Dataquest

Publication Date: 10 December 2009 ID Number: G00173236

Dataquest Insight: Designing Future Communications

Service Provider Pricing Strategies
Alex Winogradoff

The pricing of non-regulated communications services will change dramatically during

the next three years. A number of complementary forces are creating a "perfect storm"
environment benefiting consumers: marketing innovation from over-the-top (OTT)
providers changing customer expectations, increasing competitive choice enabled by
open networks, and through a more aggressive deployment of next-generation IT
platforms. What pricing strategies must communications service provider (CSP)
marketers consider to remain competitive?

Key Findings
• The majority of CSPs will move away from an unlimited and flat rate pricing structure
toward a consumption-based and metered pricing construct for Internet and content-
based services. At the same time they will continue to make their pricing bundles more
comprehensive and self-customized to mitigate churn.

• Cloud-based communications services from OTT providers (like Google) and more
traditional telecom vendors (like Microsoft and Cisco) are starting to impact what
consumers expect to pay for communications services.

• Open networks will give consumers greater direct control over communications
elements/options. This will force CSPs to adopt more flexible pricing strategies, not just
for commodity voice services but also for high-demand enhanced services (Internet
access, content/entertainment, and data services like SMS).

Recommendations
• Cease offering unlimited/flat-rate plans in line with local market realities and develop a
segmented migration strategy — promotional plans to retain strategic customers and a
"good riddance" approach for high-user/high-cost customers.

• CSPs must develop business processes and IT solutions that will allow on-the-fly pricing
for non-regulated services by all sales channels while still meeting tariff requirements for
regulated services.

• Move to usage-based pricing models to help manage consumption until 4G networks

arrive. In the mean time look to develop ways to make content/apps and bandwidth
utilization more efficient via data compression, more efficient coding and so on.

© 2009 Gartner, Inc. and/or its Affiliates. All Rights Reserved. Reproduction and distribution of this publication in any form
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TABLE OF CONTENTS

Analysis ............................................................................................................................................. 3
Near-Term Pricing Strategy Trends — "Provider Push" Pricing .......................................... 3
Moving Toward Metered Pricing for Internet Access Services................................ 3
Consumption-Based Pay-As-You-Go Pricing Model Adoption Will Accelerate ...... 4
"Ultimate Bundle" Pricing Strategy .......................................................................... 4
Long-Term Pricing Strategy Trends — Customer-Defined Pricing ...................................... 5
Optimum Price-Point Concept ................................................................................. 6
Key Drivers and Influencers Impacting Pricing Strategies ................................................... 6
Background and Context ................................................................................................................... 7
The Impact......................................................................................................................................... 7
Conclusion ......................................................................................................................................... 8
Appendix............................................................................................................................... 9
Overarching Pricing Influencers .............................................................................. 9
Downward Pricing Pressures .................................................................................. 9
Upward Pricing Pressures ....................................................................................... 9
Recommended Reading.................................................................................................................. 10

LIST OF FIGURES

Figure 1. Flexible Pricing Structures Will Start to Dominate Service Pricing in 2015 ....................... 5
Figure 2. Price Influencers................................................................................................................. 7

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ANALYSIS

Near-Term Pricing Strategy Trends — "Provider Push" Pricing

For the vast majority of customers, price remains the pivotal element in a customer's buying
decision. Therefore developing the right pricing strategies, for the right customer segment, at the
right time becomes critically important.
There seem to be an almost infinite number of nuances in telecom pricing strategies, tactics and
promotions, often making it very difficult for customers to compare and discern the best value for
their needs. However, after one strips away these nuances there are some fundamental
principles in play: flat pricing, usage-based pricing and bundling. So what are the top three pricing
trends that will impact customer decision-making the most during the next three years?

Moving Toward Metered Pricing for Internet Access Services

The most dominant mass-market pricing model currently in vogue for fixed broadband — flat-
rated continuously expanding bandwidth and throughput — can't be sustained. Therefore, CSPs
must explore metered usage and quality of service pricing for their fixed broadband access
services as soon as possible, with offerings in 2011.

• In competitive markets like the U.S., metered usage and tiered pricing for broadband
access will likely develop more slowly than in non-competitive markets.

• In competitive markets, marketing strategies as well as regulatory issues, come into

play. Competitors in these markets use throughput, speed and pricing to differentiate
their services. The Internet network in these markets is also under greater stress from a
larger segment of customers downloading high-bandwidth content.

• In markets with limited "last mile" competition, metered pricing is primarily a regulatory
issue because it will impact unbundling tariffs.
For mobile broadband, while unlimited data plans still exist and are promoted by operators like
Sprint to gain market share, most plans today already have volume caps (for example, 5
megabytes per month) and data-rate (for example, 3G/4G) pricing. Vodafone is trialing tiered data
services to Spain, priority data for business customers and more intelligent application of fair-use
capping. The only drawback may be net neutrality regulation. Other providers like TeliaSonera
are also experimenting with traffic prioritization and volume caps that will give preference to its
own services over others once a volume cap has been reached.
The concept of fair-use has been built into the fine print of broadband access contracts but has
not been enforced by any providers until just recently. In the U.S. the possibility exists that the
Federal Communications Commission (FCC) may not allow content prioritization or volume
restrictions (except under severe network congestion), while European Union (EU) regulators at
this point seem to be in favor of giving CSPs more leeway as long as CSPs clearly announce
their policies to customers. We expect it will take at least two years before there is a final
agreement between CSPs and local regulators on metered usage, charging for tiered quality of
service, and content prioritization rules — and these rules will likely be different by country and
regional jurisdictions.

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Consumption-Based Pay-As-You-Go Pricing Model Adoption Will
Accelerate
Today, the fixed services market is a monthly subscription-based pricing model. But it wasn't
always so. Pre-paid calling cards (essentially a pay-as-you-go pricing model) was a niche pricing
segment targeting primarily immigrant ethnic minorities that did not qualify for subscription-based
fixed services in the 1970s and 1980s.

• This pay-as-you-go and consumption-based pricing model is expected to make a return

and be more broadly adopted by customers that simply want more control.

• Consumers are becoming more discriminating: they do not want to be tied down to
particular providers for enriched applications and next-generation services; they want to
control their spending, to have choice and buy as needed.

• Utility hosting/cloud computing services are examples where usage-based pricing

strategies have been adopted — pay by day for usage of virtualized server capacity, for
gigabit storage used, for Mbps tiered bandwidth/throughput and so on. While this model
is still evolving and being trialed for critical functions, we expect that within three to five
years hourly pricing options will become more widely available.

• Another example for more traditional voice and data services, price-sensitive customers
will receive alerts when preset spending limits are being approached, and some CSPs
may even provide consumption charts similar to those sent by the utility company to let
customers track and modify their usage patterns over time.
For mobile services the subscription-based pricing model ("post-paid") still dominates in
mature markets (for example, in North America about 84% of customers are post-paid),
while the pay-as-you-go model ("pre-paid") which arrived in the 1990s has now become the
dominant payment method in developing markets (exceeding 90% of customers in some
countries).

• Expect greater adoption of the pay-as-you-go for both mobile and fixed services in all
markets globally.

"Ultimate Bundle" Pricing Strategy

Bundling has been an approach the telecom carriers have been using for 20 years to promote a
perception of "increased value," even if in some cases adding features did not add value. It has
been essentially a marketing gimmick to compete against lower-priced and less robust
competitors. Offering double-play, triple-play and quadruple-play (Internet access, fixed voice,
mobile access and TV) is just another variation on this bundling theme. It is simply a multiple
product/revenue discount pricing scheme — delivering multiple individually-priced services at a
promotional or discount price advantage. Once telecom carriers or cable companies have offered
these bundles, what comes next?

• We expect these providers to move toward an "ultimate bundling" strategy during the
next three to five years. This paradigm allows a customer to craft his or her own bundle
across accounts (multiple users within the home, within the family and businesses),
technologies (mobile, fixed, satellite) and the full gamut of services (telecom carrier
provided or partner-provided), encompassing: prepaid and postpaid; content; security
services; Internet access and services; voice and data, including SMS, content, location
services, social networking.

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 • This "ultimate bundle" pricing strategy is just a more robust way of bundling. It still prices
the bundle according to the individual product pricing structure, contract terms, and use
or license fee, thus there is essentially no impact on rating and only on bill presentment
(how much is presented on one bill). However, it is the first step toward a customer-
defined pricing model that is discussed in more detail in the section below.

Long-Term Pricing Strategy Trends — Customer-Defined Pricing

We are moving inexorably from product commodity pricing to individualized pricing strategies,
something unthinkable just five years ago. During the next five years there will be a distinct shift
from standardized pricing tariffs to a flexible pricing paradigm (see Figure 1). For consumers,
CSPs have been providing too few differentiated products while they have providing too many
customized solutions (too little commercialization of complex products) for enterprises.
Figure 1 emphasizes that regardless of the market, in the future pricing must be flexible enough
to address the customer in his/her milieu. How CSPs will position themselves is really up to the
market strategy they want to pursue — niche, mass or all markets. Clearly, different pricing
strategies will have to apply.

Figure 1. Flexible Pricing Structures Will Start to Dominate Service Pricing in 2015

Source: Gartner (December 2009)

• As individual users look to personalize or customize their services to meet their specific
just-in-time needs, service providers will be forced to develop and experiment with highly
dynamic and individualized pricing schemas.

• While some simple commodity services will continue to be sold under a uniform pricing
rubric (especially regulated services), many of the personalized or mashed services
(those created by customers from a menu of individually-specified features and
elements) will need to be priced on-the-fly.

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 • Not only will there be fewer "commodity" services with uniform price points, customers
will be less willing to pay the same price for the same or similar service.

• Prices must become more elastic based upon the immediacy of the need, the perceived
value and the individual user's willingness to pay.

• In essence, pricing will move from the realm of a service provider stipulated price-point
model to a consumer offering-to-pay model. First generation examples of this type of
pricing paradigm already exists and is used by many customers to "bid on" air travel,
hotels, cars — for example, Priceline.

• These trends will not totally eliminate the product/pricing catalog it will be the death of a
uniform pricing structure for all individualized/personalized services and will make
charging, billing and customer service more complicated.

Optimum Price-Point Concept

The optimum price-point concept is a concept that most directly aligns customer perceived value
with willingness to pay. Although difficult to calculate, price sub-optimization reflects how much
money is left on the table compared to what a customer was willing to pay. Traditional ways to
uncover optimum price points are too costly and time consuming for the more tailored or
individualized services. So what is the solution?

• Developing a "whole-life" approach to meeting individual customer needs —

understanding the customer in his current environment, understanding his relationships,
preferences and values, demographic profile (likes and dislikes) and typical interactions
— will permit service providers not only to craft the most-valued service experience but
also the optimum price points.

• Implementing a "whole-life" approach will be slow and evolutionary and will involve a
cultural change on the part of consumers and businesses as well as providers.

• Marrying contextual information and use of customer demographic and transactional

profile information is already being applied by Google and OTT providers like Netflix to
make the customer buying experience more beneficial.
Bottom Line: Commodity pricing for the mass market will not disappear, but will become much
simpler and much less dominant than it is today. In essence, two pricing environments will
dominate: a standard/simple world for commodity services which will be primarily pre-paid,
allowing for clear feature/price comparison, and a high-touch complex retail world where price
comparison for customers is impossible and personal value is the main differentiator.
The optimum price point will be different by individual, by market and geography based not only
on personal preferences but on regional and cultural differences as well. The overall price for the
individualized service solution will be a single mashed price that can include a customer-specified
quality of service, period of use and so on.

Key Drivers and Influencers Impacting Pricing Strategies

Numerous external (uncontrollable) and internal (controllable) drivers will shape the future pricing
strategies of CSPs. These drivers are not independent variables but interact with each other in
various ways to magnify their cumulative impact or to mute their individual influence.
The greater the number of independent variables the more difficult it is to develop effective pricing
strategies that will optimize both revenue and profitability. Some of the key pricing influencers and

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pressures during the next three years are discussed below. Figure 2 shows the impacts these
influencers and pressures will have on pricing during the next three years.

Figure 2. Price Influencers

Economic Crisis/Promotional Pricing Impact — Short-Term

Customer Chose Functions Over Quality — Long-Term

Customers Used To Free/Unlimited — Medium-Term

Competitive Intensity — Long-Term/Ever Changing

Government Regulation/Policy — Long-Term/Step Change

Internet Demand — Long-Term/Outstrips Capacity

Spectrum Scarcity/Efficiency — Medium-Term

Decreases Prices Increases Prices

Source: Gartner (December 2009)

As seen in Figure 2, the prices for similar communications services using measures like voice
usage (minutes) and data access (bandwidth and throughput per megbyte/gigbyte) will continue
to vary during the next three years due to market forces, government intervention and a steadily
improving CSP cost structure.
It must also be recognized that demand for higher bandwidth often results in higher prices despite
continual improvements in price performance. In North America, for example, enterprise traffic is
expected to grow 30% with revenue for Internet access and virtual private networks (VPNs)
growing by more than 10% CAGR during the next five years. Thus, while prices will continue to
rise due to bandwidth creep, the price per megabyte will continue to plummet annually by 5% to
10% depending on competitive intensity. (See Appendix for detailed discussion of pricing
influences and pressures.)

BACKGROUND AND CONTEXT

The competitive landscape for communications services as well as the move to open networks
will give consumers more and more control over the way they purchase their communications
services. While today most consumers try to compare CSP pricing plans before making a
decision to purchase commodity voice services, voice and data service usage are still
predominantly bundled with purchasing access as well as devices (handsets, modem, PC card)
from the same provider. External forces like government regulation and competitive market forces
will decouple these linkages during the next three to five years. What pricing strategies must the
traditional telecom carriers consider and adopt to win against more agile OTT competitors and
those competitors (for example, cable television) that don't have regulatory constraints?

THE IMPACT

Over the years CSPs have been artificially making it difficult for consumers/SMBs to compare
voice and data price plans (be they fixed or mobile). This is even more of a truism when it comes
to comparing triple-play and quadruple-play bundles. For enterprise customers — other than for

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simple tariff services — price comparisons have always been difficult because of the many
variables that play into providing solutions.
Power Shift to Consumers — CSPs will have no choice but to adopt flexible pricing because
consumers can demand it in an open network environment.
Value-Based Pricing — The value proposition beyond price will become an even more important
element in the decision process of customers — service-level agreement clarity, T&Cs will be
major decision factors.
Regulation — Regulation will remain a wild card as regulators step up market engineering:
controlling prices in mature markets and interventionist.
CSPs Will Scuttle Most Flat Rate/Unlimited Plans — The majority of CSPs will move away
from an unlimited and flat rate pricing structure toward a consumption-based and metered pricing
construct for Internet and content-based services and expand their price bundles in a big way.
Significant Challenges for CSP IT Environment — These new service requirements and future
pricing schemas pose significant challenges for legacy systems and even for the newer platforms
that are handling next-generation services and content. IT systems will need to be highly flexible.
They must continue to support a service catalog but also integrate with an on-the-fly service
creation/management system, which will also significantly impact ordering, fulfillment, billing and
rating systems.

CONCLUSION

• CSPs should develop personalized tariff plans to compete for commodity services,
featuring special promotions for birthdays, other personal or business events, or public
holidays, and deals based on users' own choice of peak and off-peak hours. CSPS
should also start to exercise control with real-time tariffing. One example is dynamic
load-based tariffing where CSPs can send targeted texts, offering immediate discounts
when the network is quiet, to encourage off-peak calling.

• CSP should terminate offering unlimited/flat-rate plans and develop a migration strategy
for customers that have unlimited plans — promotional plans to retain strategic
customers and a "good riddance" approach for high-user/high-cost customers.
Obviously this needs to be done within the context of each country's market reality.

• To minimize customer disaffection, CSPs must segment customers based upon

their usage profile and develop marketing strategies that optimize perceived value
(price and usage) for each segment.

• Develop a combination of tiered bandwidth, tiered download volume, and content

prioritization pricing strategy and premium customer experience to ensure retention
of low-cost strategic customers.

• CSP marketers, IT managers and business support system/operations support system

vendors must develop business processes and IT solutions that will allow on-the-fly
pricing for non-regulated services by all sales channels while still meeting tariff
requirements for regulated services.

• Develop standard commercial arrangements (T&Cs) and service levels that benefit both
the service provider and the customer. For businesses-standard T&Cs, reduce contract
review/approval and negotiation time as well as cost. T&C standardization will benefit
even complex business solutions (for example, hybrid cloud) requiring customization.

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Appendix
Overarching Pricing Influencers
Pricing Remains Local — Despite the globalization of communications, instant 24/7 access
everywhere, pricing will remain uniquely local to meet local market dynamics (for example, daily
pricing plans in India).
Economic Crisis — The cyclical nature of economic prosperity will always impact market
demand and therefore will foster increased promotional pricing until the economy and demand
improves.
Telecom Carrier Financial and Revenue Trends — Telecom carriers will continue to be price
followers and not price leaders as they continue to struggle with profitable revenue growth. These
financial pressures will keep CSPs resisting downward pricing changes — they will follow prices
downward and cannibalize their services only when they are forced to.

Downward Pricing Pressures

Competitive Landscape — Downward pricing pressure will continue to come from OTT and
other non-traditional players that are flocking into telecom, many of them well-established players
like Google, Microsoft, IBM, Cisco, Nokia and HP. The smaller players have not taken substantial
market share but have been disruptive in the mass market through predatory pricing, product
substitution (including instant messaging), viral marketing tactics and indirect revenue models (for
example, advertising). The larger players, on the other hand, are pursuing a competition strategy,
for example, as suppliers of unified communications and cloud services as well as partners to
telecom carriers. A recent Pew study indicates that four competitors in a market for broadband
access can reduce prices by as much as 39% compared to one player in a market.
Customer Acceptance of Function Over Quality — Consumers, who are generally more digital
technology-savvy, have high expectations of technology in all aspects of their lives — at work, at
home and at play. However, they also will accept lower quality (thus expect to pay lower prices),
trading quality for features, for example, text messaging, IM, low-quality streaming and pictures.
For personalized services on the other hand, higher value will mean higher compensation. The
Internet-connected world has become a "beta" marketing laboratory in which success and failure
will be judged quickly and cheaply, resulting in lower-quality products developed at
unprecedented speeds.
Customers Becoming Conditioned to "Unlimited" and "Free" — Strongly-branded new
players from outside of telecom are offering communications products for free (for example,
Google Voice) or cheaper. At this point, the advertising-supported model of Google and the lower
cost structures of other OTT providers have conditioned a significant portion of the highest users
so they would be unwilling to pay higher access costs.
Regulation and Government Policies — Regulators in mature markets are wrestling with how
to best provide universal access to broadband, improve consumer choice, increase competition,
ensure open access and Internet network neutrality. All of these activities will stimulate
broadband demand and put increased pressure on an already stressed Internet infrastructure. It
will also tend to stimulate lower prices to ensure uptake and affordability.

Upward Pricing Pressures

Internet Demand Exceeding Capacity — This will put stress on unlimited Internet access and
throughput pricing strategies. Demand for network capacity is increasing at a rapid rate, driven by
increasing deployment of access capacity, growth in customer use of this bandwidth (for

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example, peer-to-peer activities, content sharing, video downloads and video-streaming
applications) and rising broadband adoption globally. Today 40% of wired Internet traffic is
already video, with 3UK, a small network operator indicating that 94% of its network traffic is data,
up from 15% just four years ago. With the emergence of more bandwidth-consuming mobile apps
through unlimited plans Internet traffic will grow five-fold in the next three to four years with
personalization estimated to increase Internet traffic 30 times more than today's networks can
accommodate.
Spectrum Scarcity — While some players with excess broadband capacity (for example, Sprint)
will focus on pushing unlimited data pricing plans, most players in the wireless industry are facing
a growing crisis as mobile 3G Internet usage overwhelms the spectrum available today. This will
be even more of a problem with the introduction of 4G/Long Term Evolution technologies unless
this spectrum crisis is addressed. In the U.S., Canada and in the EU plans are under
consideration to improve spectrum efficiency, examine ways to offload mobile to fixed broadband
to free up capacity, and to reallocate spectrum currently being used for other purposes. However,
significant relief is unlikely to come before 2011 and tiered pricing is likely to be introduced by
most leading players.

RECOMMENDED READING

"Dataquest Insight: Turning Mobile Broadband Growth Into Profit in Western Europe"
"Dataquest Insight: Best Practices on How to Change Consumer Contracts Without Causing a
Backlash"

This document is published in the following Market Insights:

Carrier Operations & Strategies Worldwide

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