Zain plays hard ball with Safaricom

When Zain assaulted the mobile market last week, it did so with the vengeance of a wounded lion. Pushing its mobile calling rates to the bottom of the market to Sh3 for cross-network calls cut closer to the born for its main rival, Safaricom.

The bitter exchange between two companies last week masks the challenges and possibly a bloody war that lies ahead for mobile phone operators as Zain, now driven by Bharti Airtel of Indian, has forced price and subscription numbers to become a game-change again.

Experts are yet to figure out how far down calling charges can go without trimming excess fat from the operators’ bottom lines. But telecommunications experts caution that mobile phone operators are likely to experience reduced revenues and profits in the new wave of price wars, with customers the happier lot, but only those who win over customers for the long-term will make an impact.

The downturn in calling rates triggered by halving of interconnection fees last week by the Communication Commission of Kenya has shown that there’s still room for more shake-up in the market to reduce charges and deepen penetration.

Small operators dilemma

“Price wars have depressed profit margins in the past. For example, between October 2008 and early 2009, Safaricom experienced this following price wars. This could happen again,” says Mr Judd Murigi, head of research at CFC Stanbic Financial Services.

But small operators could be hurt more with Safaricom having the advantage of a huge war chest and an unmatched national distribution system. The stock market reacted to the changed market circumstances, downgrading Safaricom share price target from Sh6.40 to Sh 5.60, which analysts at Morgan Stanley attributed to the price wars and the reduction in interconnect charges.

Investors need to reprice voice revenues, Morgan Stanley says, looking at various factors: is this a permanent shift in the pricing curve or a temporary one? What is the likely longevity? And hence the sharp (over) reaction? “This price war edition two might prove as expensive as the first one did for its then Kuwaiti owners,” Morgan Stanley analysts said last week.

Though Safaricom is bound to feel the pressure trying to maintain profitability, which has seen it become the most profitable firm in East Africa (pretax profit of Sh20.9 billion in 2009), its competitors are unlikely to reap healthier accounts. “Safaricom is likely to lose ground on voice but grow on data traffic, but in the long term there is bound to be pressure on its share price. The competition is here to stay and the company will be hard pressed to maintain its profit margins and is unlikely to experience the double-digit growth moving forward,” said Mr Isaac Njuguna, a stock analyst at Zimele Ltd.

Mr Njuguna said the company could take advantage of its wide variety of products and national network to whether the current market onslaught. Mr Murigi of CFC financial services said the interconnection fee forms just 5 per cent of the company’s total revenue, while the expected massive migration of subscribers from Safaricom might not materialise because other value-added services like money transfer service M-Pesa.

What is likely to happen is for subscribers to maintain two or more lines of different operators to savour the different offers and pricing. Knowing Safaricom’s pressure to maintain its level of profitability, Zain is using this to wage a psychological war on it.
“We don’t foresee Safaricom cutting its tariffs close to what we have done but if they do it we will cut ours further,” said Mr Rene Meza, Zain Kenya managing director, in an interview with our sister paper, Business Daily.

Analysts say this is not unique to Bharti Airtel, which has a track record in India. “They can go down as far as next to nothing, so long as there are customers to be won. A look at Bharti Airtel in India shows that they are not averse to gritty price wars, and have been known to engage in prolonged ‘survival of the cheapest’ price wars in India,” said Mr Peter Wanyonyi, an IT consultant.

He said the key strategy for Bharti seems to be to whittle down Safaricom’s commanding lead in the numbers game. “They have to find a way of signing up enough customers to justify remaining in this market. So prices could tumble even further,” Mr Wanyonyi said.

Over time, he added, the company might introduce other incentives like phone bundles or phones bundled with lots of airtime and special deals, for example, alongside data bundles. Safaricom CEO Michael Joseph said the company would not react immediately to the new shift, but added the rates could go down in the future.

Yet a weekend teaser advert showed it could counter the move sooner, possibly with lower rates or some hard-to-resit offer. “We have to give value to our shareholders and that means retaining a certain margin, but the rates could come down in the future,” he said.

The cutting of interconnection fees was a boon to other operators who have been complaining about dominance by Safaricom, blaming it on the “club effect” brought about by punitive charges on its subscribers calling other networks. Safaricom charges Sh12 per minute on those calling to other networks, while Orange charges Sh8 and yu Sh6, while Zain charged Sh8 before the recent revision.

This, the rivals claim has entrenched the market leader’s dominance. “This phenomenon is common practice in telecommunications markets where operators with larger subscriber base price their off-net services onerously to discourage calling to other networks. “This pricing mindset is offensive to competition as it entrenches traffic imbalances in their favour and makes other networks net payers to large networks,” CCK Director General Charles Njoroge said.

However, while other operators work on how to enter the profit bracket, Safaricom posted Sh20.9 billion for the year ended March 2010 and controls 78.3 per cent of the 20 million-strong mobile market. Mr Njoroge indicated that the issue of market dominance will be dealt with more comprehensively through a report to be soon released.

The study will identify the dominant company in various segments. This, combined with number portability (where you can change operators while retaining your number) that will come into effect in December, is expected to boost the small players. Communications Commission of Kenya said focus will turn to value-added services to hook up subscribers.

Mr Murigi said the price wars and regulations will continue to be the main threat to Safaricom’s profit levels, as the regulator evens out the field to allow competitors a room to manoeuvre. However, Safaricom will fight to claw back any losses as its known to do.

With the smaller players having upped the ante by cutting their calling charges and SMS charges, Safaricom, according to experts might just follow suit. Zain reduced its calling charges from Sh6 to Sh 3 across networks and SMS charges from Sh2 to Sh1. Essar’s yu cut its charges to 5 cents per second, translating to Sh 3 per minute and the SMS charges to Sh0.50.

Mr Murigi added cut-throat competition is not peculiar to Kenya, with more telecommunications country like India, where price wars have been used a strategic tool, hence undermining companies’ bottomlines. The regulator, it would seem, is finally listening to grouses of the smaller operators, who have always complained that Safaricom, with a dominant market share was suffocating them.

“Our strategy is to be the best value-provider for telecoms services in Kenya and we stand by it. The lowering of interconnection charges by CCK is welcome move and we have to pass this benefit to our subscribers,” said Mr Atul Charturvedi, yu’s country director in Kenya.

Experts said Zain will pick up a number of new customers give the instant reaction to the offer with most subscribers activating their Zain lines and others acquiring Zain SIM cards. “As a result, the only realistic growth area for Zain with regard to this will be in the rural areas, as well as with urban areas as a second line for existing Safaricom subscribers seeking to take advantage of the new Zain tariffs,” said Mr Wanyonyi.

Zain has been angling for a slice of Safaricom’s subscriber base estimated at 16 million. The experts acknowledge that the cutting of charges by Zain and yu will alter the market considerably, but the small players are likely to lose most as the big two fight it out. On the flipside, they could be more aggressive in an attempt to remain relevant and trigger more price cuts.