A Healthier, Fat-Free Telstra

Against the backdrop of a sinking share price and the prospect of more volatile trading in the weeks ahead, there are two fundamental questions for the Telstra investor: First, can you trust Sol Trujillo’s version of what the future might look like? And second, can Telstra stop viewing its customer base like an old-fashioned utility and transform its thinking from customer volume to customer yield?

To take the first question, Sol’s vision of the new Telstra certainly looks more like the internet than an old-fashioned copper wire utility. And that sounds like good news for investors.

The internet has attracted rich advertisers: last financial year online advertising rose to almost $500 million; it is expected to surge within two years to 10% of total advertising spending in Australia, pushing it past both the radio and magazine industries’ share of the advertising pie.

Moreover, in the next two years, mobiles will transform from phones with novelty cameras to interactive gateways for 3G network operators, video television broadcasters, content publishers, content producers and '¦ advertisers.

In the UK, the mobile phone company 3 is set to become the world's first operator to sell airtime on its own network to advertisers, opening up its 3.2 million British customers to targeted marketing and advertising campaigns.

In addition to its 10.3 million Australian fixed-line customers, Telstra has 6.5 million mobile customers in Australia it intends to migrate to the new 3G platform over the next three years.

The probability of customers churning (switching to another service provider such as Vodafone or Optus) will be perceived by Telstra as a significant threat during the Trujillo era. But churning customers may become an opportunity for Telstra. Higher profit from higher margin can be a positive outcome of churn – but only for those companies who change the ways they determine customer value.

THIS LEADS us to the second question, on customer volumes versus customer yield

A signifier of Telstra’s success and potential value to investors will be its ability, not only to create a technological transformation into sleek broadband and wireless platforms, but also to achieve success in extracting higher yield from high-spending customers.

Managers of telecommunications companies often take price marketing as the principal tool in mitigating churn-exit or in attracting customers from competitors. In a competitive market, executives often attempt to protect their overall market share, acquire new customers and prevent customer churn by lowering the price of services or by offering price-rewards.

But market share and volume, while critical, are not the Holy Grail.

Low-yield customers are motivated by price offers and will behave promiscuously in a highly competitive market. A telco facing a changing competitive landscape often becomes obsessed by how many customers it might lose, while simultaneously being aroused by the prospect of acquiring its competitors’ customers. It should do neither.

A recent report from McKinsey & Company says that rather than blindly undercutting aggressive competitors, incumbents can safely charge high-margin residential customers and SME (small to medium enterprise) customers a price premium that secures their business, avoids costly price wars and preserves the market.

But this premium approach requires management to reinvent its own thinking.

Despite the push for volume, the opportunity is for a telco such as Telstra to accept, and even welcome, the loss of a proportion of promiscuous, low-yield customers. Indeed, the loss of price-sensitive customers to a competitor offering price or cash incentives simply means the competitor is paying to acquire the low-yield customers that Telstra can afford to lose.

According to the traditional view, volume rather than marginal average revenue per user (ARPU) drives the share price of a telco. The new challenge is however to identify who is low-yield and promiscuous and who is high-yield, valuable and potentially loyal and, at the absolute minimum, stop acquiring low-yield customers.

SO HOW DO telcos identify customers with high-yield consumption and a reduced propensity to churn?

A group of consumers known as the New Economic Order (NEO), numbering four million in Australia alone, spend more, read more, know more, earn more and demand more from service providers.

They are exemplars of the customer willing to pay a premium for a premium service. NEOs are dramatically different from the majority of the population. A telco that can provide NEOs with a fundamentally different set of experiences will lift both revenue and margin.

• NEOs dominate the top quartile of telecommunications spending.
• NEOs dominate all mobile phone spending levels above $100 per month.
• 98% of NEOs are online frequently.
• NEOs dominate broadband usage.

Put those NEO facts together and the effect on the telco industry is dramatic. The cost to a telco (direct costs and value forgone) of a NEO churning is 15 times higher than a low-yield customer. The loss of a NEO costs $750 compared to $50 for a customer in the bottom quartile of spending

Telstra should stop seeing itself as a provider of basic telephony and see itself as a service provider delivering to an individual all the personalised solutions that make their life richer, more in touch and more in control. And it should charge a premium for those premium services.

According to the smart analysts, at $4 a share, Telstra should yield 8.4% fully franked in 2005-06, falling to 6.9% fully franked after in following years. This represents the highest yield on the Australian market. It will need a high-yield customer strategy to secure that return.

Ross Honeywill is an internationally published author and a foundation director of consumer think-tank the Centre for Customer Strategy. Consumer data used in this article is drawn from Roy Morgan Single Source and is subject to copyright.