“The history book on the shelf keeps repeating itself.” -- ABBA, 1974



Last month, Atlantic-ACM’s Fedor Smith repeated a warning that it gave half a generation ago. The warning about price wars is as valid today as it was then. Understanding what happened in the telecom industry in the late 1990s could offer some key insights to what may happen again.

Atlantic-ACM’s founder, Dr. Judy Reed Smith, (who is also Fedor’s “founder,” his mother) began sounding the warning early, at the first onset of competitive international long distance telecom companies.  In the mid-1990’s, international callback enabled the introduction of competition in markets that were “officially” closed to telecom competition, by clever use of existing technologies.

One of the first targets was Argentina. Argentineans paid more for outgoing international long distance than most any other people anywhere else in the world. A one page fax to the U.S. cost $18.00 to send; $6 a minute, 3 minutes minimum. Argentina had a lot of trade with the U.S., and the U.S. was the biggest single destination country from Argentina, by far.

Faxes were frequently used between Argentina and the U.S. because a lot of information could be put on a single page, at the same time eliminating errors due to bad circuit quality or language barriers.  An outbound call from the U.S. to Argentina cost less than $.75 with a one minute minimum, so a two legged callback call had a cost of only $1.50 per minute. Since the existing cost for a one page fax from Argentina cost $18.00, there was a lot of margin to be had.

So, callback was born, and the early adaptors made money, a lot of money. At $16.50 a minute, a single T-1, running at 30% of capacity could realize upwards of $80,000 per month in net profit, if they offered a 15% discount to end users. Lots of new companies sprang up to capitalize on the opportunity.  The Argentinean market was huge, so there was plenty of room for competitors. The high outbound rates meant that only a small percentage of the potential market was being tapped. A discounted product would find new users, and did. The same potential, although not as dramatic as Argentina, existed in scores of other countries whose outbound international calling rates were artificially high.

What happened next is the crux of the lesson.  Instead of working hard and developing new markets, the callback companies began competing for the first wave of callback users, a small percentage of the potential market. How did they compete? They took the easy way out, and began dropping prices. There was plenty of margin, they reasoned, so why not? Why not go after the low hanging fruit, and leave the higher up fruit to rot?

So, callback rates began to drop, and margins collapsed rapidly. By the summer of 1997, some callback operators were charging less than $4 per minute from Argentina.  It takes a lot of calls at $1.50 net per minute to make up the loss of $16.50 net. There is nothing wrong with this, competition is supposed to bring down prices. What is wrong is when competitors make price the sole criteria in the mind of consumers.  By 1999, the entire telecom sector began to collapse. Billion dollar startups were flopping almost daily, unable to make a decent margin in the face of an unrelenting price war.

Now, let’s flash forward to 2010. Prepaid wireless has been making great strides over the last couple of years, picking up new subscribers for reasons mostly unrelated to price. Historically, the credit challenged were important markets, but other, mainly younger users have gravitated towards prepaid to avoid constrictive contracts and leave options open. The recession also helped build the prepaid market.

Faced with a flagging customer base, Sprint, through its Virgin Mobile subsidiary, has launched Beyond Talk, offering cut rate prices and low cost handsets.  This may be, as some analysts have suggested, a desperate move on the part of Sprint.

Back in 1997, the beginning of the price wars was desperation on the part of a couple of startups with lots of capital and few customers.  But, after more and more companies followed suit, the bottom began to fall out.

Sprint CEO, Dan Hesse, has said the move to a price competition model will turn the industry “upside down.” That may well turn out to be true, but, if the history of long distance competition is any lesson, turning a market upside down often turns profits upside down as well.