T-Mobile Hasn’t Incited a Price War…Yet

T-Mobile is basking in the limelight courtesy of masterful marketing and an aggressive promotion launched last week. First, its CEO, John Legere, was ceremoniously kicked out of a Las Vegas party thrown by wireless rival AT&T. But what’s really generating buzz is the fourth largest U.S. wireless carrier’s offer to pay up to $650 for new customers to switch to its service. While analysts fear this will spark a margin-eroding price war, this concern is premature.

Since early last year, T-Mobile has spearheaded what I call a value war — as opposed to a price war — in the wireless market. Instead of attracting customers by promoting discounts on its monthly service prices, it’s wisely chosen to compete by adding value.

T-Mobile’s most hyped action has been to abolish the industry-standard two year contract (and those dastardly early termination fees). While this promise to “un-leash” customers from contracts sounds appealing, in reality this pledge is a bit of a shell game. Most carriers “bake in” a financing payment into their two year plans (monthly fees implicitly include both a wireless service and a financing payment for a new device). T-Mobile uncoupled these fees. So instead of a two year contract, T-Mobile customers pay a month-to-month wireless service fee and enter into a 24-month financing plan (zero down, zero percent financing). Customers can stop the service at any time, but to do so they have to pay off their financing balance immediately (which is akin to the early termination fee). This no-contract policy is almost always financially advantageous to customers compared to two year contracts.

T-Mobile has built upon its no-contract foundation with two additional value-enhancing offers.  Roaming charges for text and voice have been eliminated — a great value to those who travel abroad. Borrowing from the flexibility of leasing plans used in the auto industry, customers also have the opportunity to trade in their phones for a new one every six months.

What’s interesting is that despite T-Mobile’s aggressive value-enhancing actions, rivals have not reacted by slashing prices. It’s actually common for companies with varying value propositions to  co-exist peacefully. Consider the airline industry. Southwest Airlines generously offers free baggage and a liberal flight cancellation policy — great enhanced value. But this has not provoked a price war. A lesson to managers of all companies — it’s less threatening to compete on value than price.

What’s generating rumblings of a price war is T-Mobile’s offer to pay “up to $650” to customers who switch carriers. Price wars are great for customers, but disastrous to the margins of the discounting companies. Price wars commoditize products (customers focus on the lowest price) and often lead to emotionally irrational behavior — managers don’t like to lose. “We’re angry,” declared a pizza parlor owner last year in a widely-publicized Manhattan pizza price war that resulted in slices dropping from $1.50 to 75 cents. While this price war was finally settled, the end results were typical: companies lost money, it became personal (one owner vowed to sell land in India to finance the battle), and the ultimate market price decreased (to $1).

T-Mobile’s $650 offer is simply a customer acquisition strategy. Early termination fees up to $350 are reimbursed (receipt required) and customers receive the market value for trading in their current cell phones (up to $300). Thus, only the switching costs are covered — there’s no immediate financial windfall for customers. It’s a common practice for companies to pay the fees that customers incur to switch services (though a long term commitment is generally required).

The barrier that’s preventing a knock-down price war is the belief that T-Mobile has a smaller 4G network (which reportedly currently serves 254 markets versus Verizon’s and AT&T’s 4G service in 500 and 488 markets, respectively) and many customers value a large 4G network. Due to this perceived inferiority, only a sub-segment of Verizon’s and AT&T’s (the largest and second largest U.S. wireless operators) customers will consider switching. So instead of an across-the-board price war cut, it’s better for rivals to deal with at-risk-of-defecting customers individually. This will lead to what I call a private price war, which is less threatening to margins. When customers intent on switching to T-Mobile attempt to cancel service, their current carrier will offer an inducement — say a $100 or $200 credit — as an incentive to stay.

What’s going to trigger a price war? As T-Mobile’s 4G coverage expands, it becomes a larger threat — it’s a more viable alternative to customers of larger wireless carriers. But in the short term, the biggest threat comes from T-Mobile’s endless taunting of its rivals. One day this poking may lead a competitor to take it personally…and if this occurs, the wireless industry had better brace for a Manhattan-pizza-like price war.

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