By now we are all well aware of the big hue and cry over allocation of 2G spectrum. And alteast one thing has come out clearly that due to the scam everybody i.e. the telecom cos., have benefited by the allocation in some way or the other, and so has Mr. Raja. Some telecom operators have got the spectrum at throw away prices and some are riding on other operators spectrum, in turn paying less for the spectrum actually allocated to them.
Therefore be it the new entrants or the old players in the telecom sector, both have benefitted from the pricing policy of issuing licenses. In both the cases be it in the year 2001 or 2008, there wasn’t any auction like in the case of 3G services. As we know that, an auction ensures that the highest bid get the license and more importantly the entire bidding process ensures transparency.
Therefore one would ideally say that if an organization is paying less for something, it would obviously save money and it will impact their bottom line positively. Right? Well, yes, but not all the time. Especially if you observe the telecom space in India.
Lets see how is that possible…
Ok, let us first understand for the economic point of view what is the market structure telecom cos are operating in. The Indian market was once monopolised by just one player- ‘BSNL Zindabad’. But now there are more than 15 players in the sector but the market share is concentrated in the hands of few players, to be precise only 4 players. Bharti, Voda, Idea, Reliance control more than 70% market share and revenue share. This is typically an Oligopoly kind of a structure where the power is concentrated in the hands of few players inspite of numerous players in the market.
Cheap licenses have meant higher EBIDTA for the telecom players, no doubt. Bharti for example is operating currently at 36% EBIDTA margin, Vodafone is roughly at 30% and Idea at 20%. So one can imagine what would be the EBIDTA levels before the competition actually crept in. Therefore one would conclude that by paying less for the licenses the telecom cos have actually made a lot of money.
Yes they did, infact if I was put it in economic terms, they have made ‘Supernormal profits’. Lets first understand what are normal profits. Normal profits by definition represents the ‘opportunity cost’ for an enterprise, since the time that the owner spends running the firm could be spent on running another firm. But, in case of supernormal profit the enterprise is not losing out on an opportunity cost as it is earning more than normal profits, therefore in simple terms he is happy running one firm. Infact, if you look around, companies are operating on wafer thin margin, e.g. manufacturing 5-10%, Petroleum 10%-12%, food and tabacoo 8%-12%.
Supernormal profits have a flip side. They attract competition. Lets say if one were to start a business, one would obviously look for something to invest in where one would be assured of more than average profit. That’s a no brainer, right? And that is what exactly happened in the telecom sector. It attracted competition from all over the world and even enterprises who didn’t know head or tail of telecom, case in point- Unitech. So economically speaking, as new firms enter the industry, they increase the supply of the product available in the market, and these new firms are forced to charge a lower price to entice consumers to buy the additional supply these new firms are supplying (they compete for customers). Time to go back to the basics, excess supply of goods and services results into lower prices and lower prices means lower profits.
Now let us say that the telcos would have got their 2G licenses through an auction just like they got them for 3G services. All of them would have been very careful in investing their money, just like they were during the 3G auction. They would been very selective in choosing the circles where they wanted to offer the services to the customers, just like 3G. They would have done a backward calculation in terms of their NPVs and IRRs, just like in 3G. And most importantly they would have send out a very strong signal to other companies, that this is an expensive business to be in, and the entry barriers are high, very high. That is what has happened in the 3G auction, handful of telcos have opted for 3G and ones who have opted have opted for even fewer circles.
Things have a strange way of balancing out and finding an equilibrium, be it life or business. In the long run it all evens out. Today, so many players have entered the telecom sector that the average cost of providing the service is same or lower than the break even point of offering the service, in which case profits slowly disappear. And when this happens then the companies outside the scenario don’t see any advantage in entering the industry and finally price of the goods and services stabilizes.
Therefore, some times my dear friends, it not a bad idea to follow the rules of fair pricing and save yourself from a lot of trouble in the long run.
Therefore be it the new entrants or the old players in the telecom sector, both have benefitted from the pricing policy of issuing licenses. In both the cases be it in the year 2001 or 2008, there wasn’t any auction like in the case of 3G services. As we know that, an auction ensures that the highest bid get the license and more importantly the entire bidding process ensures transparency.
Therefore one would ideally say that if an organization is paying less for something, it would obviously save money and it will impact their bottom line positively. Right? Well, yes, but not all the time. Especially if you observe the telecom space in India.
Lets see how is that possible…
Ok, let us first understand for the economic point of view what is the market structure telecom cos are operating in. The Indian market was once monopolised by just one player- ‘BSNL Zindabad’. But now there are more than 15 players in the sector but the market share is concentrated in the hands of few players, to be precise only 4 players. Bharti, Voda, Idea, Reliance control more than 70% market share and revenue share. This is typically an Oligopoly kind of a structure where the power is concentrated in the hands of few players inspite of numerous players in the market.
Cheap licenses have meant higher EBIDTA for the telecom players, no doubt. Bharti for example is operating currently at 36% EBIDTA margin, Vodafone is roughly at 30% and Idea at 20%. So one can imagine what would be the EBIDTA levels before the competition actually crept in. Therefore one would conclude that by paying less for the licenses the telecom cos have actually made a lot of money.
Yes they did, infact if I was put it in economic terms, they have made ‘Supernormal profits’. Lets first understand what are normal profits. Normal profits by definition represents the ‘opportunity cost’ for an enterprise, since the time that the owner spends running the firm could be spent on running another firm. But, in case of supernormal profit the enterprise is not losing out on an opportunity cost as it is earning more than normal profits, therefore in simple terms he is happy running one firm. Infact, if you look around, companies are operating on wafer thin margin, e.g. manufacturing 5-10%, Petroleum 10%-12%, food and tabacoo 8%-12%.
Supernormal profits have a flip side. They attract competition. Lets say if one were to start a business, one would obviously look for something to invest in where one would be assured of more than average profit. That’s a no brainer, right? And that is what exactly happened in the telecom sector. It attracted competition from all over the world and even enterprises who didn’t know head or tail of telecom, case in point- Unitech. So economically speaking, as new firms enter the industry, they increase the supply of the product available in the market, and these new firms are forced to charge a lower price to entice consumers to buy the additional supply these new firms are supplying (they compete for customers). Time to go back to the basics, excess supply of goods and services results into lower prices and lower prices means lower profits.
Now let us say that the telcos would have got their 2G licenses through an auction just like they got them for 3G services. All of them would have been very careful in investing their money, just like they were during the 3G auction. They would been very selective in choosing the circles where they wanted to offer the services to the customers, just like 3G. They would have done a backward calculation in terms of their NPVs and IRRs, just like in 3G. And most importantly they would have send out a very strong signal to other companies, that this is an expensive business to be in, and the entry barriers are high, very high. That is what has happened in the 3G auction, handful of telcos have opted for 3G and ones who have opted have opted for even fewer circles.
Things have a strange way of balancing out and finding an equilibrium, be it life or business. In the long run it all evens out. Today, so many players have entered the telecom sector that the average cost of providing the service is same or lower than the break even point of offering the service, in which case profits slowly disappear. And when this happens then the companies outside the scenario don’t see any advantage in entering the industry and finally price of the goods and services stabilizes.
Therefore, some times my dear friends, it not a bad idea to follow the rules of fair pricing and save yourself from a lot of trouble in the long run.
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