Foolish Fundamentals: Service Provider Metrics

As if understanding margins, EBITDA, and free cash flow weren't enough, telecommunication and other media service providers regularly issue a slew of additional performance metrics by which investors can judge them. Here's a Foolish rundown of the more popular metrics, what they mean, and why you should care about them.

Subscribers
The total number of customers paying for a company's service -- and the growth or decay in this number -- should understandably be a closely watched metric for any company providing a paid service, because it directly affects top-line revenue.

There are some important distinctions to make in the area of subscribers, particularly between gross additions and net additions. Gross additions are the total number of new customers signing up for or beginning a company's services in a given period. The net additions reported in a time period subtract from the gross those subscribers who have left the service for one reason or another (see churn, below).

Costs per gross addition (CPGA)
The amount of money a service provider spends to acquire each new subscriber is captured in the CPGA metric. It basically indicates how hard a service provider must work to attract new subscribers. CPGA includes the sum of general expenses such as sales and marketing, as well as any equipment discounts or subsidies the service provider offers to new customers. Keep in mind there may be slight differences in how different providers calculate this number, sometimes making an apples-to-apples comparison difficult.

A low CPGA relative to similar competitors indicates that a service provider has a more efficient marketing and sales channel structure and is more successful at branding its service. Higher CPGAs, especially around the holiday seasons, tend to indicate heavy spending in marketing, as well as offer equipment or bundled service subsidies to entice new users to sign up for service. Telecom and wireless service providers that operate on a regional scale can have lower CPGAs relative to national providers, because their marketing is limited to smaller geographic areas where advertising is cheaper.

Churn: net turnover of accounts
Service providers operate in heavily competitive markets where customer retention is a major focus. Customer churn is a metric that describes the rate at which a service provider is losing subscribers. It's stated as a percentage of the total subscriber base. It can be calculated simply by taking the number of service cancellations (difference in gross subscriber adds versus net subscriber additions) in a time period, divided by the total subscriber base. Churn is often quoted as a monthly figure, but it sometimes shows up in annual terms. For instance, a typical total monthly churn rate for wireless service providers is 2%-3%, which roughly translates into about 25% to 35% of the customer base annually. This means that roughly a third of their customers leave the service every year.

There are basically three types of churn: voluntary, uninitiated, and forced. Voluntary churn is those customers who dropped service because of dissatisfaction with the service or the associated fees; it's largely composed of customers finding a better deal with another provider. Uninitiated churn is made up of customers who leave a service for reasons such as moving out of the coverage area, death, or the service provider selling off or halting service in a region. Forced churn is where the service provider itself terminates a subscriber for defaulting on bills, failure to meet terms of the subscriber agreement, or account inactivity. The most important of the three types is generally the voluntary churn, since this indicates the quality of the service, and its customers' satisfaction.

Average revenue per user (ARPU)
This metric is usually stated in monthly terms, but some service providers state this number on a quarterly basis (three-month aggregate). ARPU is calculated by dividing the total service revenue booked in a period divided by the average number of users on the service. It is probably the most prominent metric for service providers because it generally measures the quality of customers in terms of how much they spend on services. A low ARPU relative to competitors indicates that the services appeal to more cost-conscious users. These customers may use the service less frequently or sign up for fewer features with the most basic plans. Service providers who regularly report higher ARPUs are more successful at attracting customers who make frequent use of the service and sign up for many of the bells and whistles.

In order to combat a gradual decrease in ARPU for telecommunication services, companies continue to offer new and differentiated features to basic plans. For instance, wireless communications service providers are now offering email, Web browsing, and other value-added data services to generate more revenue from customers who are paying less and less for voice services. Another component that can significantly lower ARPU for wireless companies is subscribers on prepaid calling plans. Such subscribers tend to use their phones very little, limiting the operator's income. Service providers often use prepaid plans as a means to attract customers they then hope to convince to upgrade to a more profitable service plan.

An example
Leap Wireless
(Nasdaq: LEAP  ) is a low-cost, regional wireless carrier that reported the following metrics in the third quarter of 2006:

Metrics

Q3 2006

Q3 2005

Change

Net Subscriber Additions

161,688

23,298

594.0%

Average Revenue per User

$44.39

$40.22

10.4%

Cost per Gross Addition

$176.0

$142.0

23.9%

Churn Rate

4.3%

4.4%

(0.1) *

*Expressed in percentage points.

Management's discussion of these numbers focused on explaining the significant rise in CPGA year over year, which was largely due to increased incentives offered to new customers. This extra expense was made up for, however, in the increased ARPU. Thanks to more featured services, Leap is earning $4.17 more per month from every current customer.

It is difficult to directly compare Leap to a larger national carrier like Verizon Wireless, a subsidiary of Verizon Communications (NYSE: VZ  ) . Verizon turns in a much better churn rate in the comparable period at 1.24%, and the ARPU is much stronger at $50.59 per month. The little guy does have at least one edge on Verizon, though, as CPGA is a good bit lower for Leap. Though Verizon does not directly provide the CPGA figure, historical reports and estimates put it in the range of $200-$300 or more. With the variances in reporting among service providers of all types, these metrics are most useful when monitoring the ongoing improvement, or deterioration, of a single service provider.

Fool contributor Dave Mock contributed to this article. He owns no shares of companies mentioned in this article.


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