Research on Price Elasticity of Demand for Telecom Essay Example

Research on Price Elasticity of Demand for Telecom Essay Research on Telecommunications pricing Research on Telecommunications pricing Prepared By: Mina Ibrahim Prepared By: Mina Ibrahim Contents Contents1 Executive Summary2 Theoretical Background3 The Theory of Price3 The Demand Function3 The Demand Function for Telecom industry4 The availability and price of Substitutes amp; Complements4 Research Background6 The Egyptian Scenario6 The Egyptian Company for Mobile Communications (Mobinil)7 Important Milestones7 Mobinil Market Position9 Research Analysis and Results10 Quantity Demand Analysis10 Cross Demand Function11 12 Regression Analysis13 Research Conclusion16 Executive Summary Telecommunication is a fast growing industry which is promising its investors secured and growing revenue due to its important in every person’s life and day to day activities. In particular, mobile telecommunications has been a new entrant to the industry. Starting in late 1990s mobile telecommunications achieved a huge growth in a small period of time. The ability to perform calls in any location to any required destination has been accepted and motivated by the users. The advance in technology has made the mobile products highly available to the public with different price ranges that vary based on the functionality and features produced. On important aspect we will be discussing in this document is the minute rate pricing schema adopted by various operators in Egypt. Pricing has been and will be one of the most important aspects in any business and especially for service providers such as telecom operators. We will write a custom essay sample on Research on Price Elasticity of Demand for Telecom specifically for you for only $16.38 $13.9/page Order now We will write a custom essay sample on Research on Price Elasticity of Demand for Telecom specifically for you FOR ONLY $16.38 $13.9/page Hire Writer We will write a custom essay sample on Research on Price Elasticity of Demand for Telecom specifically for you FOR ONLY $16.38 $13.9/page Hire Writer There are two major categories in which pricing can depart from marginal costs as per Armstrong (Armstrong, 2001) 1. The problem caused by fixed and common costs, setting all the prices equal to the marginal costs will not allow the operator to break even 2. Pricing is usually determined in some ad hoc manner and may not reflect the costs at all, depending on that profits from one market may subsidize the other The second point is mainly evident in different pricing schemes applied in the Egyptian market. The literature will be discussing various factors affecting the pricing and will be proposing a way in order to effectively determine the pricing that will achieve profit maximization by increasing the gap between the marginal costs and the marginal revenue. Figure 1 Profit Maximization Theory Theoretical Background The Theory of Price The theory of price is an economics theory that provides the optimum price for a certain good or a service based on the supply and demand forces. In hat theory, each force is studied in details and various factors are combined through regression analysis in order to find the optimum price in which supply and demand are equal to reach the market equilibrium. The Demand Function Demand is the quantity of a certain commodity the consumer is willing to buy at a certain price in a certain period. The demand function of a certain good or service is the relationship between the price of the good or service and the amount of it that consumers are willing and a ble to purchase at that given price. Mathematically the demand function can be stated as follows Dx= f(Px, Ps, Pc, I,T) Where Dx = Demand for commodity X Px = Price for commodity X Ps = Price for Substitutes goods of X Pc = Price for complementary goods of X I = Money Income T = Qualitative factor of taste In the mobile communications market substitutes can be described as fixed line communication and voice over IP communication through the internet such as Skype amp; Magic Jack On the other hand complementary goods are replacements of the mobile calls such as short text messaging (SMS) and Blackberry messaging (BBM). Taste is another important factor that affects demand on the mobile phone usage. A recent incident occurred with one of the largest mobile operators in Egypt Mobinil, in which the former CEO and board member Naguib Sawiris has posted an offensive cartoon on his twitter account, which criticize one of the Islamic beliefs. This incident has caused a boycott of Mobinil service by many people. A 4 per cent decline was incurred in its share price during trading in Cairo. The Demand Function for Telecom industry The availability and price of Substitutes amp; Complements Fixed Line As discussed in the theoretical part, mobile phones have come to substitute the fixed line industry as they provide a very important feature which is not found in the fixed lines which is the portability feature. The below figure shows the rise of the number of subscribers for both the mobile market and the fixed line market Figure [ 2 ] Mobile Operator Total Number of Subscribers and Penetration Rate Figure [ 3 ] Fixed Line Subscribers and Penetration Rate We can see clearly how the penetration rate and growth rate for mobile subscribers has exceeded by far the rates for fixed line subscribers. These figures suggest that phone users in Egypt see the mobile telecommunications as a strong substitute to fixed line phones. We can clearly notice this as mobile phones has been in the hands of the rich and the poor; from a famous business man who uses the phone for important conference calls and emails to the poor grocery man who uses his phone as part of his on-going business receiving requests for delivery items. The pricing schemes as well has its factor of having the mobile communications as a stronger substitute, below figures shows the fixed line pricing schemes Figure [ 4 ] Fixed Line Pricing Schemes The rates has been less by far in mobile to mobile communication, where rates has been as low as 15 pt. which is half the price of fixed to mobile price. Internet Voice over IP, The technology used to transmit voice conversations over a data network using the Internet Protocol. Such data network may be the Internet or a corporate Intranet, or managed networks typically used by long and local service traditional providers and ISPs that use VoIP. VoIP Applications include * PC to PC VoIP * PC to Phone VoIP * Phone to Phone VoIP * Prepaid cards Phone to Phone VoIP The third option is considered as one of the greatest substitute for the telecom industry, several phone applications have been spread that include the functionality of performing VOIP calls, example for such applications include Skype, Viper, and Tango that are widely spread on all types of smart phones. Although VOIP calls are considered cheap, they do not offer carrier grade quality; quality depends on connection and state of Internet traffic. Receivers of calls may blame their network operators (not VoIP operator) for the occasional poor quality. Research Background The Egyptian Scenario Mobile phone services where introduced to Egypt about 10 years ago. Since then the mobile phone service has grown enormously with having the subscriber base covering more than 2 thirds of the Egyptian citizens People use the mobile phone service for various reasons, either for mobile calls or for broadband services. The communication sector achieved a growth rate of 14. 1% and 14. 2% in the FY2006/07 and FY2007/08, respectively. In addition, the sector contribution to the overall real economy kept improving, reaching 3. 5% in FY2007/08, compared to 3. 2% in FY2006/07 and 3% in FY2005/06. Figure [ 5 ] Communications Growth The mobile market in Egypt is currently composed of three players, namely Mobinil, Vodafone and Etisalat. The duopoly of Mobinil and Vodafone ended by the entrance of Etisalat after winning the third mobile license bid in July 2006, with a total consideration of LE16. 7bn. It is worth mentioning that Mobinil, the first mobile operator in Egypt, commenced operation in May 1998, followed by Vodafone, which started rendering mobile services at the end of the same year. The entrance of Etisalat in the Egyptian telecom sector changed the market structure and intensified the competition among the existing market players. In response, mobile operators reduced their tariffs on the different price plans and were motivated to introduce multiple packages, as well as improving their service quality, including network coverage and voice quality, in order to keep their market shares and maintain their growth trends. The Egyptian Company for Mobile Communications (Mobinil) The Egyptian Company for Mobile Services (ECMS), launched in May 1998, provides a wide range of telecommunications services. ECMS operates under the brand name â€Å"Mobinil†. It is owned by France Telecom Group (FT), Orascom Telecom Holding (OTH) and public market equity investors. FT and OTH have respectively 36. 34% and 34. 66% economic interest in ECMS. The remaining 29% of shares are publicly traded on the Egyptian Exchange. Mobinil offers its customers 3G services and EDGE technology for high speed download, Internet communication, and high capability browsing. It is also working on the deployment of HSPA+ technology. Figure 6 ECMS Company Shareholder Structure Important Milestones Telecommunications Market is a very dynamic and competitive environment, and over the last five years Mobinil has passed by several milestones which have significantly shaped Mobinil’s performance and position at the moment. Figure 7 Important Milestones in Mobinil History In 2007, Etisalat official launch announcement was on 30th of April. Along with announcing the 3G services launch in Cairo. Being the sole 3. 75G network in Egypt has given Etisalat its edge in the market providing faster connection utilizing a distinguished infrastructure notably a NGN over the first IP backbone solution in the country. Although the incumbent is still new in the market, network coverage has extended to make sure there is coverage in all major cities including Cairo, Alexandria, Zagazig, Tanta, Sharm el Sheikh, Luxor and many more. A management decision has been taken not to go for the 3G services, which has been proven to be a bad decision, especially with the deteriorating ARPU the company was achieving by that time, and the Market Share shrinking it was suffering from to both Vodafone and Etisalat. In 2008, Mobinil has officially announced the start of its 3G operations and the launch of the Largest and Newest mobile network in Egypt on the 1st of September, after teaming up with the global telecommunication manufacturers Nokia Siemens Networks and Huawei for the 3G roll out. In 2009, Mobinil dispute began as a disagreement between two of the company’s major shareholders, France Telecom and Orascom Telecom, about the implementation of an agreement they signed in August 2001 as partners in Mobinil’s holding company. Fifty-one percent (51%) of Mobinil’s shares is held by a holding company which, in turn, is co-owned by France Telecom and Orascom Telecom. France Telecom holds 71. 25 percent of the holding company’s shares while Orascom Telecom holds 28. 75 percent of the shares. Orascom also holds a 20 percent direct stake in Mobinil. The remaining 29 percent of Mobinil’s shares are traded freely on Egypt’s stock exchange. Overall, France Telecom controls approximately 36 percent of Mobinil’s shares while Orascom Telecom controls about 35 percent of the company’s shares. The dispute between France Telecom and Orascom Telecom centered on differing strategies for Mobinil. Orascom Telecom favored greater investment in Mobinil than France Telecom. The two shareholders also differed over Mobinil’s budget and expenditures, its marketing strategy, and the start up of its 3G services. 2] In 2007, Orascom Telecom took the dispute to the International Court of Arbitration at the International Chamber of Commerce in Geneva. In 2010, Egyptian Company for Mobile Services (Mobinil) has announced its acquisition of LINKdotNET, the leading private-sector Egyptian internet service provider, from InTouch Communications S. A. E. , a subsidiary of Orascom Telecom Holding (OTH), in a landmark deal wh ich will improve customers’ access to a wide array of integrated communications services, will create high value for shareholders, and will benefit Egypt’s telecom sector and the country’s overall economy. At a press conference on 4 July 2010, headed by representatives from Mobinil and LINKdotNET, Mobinil announced the signing of a share sale and purchase agreement with InTouch Communications, a wholly owned subsidiary of OTH for the purchase of 100% of LINKdotNET and Link Egypt (LINK). The enterprise value is USD 130 million. In 2010, France Telecom and Orascom Telecom Holding have presented a joint plan to resolve their long running and acrimonious dispute over the ownership of Egyptian mobile network, Mobinil. The agreement, which has been signed on 15th of April, has effectively brought to an end all disputes in relation to their joint investment in Mobinil. In a statement, FT said that the two groups will continue their partnership on a renewed basis going forward, implementing a revised shareholder agreement but with no change to the existing ownership structure or their shareholders voting rights. In 2011, 25th of January 2011 Revolution took place following a popular uprising that began on Tuesday, 25 January 2011 and is still continuing as of December 2011. The uprising was mainly a campaign of non-violent  civil resistance, which featured a series of  demonstrations, marches, acts of  civil disobedience, and labor strikes. Millions of protesters from a variety of  socio-economic  and religious backgrounds demanded the overthrow of the regime of  Egyptian President  Hosni Mubarak. Despite being predominantly peaceful in nature, the revolution was not without violent clashes between security forces and protesters, with at least 846 people killed and 6,000 injured. The uprising took place in  Cairo,  Alexandria, and in other cities in Egypt, following the  Tunisian revolution  that resulted in the overthrow of the long-time Tunisian president. On 11 February, following weeks of determined popular protest and pressure, Mubarak resigned from office. Egypt after 25th Jan Revolution has shown a great initiative to be better from all aspects, surprisingly; Egyptians have shown a great social accountability and awareness, after suffering from a very long period of suppression, however the current instability and uncertainty is badly affecting all the industries including the telecommunications. In 2011, Criticism and calls for boycotting were raised tremendously in a response for Mobinil’s founder Naguib Sawiras who has posted some caricature, which has been accused of offending Islam. This has really affected Mobinil severely especially with the MNP availability in Egypt, causing a hundreds of thousands of subscribers’ migration to competition. Mobinil Market Position Mobinil is the oldest and largest operator in Egypt in terms of number of subscribers. Mobinil has maintained market share leadership up until 2011 with almost 32. m subscribers at Year End 2011 close to some 50% of the market. However, it lost the market share leadership to Vodafone in 2011 due to various events, some related to the management structure at that time and other related to the dispute between the two holding companies; Orascom Telecom and France Telecom which had it’s impacts on company flow and management decisions. In addition to the direct competition Mobinil faces from the other two mobile operators, Mobinil is also facing competition on indirect fronts such as fixed lines, payphones, and Internet connectivity. A monopoly on fixed lines remains with Telecom Egypt as the sole provider, which is still a public entity despite its partial liberalization at the end of 2005. Research Analysis and Results Quantity Demand Analysis Since more than 75% of the revenue comes from the prepaid segment and the trend – both in terms of number of subscribers and revenue- is moving in the direction of the prepaid services, we decided to conduct a demand analysis on the prepaid market. Also it is worth to mention that prepaid segment constitutes more than 96 % of the subscriber base making them the most efficient contributors in the economic analysis and demand analysis The figures for the total minutes and the total revenue were obtained for the last three years period, the figures can be referenced in the appendix, the average price per minutes was assumed to be the total revenue divided by the total minutes performed by the subscribers and the demand was mapped to the number of minutes. The below graph shows the price demand curve for the prepaid segment in Mobinil, during the last three years and due to the harsh competition, Mobinil had to drop the average price per minute and accordingly we can notice that as the price decrease the demand has increased since people started to perform more minutes. Figure 8 Price Demand Curve for Mobinil In real life the price demand curve can be noticed clearly, back then at the start of the company, the price per minute was too expensive, average 40 piasters per minute, and the subscribers at that time were performing minimal calls which were done for the sake of emergency of important work. A phenomena back then was raised which was giving missed calls in order to pass greeting, this phenomena resulted in a high call attempts per second that required a lot of capacity extensions, decreasing the price resulted in the decrease in this phenomena were people started doing calls instead of missed calls, this can be illustrated in the increase in both minutes and revenue showed in Figure 8, the below figure shows the decrease of the call attempt per second per subscribers over the period in study. Figure 9 Average Call Attempt per second per sub Cross Demand Function During our analysis, and referring back to the theoretical section, the complementary products was considered as the SMS part which complements the voice call while the supplementary products were considered as the skype and viber calls. An assumption was made was the revenue from the GPRS was considered as a reflection for the price of skype and viber calls, since these calls are made through the data network GPRS connectivity, subscriber would pay for the data session for this call since calls from Skype to Skype or Viber to Viber are for free. Below graphs shows the change in demand versus the price of complementary goods. Below graphs shows the change in demand versus the price of supplementary goods. Regression Analysis As stated in the theoretical section, the demand function is affected by various factors, including the price of the product, price of substitutes and the price of complementary goods. The impact of various factors on the price elasticity of demand is determined through regression analysis which constitutes the impact of each factor of the product demand. Below is the regression analysis output | Coefficients| Standard Error| Intercept| 181,047,973| 7,686,663| Average Price Per Minute (Px)| -209,067,710| 17,507,478| Average Price of Data (Ps)| -2,391,333| 8,670,406| Average Price of SMS (Pc)| -169,109,146| 24,772,181| Below is the best line fit according to the model used Accordingly the price elasticity of demand can be calculated by the below equation Short run price elasticity of demand = The slope of the price * (Average price / Average quantity) The short run price elasticity of demand would equate to 0. 44 Short run cross elasticity of demand = The slope of the price * (Average price / Average quantity) The short run CED for substitutes would equate to 0. 01 The short run CED for complements would equate to 0. 35 Checking the regression statistics below the following is noticed Regression Statistics| Multiple R| 0. 640469195| R Square| 0. 410200789| Adjusted R Square| 0. 406604453| Standard Error| 22321565. 66| Observations| 496| High Standard Error This is due to the fact that other factors affect the demand on voice calls such as the factor of income and taste, referring back the data used in the analysis dated from 2009 – 2012 in which the range of income per person has ranged significantly. We can identify the income per person from the Per capita income or average income or income per person is a measure of mean income within an economic aggregate, such as a country or city. Below figure shows an increase in the per capita income over the years in study. Since the income elasticity of demand affect the product elasticity, this measure could be affecting the price elasticity of demand and accordingly would result a more accurate calculation of the price elasticity of demand. High R Square In statistics, R Square is the proportion of variability in a data set that is accounted for by the statistical model. In our case R Square is equal to 40 % , a high value meaning that means that the fit might not be good enough to represent the real case. One of the main reasons that might result such high value of R Square is the contribution of brand name and taste in the demand of the subscribers on voice calls. Especially in country like Egypt, people tend to change their demand habits based on their emotions or relationship with a certain company or a certain brand. Mobinil brand has always enjoyed a deep relationship with the Egyptian people, being the pure Egyptian telecom company founded by an Egyptian business person rather than other Multinational companies which were either British (Vodafone) or Emirates (Etisalat). However, actions made by top executives like the Naguib Sawiris twitter scandal may result a change of taste of Subscribers were more than million subscriber decided to port out to other operators after this incident. Since the statistics ranged from 2009 to 2011 containing both the deep relationship and confidence gained by Mobinil and its subscribers during 2009, to the relative change of taste due to the twitter scandal in 2011 and that’s why the goodness of fit is expected to be poor. Research Conclusion Currently Mobinil operates in in-elastic region of price elasticity of demand (PED lt; 1) which means that it should increase the price to obtain higher revenue. However due to intensive market competition and the fact of having Etisalat doing extensive price reduction for the price per minute; backed up with financing from the gulf operations, Mobinil is forced to reduce its price to maintain its market share and avoid churn of subscribers. Accordingly, Mobinil should not be the firm to start lowering the prices, in order not to reduce its revenue, however it should be a market follower rather than a market initiator in areas of price reduction. Mobinil should also focus on providing better quality service which would entice upper segment of the community who would be concerned with quality of service rather than the price of service. [ 1 ]. (Footnote continued)