New Entrants Must Compete On More Than Price

A recent story in Japan introduces the issue of competitive telecom service pricing when new entrants launch into the market. In this case, the incumbent is Nippon Telephone and Telegraph (NTT), who is facing price competition in the fixed line business from recent entrants including Softbank and KDDI. Softbank priced their services below NTT, which is now responding with an 8% price cut of its own. In Japan, this cut is not enough to stop the growth of Softbank or similar VoIP services, but it may slow it down. Meanwhile, the lesson here can be very easily applied to hundreds of other situations around the world: New entrants that think they can win a market by simply offering lower prices than the incumbent will have their business plans busted when the incumbent does the obvious move of lowering prices to match. The situation to which this applies includes: wireless competitors to DSL, VoIP service providers, fixed wireless competitors to T1 or E1, and much more. The incumbents, for the most part, have already amortized their heavy investments in plant, and are now simply pricing to extract economic rent on that plant. Incumbents, in fact, are likely to have the true competitive advantage when it comes to cost/price, and can use that advantage as soon as a competitor challenges them on price. If a new entrant, say a fixed wireless broadband ISP, thinks that entering a market with 20% lower prices than the incumbent offers them a sustainable competitive advantage, the entrant will be crushed by its own success — as soon as it becomes more significant than a thorn in the side of the RBOC, the RBOC will drop its price to match the competitive threat. (Good news for customers, either way.) This can apply to cable companies equally, since they have massive amortized investments in underground last mile cable. The new entrant will ultimately have less ability to lower prices, since it needs adequate cash flow to service the debt incurred to launch the business (equipment is not already amortized.) VoIP in the USA is an interesting case, because for now the FCC has protected it as a nascent industry and thus VoIP providers don’t pay all the fees that the RBOCs pay for each fixed line. Without this protection (which we support), the VoIP providers would have a narrow price advantage, and one which the incumbents are starting to erode already (flat rate long distance, etc.) The bottom line is: If you’re going to compete against an incumbent telco, make sure you have sustainable competitive advantage in something other than price, because as game theory predicts, they will react to your market entry.

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