that they should not also make the necessary, concomitant investment in the physical plant needed to deliver content to consumers.  The new, or upgraded infrastructure will exploit technological innovations, such as the fifth generation cellular radio.  Some desirable technologies will not become ubiquitous simply because a profitable business case cannot be made for rural market penetration.

            Let us put to rest the red herring that today’s regulatory wingspan stymies investment in telecommunications.  Ask any senior executive—off the record—and she or he will acknowledge that the regulatory climate falls well below key financial and marketplace variables.  When regulation enters the calculus, too often incumbents use it as a vehicle to stymie innovation and competition. 

            I still do not understand how choice in set top box interfaces with broadband networks somehow hurts consumers and competition.  It does not, but incumbents can cast themselves as victims of bullies like Google and throw sand in the works.  Meanwhile managers at these very same companies proceed with multi-billion dollar acquisitions.  They seem quite optimistic about their staying power and ability to identify and capture new revenue streams.

The Myth of Broadband Investment "Disincentivization"

            Some people, who really should know better, have combined one questionable statistic with an absolutely unreasonable inference.  Ostensibly to bolster their argument that the FCC’s Open Internet Order will either enslave or impoverish carriers, sponsored researchers and one or two easily-persuaded FCC Commissioners make this unsustainable leap of faith:

            Wireline broadband providers have reduced plant investment following the FCC’s Open Internet Order.  Therefore, the entire cause of this diminution investment results from the Order.

            Might there be alternative statistics that identify where the money is going and what, if anything, has caused this sudden conservation of capital?

            First, when considering capital expenditure by companies such as Verizon, converging markets and technologies, surely require an examination of the many places money might go.  Verizon might perceive no competitive necessity to invest in wireline broadband.  Additionally the company might prioritize investments in wireless plant, as part of a major strategy to migrate from wired to wireless content distribution technologies.  Verizon is aggressively jettisoning its wireline plant and state franchises.

            Speaking of content, didn’t Verizon recently come up with a cool $4.4. billion to buy AOL whose major assets are content-based?  Would Verizon skimp on all content distribution technology after having just made a significant investment in content?  Didn’t AT&T just get conditional approval to spend over $45 billion to acquire DirecTV, whose major asset combines access to content and broadband distribution of it?

            On the issue of incentive to invest, just today I read how Verizon already wants to commit substantial funds for next generation, 5G wireless broadband distribution technology. See http://www.verizon.com/about/news/verizon-sets-roadmap-5g-technology-us-field-trials-start-2016.  Bear in mind that Verizon Wireless operates under the Title II, common carrier, telecommunications service provider “public utility” regulatory model that some consider such an investment buzz kill.  Verizon seems to well tolerate this regulatory burden and still manage to invest billion in plant.

            It bears repeating time after time: competitive necessity constitutes the major catalyst for capital expenditures, including next generation network plant. 

            Verizon knows it has to enhance the value proposition for wireless broadband.  And it surely knows the lack of competition means it does not have to extend its FiOS plant, or rush to add funds to wireline technologies about which it does not care.

Verizon’s “Free” Mobile Streaming Service and the Many Questions About Sponsored Data

           When one of the two mega-wireless carriers in the U.S. announces a mobile streaming service, the FCC soon will have to confront head on what carriers can and cannot do by way of advertiser supported data consumption. 

           At first impression, what’s not to like about Verizon’s Go90 gambit? See http://www.nytimes.com/2015/09/08/business/media/verizon-to-offer-free-mobile-tv-with-an-eye-on-millennials.html?emc=eta1&_r=0. The smartphone surely has the capability of offering a competitive alternative to other screens in the video marketplace including television sets and PC monitors.  If a third party wants to subsidize my consumption of “must see” video, well thank you very much!  I am a classic free rider likely to consume the video content without necessarily paying for the advertised products and services. 

           In class I regularly make references to beer, one of the essential food groups for my students.  Most get the economic concept of free ridership when I explain how much I enjoy the Clydesdale advertisements for AB Inbev Budweiser, without having to buy the beer.

            Free rider opportunities notwithstanding, there is a closer question whether sponsored data constitutes permissible price discrimination.  Bear in mind that carriers like Verizon and Comcast can absorb the cost of content carriage, or receive advertising revenues making it possible for consumers to watch content without seeing their often skimpy data allocation evaporate.  Netflix has not banked on competitors having the same zero cost of content delivery.

            So would Netflix have a legitimate (and lawful) complaint about how sponsored data violates the FCC’s Open Internet Order?  In the Internet Service Provider tilting the competitive marketplace for information, communications and entertainment (“ICE”) by taking the cost of content carriage out of the consumer’s cost calculation?

            I part with my network neutrality true believers on this issue, because not all price and quality of service discrimination violates the Communications Act of 1934.  The practice has to be “unfair” and the discrimination has to be “harmful.”  I can envision plenty of instances where sponsored data enhances consumer welfare, particularly free riders distributed throughout the range of incomes.

           

 

Verizon's Copper-Free Diet and the Poorly Educated Consumer

          The frustration, confusion and anger of an elderly friend showed the upcoming public relations debacle awaiting Verizon and other incumbent carriers in their expedited rush to eliminate copper-based services.  From my experience Verizon’s employees—particularly ones on the wireless side—have no clue on how to minimize the harm.

           My friend should be the kind of customer Verizon should cherish.  She’s a triple play subscriber with a triple digit monthly bill.  She accrues no benefit in subscribing to both wireline and wireless Verizon services, because the company has a bizarre policy of completely separating the business dealings of the two ventures, except for offering a single bill. She’s paying Verizon wireless for unlimited long distance even as she has plenty of anytime, anywhere wireless minutes.  She’s satisfied with Digital Subscriber Line “broadband” transmission speed.

            My friend’s satisfaction came to a quick halt when she went shopping for a new wireless handset.  She wanted to use the same shiny, cutting edge smartphone, because that’s the device her children use.  For that privilege, she had to abandon a low cost wireline/wireless service combination.  Okay so far: having access to a 4G smartphone has its costs.

            Despite repeated assertions that Verizon Wireless employees do not receive commission’s my friend’s salesperson routinely inserted a 2 Gigabyte data plan.  No examination of my friend’s data use.  To add insult to injury, the sales person convinced my friend that she should use a “wireless solution” to her in-home, voice telephone requirements. 

            Might there be a spiff, kickback or other gratuity for salespeople spearheading the migration from copper to wireless, or fiber?

            In any event, the Verizon Wireless employee conveniently failed to mention that my friend would have to buy a special version of old school cordless telephones to access a wireless router that the company would provide “free of charge.”  This router handles in-house voice calls using 2.5G cellular spectrum thereby guaranteeing that the new, allegedly cheaper voice service could not be used for data applications.

            Convenient or not, the Verizon Wireless employee also failed to mention that in migrating to the wireless solution, my friend could no longer access the Internet using her DSL connection. Of course she could use her cutting edge 4G smartphone to access the Internet cloud at speeds far in excess of wireline DSL, but get this Verizon, some people do not want an Internet experience viewed from a small, smartphone screen.  My friend still wants broadband access using a personal computer: quaint, but possibly essential for an older person with declining vision.

            To her complete dismay, my friend found out that she no longer had Internet access and that the new black box provided by Verizon Wireless did not work with any of her existing phones still plugged into the existing RG-11 jack.  Obviously this is not what she bargained.

             Verizon added insult to injury by skimping on telephone-based customer service.  Repeated called got disconnected, probably because the representative realized the call would take too long to resolve in light of severe expectations on the number of calls handled per hour.

             I got involved and accompanied my friend to the local Verizon Wireless store.  The place has an uncanny similarity to a car dealership.  The company uses multiple salespeople and a hand off process that sure looks like a way to “tenderize” the customer and beat them into submission so that the last representative can lard on insurance, extra features and accessories, of course accruing no commission, spiff, or kickback.

             Two hours later, I achieved a remedy, albeit a still costly one.  It was remarkable to see that the Verizon Wireless representative experienced the same recordings and runaround as my friend.  A wireless call triggered a wireless Verizon customer service agent even though the local Verizon Wireless employee used a wireline Verizon toll free number.  The local employee had to resort to a wireline telephone to get through to Verizon wireline.

             How ironic (copper/iron pun intended).

             The lessons learned:

 1)         Verizon is one of those “too big to fail” ventures that screws up customer care, even if arguably it invests more in the process than a company like Comcast;

 2)         Verizon is using far too aggressive tactics to nudge and push wireline customers onto wireless options, particularly in areas lacking FiOS;

 

3)         Verizon Wireless has so many walk-in customers—even in the little town of State College, Pennsylvania—that sale people forget their scripts and checklists.  The emphasis is on speeding up the transaction and not assessing the customer’s requirements, and understanding about the battery backup limitations and the need to buy new phones, etc.; and

 4)         Consumer interest in having the latest and greatest smartphone can lead of costly and unneeded service arrangements; and

 5)         Consumers surely must prepare for the high pressure, time is of the essence decision making that still locks most into a 2 year service agreement.

Verizon and the Mixed Prospects of Vertical Integration

          Verizon will invest $4.4 billion to acquire AOL; see http://www.nytimes.com/2015/05/13/business/dealbook/verizon-to-buy-aol-for-4-4-billion.html?emc=edit_na_20150512.

            At first blush, this makes plenty of sense: Verizon has lots of retrained earnings and the ability to borrow billions; the company does not want to rely solely on wireless; and moving up the vertical food chain into content helps the company diversify and augment its home grown content.

 

            Okay so far, but we should not forget the billions lost in value when Time Warner, another content distribution carrier, tried to extract the value in AOL.  So what’s different this time?  Bear in mind that a few years after divestiture from AT&T, Verizon experimented with self-generated content and failed miserably.

            On the other hand, Comcast has successfully integrated content distribution with content generation.  The company acquired NBC-Universal and has ownership interests in many cable programming networks.

            Is there a way to predict a company’s prospects for a vertically integrating acquisition?

            I can think of two factors: the willingness of the acquiring company to encourage management of the acquired company to stay and more broadly whether the acquiring company can broaden its perspective.  Verizon need to expand its telephony (Bellhead) management skills to include content and alternative distribution channel management (Cablehead/Nethead).  Telephone company management skills will not suffice.

 

            You can teach an old dog new tricks, but Verizon would be wise to bring in several new breeds.