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Is Free Mobile business model partly funded by its rivals?

posted Feb 22, 2012, 9:45 AM by Julien Pillot   [ updated Feb 22, 2012, 11:13 PM ]

As a new player in the mobile industry (more precisely, in the 3G network), Free is a constant and energetic topic of discussion. It must be stated that the entrance of Free in the early 2012 made a real splash, especially because of its very aggressive price-model. In doing so, Free goes through its own basics, replicating the successful scheme already experienced as an Internet Service Provider. While its main competitors traditionally charged customers between 40 and 70€ per month for basic unlimited cellphone plans, Free offers “comparable” plans for the very attractive price of 19.99€ per month. As every industrial economist does know, decrease in price is one of the expected (wished?) effects when markets become less concentered. But, in the present case, the price-cut sounds too important and prompt to be plainly explained by the sole mechanic price-competition processes (particularly as the demand-side of the market is mature).

Among all the reasons - more or less objective - likely to clarify the very essence of Free Mobile’s business model (absence of subsidies for mobile handsets, differences in service and after-sales guaranties, lack of physical retail points, overcharge of some roaming fees, greater opacity of contract terms…), the regulatory framework is actually the less frequently reported by sector-specific analysts. It is a pity as real asymmetries in costs between Free and other mobile operators flow from this concern.

Indeed, as a new mobile carrier, Free benefits from what we use to call “asymmetric regulation” under which operators in the same sector are subjected to different levels of regulatory restraints. The rationale for asymmetric regulation, especially in an industry as capital-intensive as telecommunication, is to ensure a “level playing field” likely to protect both investors and consumers while new entrants are able to effectively compete with traditional incumbents. A principal purpose is to give new players real chances (and time) to deploy its network facilities and to realize sector-specific (and most of the time irrecoverable) investments. That is why the French telecom regulatory body (ARCEP) imposes several regulatory restraints to operators depending on their respective market power or on the importance/origins of their network facilities. For instance, Free’s own 3G network is presently aimed at covering 27% of the French metropolitan territory* while Orange (the French historic operator) has to ensure itineration of the rest of the traffic through its own network. Despite these technical restraints**, ARCEP has also imposed tariff regulation concerning call termination (also named "interconnection calls").

When tariff for voice termination calls (VTC) are usually set by the sector-specific regulatory body, in France, prices for SMS termination calls (SMSTC) are fixed by operators (and eventually authorized by the regulator). Till December 2013, Free can consequently overprice VTC regarding its rivals (€2.4 cents against €1.5 cents) in order to support its activity during the take-off stage. This overcharge is commonly accepted amongst other operators so that it gives Free the opportunity to expand its network facilities (and thus, to limit congestion on their own networks). But, the access fee for SMSTC Free asks its rivals for is precisely where the problem might lies. Indeed, Free currently

requests its rivals to pay an average fee of €2.6 cents per SMS for 2012 (€2.85 cents per SMS during the first term, then €2.35 cents), that is to say an average asymmetry of €1.35 cents per SMS compared to traditional commercial practices among mobile carriers. Taking into account the sharp growth of Free’s market shares (1.5 million of customers by now, most of them switching from traditional operators) and the massive amount of SMS passing through French mobile networks every year (click to enlarge the scheme enclosed; source: ARCEP, 2012), many businesses fear traditional operators to bear to… 10€ per month and per consumer joining the new player’s network***, e.g. up to 50% of Free's bill. The question is: is Free Mobile’s business model viable on the long-run, or is the new entrant take advantage of asymmetric regulation to develop its activity at the expense of traditional carriers?

Facing a situation in which traditional operators refuse to accept Free’s condition, ARCEP has just announced that it is to complete its regulation framework in launching an in-depth economic analysis of the French SMSTC wholesale market. A public consultation will take place in April. We might only wonder why it had not happened prior to Free’s entrance…

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* As mentioned as a precondition for operating the 3G license granted to Free. The next deadline is scheduled for January 2015, date on which Free’s network will have to cover 75% of the French territory.

** Note that the French telecom operators associations (CFE-CGC and UNSA) have recently held ARCEP, arguing that Free Mobile does not actually respect its territory coverage requirement. Further to the intervention of Eric Besson - the French Minister of Economy, Finance and Industry -, ARCEP is bound to carry out a second report on the effectiveness of the deployment of Free’s network.

*** At first sight, this tariff seems however less important that the price set by operators from 2006 and 2010, even though the market was more concentrated (€3.5 cents per SMS for Bouygues Telecom; €3 cents per SMS for Orange and SFR).



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