T-Mobile (NASDAQ:TMUS) has been a thorn in the sides of AT&T (NYSE:T) and Verizon (NYSE:VZ) for several years now since launching its Un-carrier initiative in 2013. T-Mobile really started pulling in new customers from the two giants and exacting industry change in 2014 when it started paying early termination fees for customers leaving AT&T and Verizon. T-Mobile continues its aggressiveness to this day, putting pressure on the rest of the industry to catch up.
But T-Mobile's aggressive tactics have come at a cost. Before 2012, T-Mobile exhibited a similar operating margin as its two biggest rivals. But since it started offering customers more value, its operating margin has remained well below those of AT&T and Verizon.
While operating margin is expanding in the long term, there are some doubts about whether T-Mobile can continue the positive trend.
Giving customers more reasons to switch
T-Mobile's early investments in its Un-carrier initiative saw strong returns. But as the market grows increasingly saturated and T-Mobile has already picked the low-hanging fruit from its top competitors, customer acquisition costs can grow even more expensive.
Sprint (NYSE:S) is experiencing this problem already. It's so desperate to attract new customers, it's offering a year of its unlimited service free to subscribers switching from any of its major competitors.
With the ubiquity of unlimited plans across all carriers, T-Mobile is running out of additional value it can provide customers over the competition. In fact, T-Mobile only offers new postpaid customers its unlimited plans, making it less flexible than some of its competitors. As a result, T-Mobile may have to increase its spending on sales and marketing to continue attracting customers.
Indeed, T-Mobile is rapidly opening new storefronts this year. While the expansion gives T-Mobile access to new customers, it also costs the company a lot -- not only buying and leasing the real estate, but also paying people to work there.
Nonetheless, T-Mobile managed to increase its operating margin year over year last quarter. But it still lags well behind AT&T and Verizon.
Increasing prices for new customers
T-Mobile may be able to offset its inevitable margin compression through strategic price increases. It recently raised the price of its T-Mobile One Plus plan, putting it in line with Verizon's pricing. The price increase only applies to new customers or existing customers switching to the plan. T-Mobile expects to be able to convince lots of its customers to switch.
But if T-Mobile fails to switch customers to higher-priced plans, it has no means of raising their price without going back on a recent policy it instituted. It's most recent Un-carrier move was to remove taxes and fees from its pricing as well as lock in pricing for existing customers.
While price increases are a good sign that T-Mobile is ready to start focusing on growing profits and cash flow, they also give more room for AT&T and Verizon to breathe. One of T-Mobile's big advantages over the competition was its pricing, but its unlimited plan now costs practically the same amount as Verizon's. As such, it'll be just a bit harder for T-Mobile to attract new customers from the competition.
T-Mobile has lofty goals for operating cash flow and free cash flow growth. It expects compound annual growth of 15%-18% and 45%-48%, respectively, for each metric. In order to reach those goals, it needs to continue scaling its subscriber base. That requires the continued build out of its network, distribution expansion, and expanding more into the enterprise. All of that will cost money -- and eat into its operating profit margin for the foreseeable future.