Verizon Communications (NYSE:VZ) likes to sell a premium product, collecting premium prices. Will this high-end strategy work forever?
The "premium prices for premium services" idea is not idle speculation. Verizon's attitude can be verified from several angles.
For one, Verizon's management team doesn't mind talking about it.
"There is a little bit of angst over pricing," said Verizon CEO Lowell McAdams at a recent industry conference. But he's not worried about it, and certainly not concerned enough to make drastic price cuts of his own. "Things are coming into the market like the equipment installment plan. That is a good thing for consumers. It's neutral from a shareholder perspective. That is why we've taken the position we have."
At another event, CFO Fran Shammo took the bull by its horns:
"We are not going to buy customers. I think that you have to earn loyalty and loyalty is earned through providing a value package to your customers, making sure they get what they pay for. The network still is the number one reason why people leave you. It is not because of price.
"I mean there is price sensitivity in the marketplace that you have to respond to. But the number one reason a customer leaves you is because of network quality."
Verizon walks the talk, too.
Which provider has better pricing?
Let's say you want to buy an Apple (NASDAQ:AAPL) iPhone 6, but don't really care which network you're connecting it to.
The device costs the same across all four of the major networks -- about $650 for the 15GB model, and it's the same whether you're paying the full price right away or spreading it out over installment payments across a couple of years.
But things change when you include service plans.
Using the most popular service option for each carrier, this is how the total cost of ownership shakes out over a two-year period:
Including the cost of the iPhone itself, Verizon collects 22% more money than Sprint (NYSE:S) over the first two years. Big Red also charges a 12% premium over T-Mobile (NYSE: TMUS) and 9% more than fellow giant AT&T (NYSE:T).
The differences are magnified if you strip out the device cost, which doesn't vary between the carriers.
That's where you see Verizon charging a generous 33% premium over the lowest-cost option, Sprint. Verizon's default plan also costs 18% more than T-Mobile's equivalent, and 13% more than AT&T's.
Now, these are not straight apples-to-apples comparisons (apart from the Apple part, of course).
Three of these plans include 2GB of monthly data service, with overages added when you go beyond that. T-Mobile marches to a different drummer (wearing a magenta T-shirt), and offers 3GB and no overage charges. Instead, your T-Mobile service slows down from 4G broadband speeds to a 2G crawl when you pass that 3GB limit.
Otherwise, the only real differences would be the quality of the service you actually get. That's what Verizon is charging up to 33% more for. The company claims to offer a premium service worthy of a premium price.
Finally, all of this plays out in the telecoms' margins. Verizon simply runs a more profitable business than any of its major peers. Whether you're looking at gross margins, EBITDA profits, or cash margins, Verizon runs ahead of the pack thanks to its premium pricing. Here's the gross margin picture over the last four years, for example:
So, Verizon is committed to its premium pricing, and plans to hang onto its customers by selling a premium service.
Will that premium strategy last?
Here's the thing.
Verizon (and AT&T, but that's a story for another day) is already battling some radical price cuts from Sprint and T-Mobile. But this is just the beginning.
Under the wing of Masayoshi Son and his SoftBank capital reserves, Sprint is poised to start an all-out price war.
T-Mobile doesn't have that kind of financial backing yet, but several ultrarich entities are drooling over the opportunity to buy this company. Sprint wanted to merge with Magenta, but had to back off under regulatory pressure. But there's no shortage of alternative T-Mobile buyers. And even without a capital-infusion deal, T-Mobile is kicking butt and stealing subscribers with its innovative Uncarrier strategy.
It's a new situation for Verizon, but a well-known phenomenon on a global level. Similar attacks on high-priced incumbents have reshaped the wireless markets in places like Japan, France, and Spain in recent years. The presence of truly low-cost carriers with plenty of incentive for introducing innovative services has not been kind to giants like Orange and Telefonica, whose revenues and stock prices came crashing down while the newcomers surged.
It's true that Verizon's network beats the competition on many independent reviews. Root Metrics, for example, found Verizon beating all of its major rivals in a recent examination of voice and data services, winning in both quality and speed.
But the differences are not very large, and have decreased significantly since Root Metrics' review just six months earlier. Combine these dwindling quality advantages with a determined low-cost assault, and Verizon could be in real trouble.
Whether Verizon likes it or not, lower prices might be the only way to stay in business for the long term. I expect Big Red to join the fray when the American price wars start to pick up steam. It may never be the lowest-cost provider, but Verizon will have to stay reasonably close to the competition -- or make dramatic and unanswered improvements to boost its network quality further out of reach.
Either way, Verizon investors will likely get a few nasty surprises over the next several years, as the wireless market adjusts to a new reality. This looks like a terrible time to own big American telecoms.
Anders Bylund owns shares of Google (A shares), Netflix, and Orange (ADR). The Motley Fool recommends Apple, Google (A shares), Google (C shares), Netflix, and Orange (ADR). The Motley Fool owns shares of Apple, Google (A shares), Google (C shares), Netflix, and Orange (ADR). Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.