The price is wrong: Irrational pricing and emerging service providers

The key to success on Bob Barker’s long-running daytime game show is being the best at guessing the price of sundries typically found in your kitchen cabinet. I dare say that many start-up communications carriers would not fare very well on “The Price is Right” if their irrational product pricing is any gauge of their potential skill. To be fair, the hyper-competition that exists in markets forced many CLECs into price wars that became crippling for the cash-starved providers. However, in the data market, price slashing was a calculated decision on the part of companies looking to grab market share at all costs. It has created a situation that was, most likely, avoidable.

The Yipes fiasco that has played out over the past few weeks in the trades is a clear example of this phenomenon. Yipes, Telseon and other business-class ISPs burst onto the scene offering businesses “unlimited bandwidth” at a fraction of the price being paid to the incumbents or the Big Three long-distance companies. Using metro Ethernet services, these companies severely undercut more traditional players using older technologies. Other carriers such as the now-defunct CAVU e-xpedient used wireless equipment to offer 100 Mb/s service to businesses for as little as $100 per month.

Such aggressive pricing, though enticing to customers, was probably was unnecessary to build the business. The Eastern Management Group has conducted studies showing that enterprise customers will switch service providers for 10% to 15% in savings, yet companies like Yipes and CAVU were pricing at discounts between 50% to 85%. In effect, these companies were leaving money on the table—a taboo in the capital-intensive service provider space.

The cost for data service providers to wire a building and provide a connection to Internet backbone providers ranged from $60,000 to upwards of $100,000, depending on the technology deployed. For carriers operating in multiple markets, the dollars added up all too fast. Network equipment costs, OSSs and billing systems, labor and marketing expenses were all on top of these expenditures.

Yipes and CAVU learned the hard way that just because you can sell your service at bargain basement prices, you don’t have to (and probably shouldn’t). The remaining carriers in the space including IntelliSpace, Giant Loop and Cogent must move quickly to avoid falling victim to the same disease. Pricing should be compelling, not suicidal.

There are lessons here for the CLEC market as well, as it emerges from the harsh rationalization that began with the fall of GST Communications in May of 2000. Business customers are sticking with CLECs even as many players exit the field, as research in The Eastern Management Group’s free quarterly competition report, “CLECs, Cable and Wireless are Making Waves Despite the Downturn,” shows. CLEC penetration continues to grow markedly, although the number of CLECs has been cut in half from its peak in late 2000.

As the number of competitors in a given market gets whittled down, those that remain should seek to price their services at levels only slightly under the prices paid for comparable services offered by incumbents and other providers. More cash means an end to the anemia that has characterized the competitive local exchange carrier segment since the capital spigot was turned off in mid-2000.

Differentiated product suites, customer service and flexibility can be relied upon to close the sale; price should only be the key that opens the door to sales prospects. Irrational pricing may increase share, but it ultimately becomes an instrument of self-destruction.

Robert A. Saunders is a senior analyst with The Eastern Management Group, a management consulting firm focused exclusively on the communications industry. He can be reached at rsaunders@easternmanagement.com.

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