Long-distance Calling Cards

Date:   Friday , February 28, 2003

THE LAST TWELVE MONTHS IN TELE-communications history have seen the bankruptcies of Enron, WorldCom and Global Crossing. This has, unquestionably, deeply affected the U.S. economy. But if you think that the entire telecom industry is headed for disaster, think again. A little niche segment—prepaid communications—has emerged as a hotbed of opportunity. This is an industry that has managed to survive the current telecom turmoil, showing signs of maturity with slower growth.

According to the latest report of ATLANTIC-ACM, a telecommunications consulting and research firm, the U.S. prepaid calling card industry grew at a Compound Annual Growth Rate (CAGR) of 25.4% from 1995 to 2002, reaching $3.7 billion in 2002. The CAGR from 2002 to 2008 is expected to be just 9.7%, with revenues in 2008 expected to reach $6.4 billion. Reduced rates and smaller margins are contributing to this slowdown in growth.

Compared to the local and long distance markets, however, the prepaid industry is holding out very well with steady year-to-year growth. “Lower wholesale costs as well as packet technology improvements have helped the prepaid industry remain competitive,” stated Dr. Judy Reed Smith, CEO of ATLANTIC-ACM. “Growth is being sustained by the rise in the number of prepaid calling card users, as well as providers’ diversification into other prepaid services,” she added.

The Players
Competition in the prepaid industry is fierce, and providers are scrambling to find new and unique ways to attract consumers.

Tier one carriers—AT&T, MCI/WorldCom, and Sprint—dominate the market. The Tier two and three providers—IDT, 9278, Blackstone, and GPA, to name a few— have bought wholesale minutes on the tier one backbones and further distribute them to retailers. They have thrived in niche segments such as international markets, smaller retail outlets and distributors—segments into which Tier one carriers have not forayed.

Tier two and three providers have quickly learned that each target market has unique usage patterns and preferences and prepaid calling card providers can tailor their products and services to each customer target.

Take, for example, the ethnic markets. The Indian immigrant entrepreneurs—wholesalers—buy minutes from carriers and resell them through middlemen to customers, predominantly to the Indian community. They make their money off phone cards at various stages, from selling bulk minutes to printing cards to retailing. Profit margins diminish from an average of 30 percent for the wholesaler to as little as 1 percent in a competitive retail market, but the volume is high.

“It is a $15 million-a-year business, playing on Indian immigrants’ strong business and family ties back home,” says Ajit Balakrishnan, chairman of Rediff.com in an interview with the New York Times. “Our research shows that the typical Indian family spends $100 to $120 a month keeping in touch with people at home.” Rediff.com buys wholesale minutes from the big carriers but sells the PINs to customers online.

Ethnic markets have traditionally been, and largely remain, the main revenue stream for many Tier two and three prepaid providers.

Market forces
However, this is beginning to change. With a decline in their long distance revenues, the Tier ones have started looking to encroach on territories that could fetch revenues. For example, Sprint recently introduced a Hispanic calling card. The Tier one players have the reach. All they’ve been missing is the wherewithal, which they seem to be finding now.

It appears that the Tier ones are all set to squeeze the Tier two and three providers out of competition. This may sound absurd but given the industry strength of Tier one carriers, this could soon be a reality. Tier two and three providers should be concerned with the gradual incursion of Tier one players into the retail space.

Since Tier two and three providers don’t own their own networks or rely on Tier one carriers for a substantial portion of their prepaid minutes, tier one operators can directly affect their margins by raising prices. Doing so would drive smaller prepaid providers right out of the market.

Of course, Tier two and three players can take their business to other network owners or voice-over IP wholesale providers, but those networks typically don’t have the same scope as an AT&T or a Sprint.

A promising business
Profit margins are significant in the calling card business. Prepaid service providers typically buy the minutes in large bulk and are billed usually per actual second used. So, if a call is 65 seconds long, and the cost per minute is $.60, the service provider will be charged $.65 for the call. Now, when the service provider offers the minutes for sale, he will typically offer them on a per minute basis. In other words, all calls will be rounded up to the next highest minute. So, the service provider will actually charge 2 x $.60 or $1.20 for the call. But, since the service provider’s cost was an only $.65, he has a margin of $.55 for this call. By making the minimum call duration 3 minutes, which is a fairly common practice, an even greater profit margin can be achieved. In fact, many prepaid service providers find that the majority of their profits result from deducting call-time in three-minute increments.

There are dozens of cards out there in the market, available in different denominations. The catch with these cards is that many are loaded with hidden charges (65 cents when using a pay phone, a 49-cent connection charge, $2.95 monthly fee, billing in three-minute increments, etc.).

New Carriers
Even as the demand and competition heat up, there is a new set of carriers emerging that is employing VoIP (Voice-over IP, which uses the Internet for the transport of voice). They have developed technologies to ensure that VoIP provides consistent quality. Since VoIP has much lower capital requirements compared to the traditional networks of carriers like AT&T, it presents these new carriers with the unique opportunity to make significant inroads in the telecom market.

When the VoIP market in India was liberalized, many Indian entrepreneurs in the calling card industry feared that they would lose business. Fortunately, that did not happen. In India, using a VoIP service, a one-minute call to the U.S. would cost Rs 7 (14.5 cents). If the same call is made from the U.S. using a calling card, it costs 4.9 cents. So if you are planning to foray into this business, there is enormous opportunity. However, today’s marketplace is filled with so much competition that it won’t be easy to turn a significant profit.

Going Forward
The popularity of pre-paid calling cards has grown enormously since the U.S. deregulated the long-distance industry. Today, there are hundreds of calling cards available in almost every shop, an indication that the calling card market is too hot to handle. Current operators have demonstrated considerable resilience and resourcefulness and are unlikely to surrender their hard-earned positions easily. In this battleground the weapons used to acquire and defend coveted market share are price, brand, and, sometimes, questionable business practices. Consolidation (merger and acquisition) appears to be the logical route forward, if only to increase margins. But one should not forget that this is a marketplace that has potential for expansion.