es = $$ zs Harvard Business School BAe ELT. PHOWE HOME, INC.: FORECASTING BUSINESS DEMAND Tn Late June of 1982, Me. Jordan Elliott, president of £.T. Phone Home, Inc. (ETPH), studied the results of @ market sticvey concerniag poten. tial demand foc his company's proposed cellular radio service. Eariice that month, the Federal Communications Commission (FCC) had received appli- cations from ETOH and other companies interested in providing cellular radio services to one or more of the largest 30 metropolitan markets. With funding from baaks and a venture capital orgenication, STO had been formed by tr. Elliott and others in order to apply for cellular licenses. The company's major application concerned the Cleveland, Ohio actropolitaa Under the guidelines established by the FCC, the commission would eventually great Liceuses to one wireline company and one aoavireline com Paay in each metropolitan area. By mid-Juac, the SCC had received 194 applications for the top 30 aackets, and the commission had released goa eral information about those filings to the public. The #CC's actual decisions about cellular Licenses, hovever, were aot expected for a aumber of weeks. During the interim, tr. E1liote wanted to prepare a macketiog plan in the event that his compaay was in fact granted « license by the FCC. The first step in preparing such a plan was analyzing ia detail the demand forecasts for the Cleveland area. Like othe: applicants foc cel. Aular Liceases, ETPH had hired an independent research firm co gather data and forecast denand for cellular services in its metropolitan area. Mr Elliott believed that the research firm's study had alloved ETPH to prepace an especially thocough application for the Clevelond area aad that the study had yielded useful data about poteatial markets for cellular catio He. Elliott eccanged a meeting with nis junior pactners at ETPi, ts. Stella Trek and Mr. Richard Vere, in order to discuss the forecasts and to begin plotting a marketing strategy for Che company. "What we have in these forecasts," Me. Elliott began, "i Lote of numbers and much data about the metropolitan area. Bur ve need’ to dig deeper and ask sone quescions about the results and its implications. [£ we do indeed get a cellular License for the Cleveland area, what do we nov know, aad what do we aced to kkaow more about before we market our services thaces” This case was prepared by Frank V. Cespedes, Research Associate, under the Supervision of Associate Professor John F. Cady as the basis foc cles dis~ cussion rather than to illustrate either effective or ineffective handling Of an administeative situation. Copright © 1983. by the President and Fellows of Harvard Collage Hope penn ute es a Sd a er SS eae ace epee cad pee ean Sieenijrald Pee cries oro ane maeoS 583-121 Recent eveats vithin the teleconmunications industry, hovever, indicated that enthusiastic comments about the implenentation of eellalac radio service were more than speculation. By early 1932, ATST had spon faa estimated $100 million to build 1 prototype system ia Chicage, and through 2 subsidiary, Advanced Hobile Phone Service, Iac-, atgouaced plans to establish cellular networks in 29 other cities. Similarly, GIE, the lacgest independent telephone conpany in the U.S., had contracted to buy more thea $20 million in cellular equipment fron Motorola in order to provide such Service in several markets. MCI Telecommunications Corporation bed filed with the FCC for cellular operations in 12 major metropolitan aceas, and Geaphic Scanning, Inc. had filed applications for the largest 30 metropolitan areas. Finally, Western Union Telegraph had reached joint venture agreements vith a variety of companies in filing applications for cellular systens ia 1S of the top 30 markets Many of these companies undoubtedly hed diverse applications planned for their cellular aystens, but in 1962 the immediate target for the ney tock, Rology was the paging and mobile telephone services currently provided by an array of omall, local businesses knoun as "radio comon carriers" (Recs) In the early 19703, bulky and unreliable radio-controlled "beepers" wore replaced by sualler, more sophisticated and less expeasive wodels, By 1880, about 800,000 of these paging devices were in use, and iadustry sales were estimated to be $200 sillion and growing at a 30% annual rate. These paging services were generally sold for approximately $20 4 month acd more aad, according to one participant in the market, sales were driven by ausber of factors: "Whenever the energy crisis heats up, for example, we start heating from people sho suddealy realize hov much gas their sales ov setvice peapie waste driving to pay phones to call ia." Similarly, the ausber of mobile Belephones in the U.S. had increased from 30,000 mobile phones in 1969 to 130,000 by 1980. In aay metropolitan areas, morsqver, there were three. to teavyear vaiting lists to obtain a car phone because most available frequencies ware grossly overloaded. Mobile phones generally reated for $75 a month sal snore for basic Local service, and custonere included executives, doctors, Lawyers, construction crev sipervicors, and truckers, amoag ochers In 1982 there vere approximately 750 RCCs in the U.S., and it was believed these conpanics enjoyed a lucrative business: 2 1917 tcade assoei~ ation study, for example, indicated that average pretax ROE vas 30%, tack of these small businesses, hovever, could act afford to expand their current ‘gpecations to include the nev cellular radio technology. and during the early 1980s ‘here were indications that » cunber of these businesses vere attengtiog fo pool their resources through joint ventures in orde: to overcome the financial barriers to the cellular market. One major exception ia this frag= mented industry vas ATSE, which in 1982 cerviced approximately 90,000 pagece Erough its "Bellboy” service and coordinated a network of approximately 530,000 mobile phones As a replacenent for pagecs and mobile phones, cellular cadio was Gensidered co have a Large potential market. One representative estimate, by the rescacch firm of Frost and Sullivan, indicated that sales for “aoDile regio equipment” could reach more than $6 billion in 1990, with the business sactosae 583-121 o£ 1980, approximately 25,000 auto vorkers in the region were unemployed, and in mid-1980 nationwide steel industey enploynent waz at ite lovest point since 1993. Throughout 1980 and 1981, total unemployment averaged 9.7% in the area. Manufacturing underpinned the region's cconomy, and diminished investment and grouth ia the manufacturing sector impeded growth in other sectors, especially construction, cetail sales, and some Services. In the first half of 1981, retail sales ia Cleveland were at a zero growth rate, while residential construction was up 10% from weak Construction levels of 1980. Between 1970 and 1980, Cleveland itself Lost 36% of its population: much of this movement was relocation to the suburss, but movement out of the SYSA accounted for about 13% of this population decrease. Cleveland gained national attention in 1978 when, unable to acer its financial obligations, the city went into default on $10.3 million 9¢ aotes. Since then, a coalition of municipal, regional snd financial groups had cngaged in a massive recruiting and publication effort to cetain Sad attract business to che area A strengch of the region was Cleveland's position es the location of vorld headquarters for 33 of the Fortune 1000 industrials. Dowacova Cleveland vas scheduled for a nunder of major development projects, Seandard 41 Company of Ohio (Sohio) announced plans in 1981 to build a aew corporate headquarters at a cost of more than $100 million. Medicel Mutual. Ine, vas Duilding tts $65 million headquartecs downtown, and Ohic Bell had begun con- structing a $37 million dovatowa headquarters building. New construction of class "A" office space ia the area included a $45 million, 28-story Superior Square building, an $80 million National City Center office complex, and a $100 million office, shoppiag and entertainment complex kaoun ss Tower City. This investacat in office space and corporate headquarters supported a trend tovard secvice-celated employment in Cleveland, and waz expected to expand the job market {n these growing industries. When declines in regional manufacturing wece balanced against evidence of expected grovth in business service, cetail service, trucking and Gisteibution, the Cleveland SMSA vas considered to have good povential for cellular radio. Current Yobile Telephone Market Conditions Competitive market information for mobile telephone service was difficult to quantify precisely, because much of this Laformtion was listed for the city of a company's head office rather than by the cities of counties Wwaich the company serviced. A 1978 survey, hovever, indicated that one wice- Line carrier, Ohio Bell Telephone Company, and one RCC, Cleveland Mobile Telephone, were the major competitors in the Cleveland SSA for mobile cele- phone service. The survey showed Ohio Bell leading the mobile telephone markot with a 57.4% shace (483 units), Cleveland Mobile ith a 25.3% share (217 units), and Eive other comapnies providing service to the cenaining 17% of the macket (see Exhibit 3). In total, there vere estinazed to be 842 mobile teleplione units in service in 1978 in the Cleveland SHSAoe 583-121 The next step was to conduct a public need survey of potential business customers. The survey's objective was to determine these ome, tomers’ perceptions of, and purchase propensity for, cellular sezvics, The survey indicated that the highest levels of interest in mobile phones were ie the construction, services and wholesale trade industries (Exhibit 5), while the occupational gcoups projected to make the most use of cellulac radio were adninistrators, manages, and ovnecs, folloved by sales pecson and delivecy or service vockees Usee Profile On the basis of surveys and intervievs, Digitron provided ETPH with 4 detailed profile of potential users First, 9 random sample of business establishments in the SHSA was obtained. (ALL establishments were included in the sampling feame in ordes that governmental offices uni non-profit organizations would be iacludcd along with private-sector businesses.) Digitron then made an "ati name selection” to produce the sample. A total of 400 business respondents, representing 400 businesses, vere intervieved via telephone. Wiaety percent of those intervieved reported holding managerial or administrative positions in their companies. In cating various characteristics of mobile phone service, the respondents indicated that the most inportaat were "being able to ceceive and place a call at any tine while in s vehicle” end "having a phone in a vehicle that is as casy to use as a scandsrd. phon By contrast, “to have the prestige of a mobile phone” vas aot rated ss highly important by those interviewed. Wnen asked if they were interested in mobile phone service “at a reasonable price,” those interviewed responded in the following manners Very interested” 8.00% ‘Somewhat interested” 22.75 "Not too interested” 3/50 "Not interested at all" 60.25 The major reasons indicated by those vho were "not {aterested at all" in mobile phone service vere the following (since respondents could ceply to More than one question, totals exceed 100%): "Have no need for one” 92.35% "A quisance to carey around" 2806 ‘Don’t like to be tied to the ‘phone’ 21.96 jalieve it would be too ex- pensive” 14.29 MLack of privacy” 5.61 A umber of interviewees reported that their companies had had Previous experience vith cadio-comunication systens: 5% reported having uused mobile telephones, 21.25% had used pagers, 5% had used two-way radine Sommunicetion systens, and 15.253 had used C.B. radios ia the past two years Interest in cellular radio service "at a ceasonable price” tended to be Ectater among those businesses who had used these systems than among those who had cot. Further, vhile only 5% of those surveyed reported having used-9- $8311 Forecasting Model With the demographic data and the user profile, Digitroa's ce Searchers attempted to davelop 4 forecarting aodel. The odjactive was to Project, in terme of aumber of individual cellular units, doth aggregate denead in the Cleveland SMSA aad the nunber of uaits ETPH could expect to Sell during the 1984-1994 time period. [a addition, three forecasting Scenarios = pessimistic, expected, optimistic - vers developed in acder to define a range of demand for cellular sevice in Claveland during that time period. These scenarios differed accordiag to the assumptions made about business grovth rates in the Cleveland SUSA. Ia all scenarios, however, it was assumed that the sime price/denand relationships obtained from surveys would hold ducing the tise period forecasted ‘The individual elesents of the forecasting model ace explained below. 8) Projected aunber of businesses vas calculated by using histori- cal and projected employment growch rates. Based on U.3. Departaeat of Commerce data, the number of Businesses in the Cleveland SNSA had grown 5.0% during the five-year period, 1974-1979. Since this historical geovth cate ae derived froma period of high growth aationvide, it vas aot expected that this growth rate could be saintained during the 1986-1994 period. Therefore, the historical business growth rate was chosen as the grovth rate for an "optimistic" scenario, Data based upon 1967-1978 period, nich covered a period of slov economic geouth a2 well as peak groweh, wae chosen a2 che business grovth rate foc the "pessimistic! scenario. An average of these tue growth rates was used for the “expected” scenario ‘Therefore, the geouth cate ascumptions for the aunber of businesses were pessimistic: 0.7%, expected: 0.9%, optimistic: 1.2%; and these junptions resulted in the folloving forecast: Forecast of Business Growth ia the Cleveland SHSA Expected Optimistic 1980 40, 755, 4173 41,789 Loss 41081 41,544 42,290 1986 41,339 41.917 42,798 1987 41,628 1988 “1919 1989 42,213 1390 421508 wat 42/806 L992 43/106 1993 43,407 199% aginaan! 583-122 Digitron analysts believed that market penetration rates vere dependent upon the Level of advertising aad equipment costs, and was thus the most difficult variable to forecast. As a result, a range of penetra~ tioa percentages, from pessimistic to optinistic, were specified for each year, and che resulting values wera calculated for each of the three ‘scenarios (see Exhibit 8). 5) Estimated market demaad was equal to factor © multiplied by factor f, and represented forecasted demand for the total SMSA for each year h) Market shace for ETPH was estimated at 50% siace the FCC vould eventually grat Licenses to only tvo companies: one nonwireline competitor (e.g., ETPH) and one vireline competitor. It was noted, however, that actual maeket share would depend upon a aunber of factors including the timing of ETPH's entry in comparison to its competitor, the levels of advectising, and the pacticular streagths and services of ETPH vs. its competitor. 1) Estimated number of ETPM unite vas simply factor g aultiplied by Eactor h, and represented the total aumber of cellular unite that ETP could expect in the Cleveland SHSA ia a given year. ‘The following example illustrates the forecasting model and the calculations that were made for the year 1984 under the “expected” scenario. ‘The sane process was used for each of the other ten years, Example of Forecasting Nodel, a) Projected number oF businesses 41,273 businesses >) % demand (at a given price) xy ©) Total potential business customers 3,728 customers 4) No. of units per customer x 29% 2) Total potential unics 25,313, unite £) % penetration xing 3) Estinated market demand 1430 units in total h) %aarket shace for ETPH x $03 i) Estinated no. of ETPH units 7,215 unite for ETPH With these assumptions as the basic for calculating cach of the factors in the model, a demand forecast for the business segneat of the Cleveland SYSA vas developed for each of chree scenarios - expected, pes- Simistic, and optimistic (see Exhibit 9 for the forecasts ui Conclusion In its application to the FCC, ETPH had filed for sixtesn cellu lar radio "cells" vhich would be sufficient to provide service to virtually all of the Cleveland SMSA. The company had Listed 1984 as ite expected date for beginning service, and had estinated that construction costs and e each Scenario).-13- s8a-12t Cellular System Expense Estinates (16-Cell Systen) Annual Fixed Expenses: Depreciation on Fixed Plant (a) $1,400, 000 Interest Expense (b) 980,000 Bixed Salaries and Overhead 250/000, Total Fixed Expenses $2,630,000 Annual Variable Expenses per Unit: Depreciation (c) 5 440 Operating Costs (4) 120 Interest Expense (b) 154 Total Variable Expenses 3 114 ‘Assumes 10-year straight-line depreciation. Paocunes SO% debt financing at 14%. “Ascumes five-year straight-line depreciation. wireline access charge, aaintenance, repairs, billing, etc. Source: Capital costs from Table 1, ATT estimates. Other expenses and depreciation rates hased on security analyst estiates The company had filed with the FCC two types of rate structures for its proposed cellular service: (1) a basic service charge of $25 per month plus $.25 pec minute from 8:00 a.m. to 8:00 p.m. Monday to Friday, and $.15 per minute from 8:00 p.m. to 8:00 a.m. Honday to Friday and ali day on Saturdays, Sundays and holidays; (2) an alternative rate of $40 per month which included $20 vorth of minutes under the seme structure of per minute charges varying by tine of day and on veekends and holidays. Ia addition to ETPH, six other companies had filed applications with the FCC for cellular systems in the Cleveland SMSA. These applications cane from companies ranging from saaller, family-omned partnerships to the large subsidiaries of companies such as ATED, GTZ and MCI (eee Exhibit 10). In their discussions concerning Digitron's denand analysis, Me Elliott and other managers at EIPH sought to clarify the assumptions behind ‘the analysis and to understand the implications of altering any of thaze assumptions if conditions changed “Well,” degan Mr. Elliot, "we should identity and investigate all of the critical factors in this demand analysis. If ve get the license for Cleveland, we'll have a $10 million fnvestaent in this business and each of those factors will affect our breakeven point and potential returns. 1 believe cellulac radio is going to blast off during the next decade, but if we don't understand now - and attempt to quantify - the factors impacting denand for cellular services, we could find ourselves stranded in aliea territory a few years from now.gesiv) 4 583-102( PRECENT PENETRATION 100. Ban Exhibit 8 E.T. PHONE HOME, INC.: FORECASTING BUSINESS DEMAND Projected Business Penetcation Rates Penetration of "Interested" Group ‘e485 "8687 “88 ‘og 90182 YEARS =— PESS]HISTIC - EXPECTED <> = OPTIMISTIC “33 "98-a- 383-121 tes Exnibic 109 ELT. PHONE HOME, INC.: FORECASTING BUSINESS DEMAND applicants for Cellular Radio Licenses in Cleveland S¥SA Tune 1982) Carpenter Radio Company: partnecship ovned by James M. Carpenter and Miriam G. Carpenter of Lina, Ohio cells: 1 Financing: private funding Gellular Mobile Systens of Ohio, Inc. a subsidiary of Graphic Scanning, Tne., of Teaneck, Rew Jersey Financing: corporate financing included §200 aillion line of credie from several banks and $132 million in cash. © Subscriber costs: $4.95 per oath plus §.13 per half-miaute during "business houre," §.06 per half-minute duriog aight-tine hours NCI Cellular Telephone Company: a subsidiary of NCI Teleconmunications Corporation of Washington, D.C. Financing: corporate financing included 9300 million in letters of credit from banks. Subscriber costs: basic service charge of $15 per month within the SMSA plus §.25 per minute during 8:00 a.m. co 8:00 p.m, Monday to Friday; $.15 per minute 8:00 p.m. to 8:00 a.m., Monday to Friday and all day on Saturdays, Sundays and holidays. "Roamer Service" for $5 per day with a $20 maximum per billing period. Additioaal services included call waiting, call forwarding, teansfer of calls after a certain aunber of rings, conference calls, operator message assistance, and voice mail. Construction costs and operating expenses through year 1: approximately $10 million. © AMPS Corporation: a subsidiacy of American Telepuone and Telegraph Company. Financiag: (Taformation taken from ATRI’s capitalization plan for its cellular subsidiacy, fled with the FCC on May 25, 1982): Between July 1, 1982 and the end of 1986, ATAT and ite subsidiacies plan co invest about 3927.6'million in cellulac systems. Approxinately 92% of this financiag ($897 willion) Will be provided by AT&T. The nev cellular subsidiary will begia operations with $25.8 million in assets, of which $100,000 is cash, $2.6 million ceceived from ATST, $500,009 in deferred charges, and the cenainder in propecty, plaat ‘end equipment. Fron January 1, 1970 to October 31, 1981, the Bell operating companies provided $60.4 million for cellular activities through License contracts and $9.4 aillion in direct contributions, vhich vill be reimbursed by ATET to the operating companies "as coon a2 practicable.”