India’s telecom Industry, an oligopoly, has witnessed significant price-cutting since 2005. A metric called Average Revenue per user (ARPU), which defines a company’s per subscriber monthly revenue, has fallen from ₹370.01 in December’05 to ₹128.25 in December’13. This implies that either people lowered usage of cell phones drastically or call rates fell over the period. The former is unlikely in a growing economy and the phenomenon actually resulted due to aggressive price cutting by firms during this period.Currently Airtel, Vodafone and Idea control 70%+ of the industry’s market share. Table 1 shows the ARPU and subscriber base (in Crores) of these 3 over the past 6 years. The average subscriber base for a particular year is shown in the table. Table 2 shows % change in ARPU of the three companies over the past 5 years and their respective individual share of the total subscriber base of these 3 companies.
|Quarter Ended December||Airtel's ARPU (in ₹)||Airtel's subscribers||Vodafone's ARPU (in ₹)||Vodafone's subscribers||Idea's ARPU (in ₹)||Idea's subscribers|
|Year||% Change in ARPU||Relative Market Share (%)||% Change in ARPU||Relative Market Share (%)||% Change in ARPU||Relative Market Share (%)|
|Situation||V reduces rates||V doesn’t reduce|
|A Reduces Rates||A and V retain market share||V loses market share|
|A doesn’t Reduce||A loses market share||A and V retain market share|
TABLE 3This is a variant of the classical prisoner’s dilemma (say A and B) wherein two prisoners are separately asked about the true culprit. The situations that A and B face is shown below:
|Situation||B betrays A||B stays silent|
|A Betrays B||A and B imprisoned for 2 years||A goes free and B imprisoned for 3 years|
|A stays silent||B goes free and A imprisoned for 3 years||A and B imprisoned for 1 year|
In this scenario, no prisoner can trust the other one and the optimal solution for each one would be to betray the other. Similar is the case in Telecom industry. No company can trust the others. In a bid to save their respective market shares, companies kept cutting their own rates. Each set of companies, each year, would have faced a situation similar to the one in table 3. If A didn’t reduce its rates in 2009, its market share could have fallen to 38.8% under the assumptions made at the beginning of analysis. Hence, A decided to cut prices. Similarly, all firms in the industry decided to reduce rates. Another question that I seek to answer is what the ideal action for these firms would have been during this period? Did they make a mistake due to these price wars?
In the case of the prisoner’s dilemma discussed above, each prisoner’s ideal choice is to stay silent and spend a year in jail instead of 3 that would result if they betray each other. Would the telecom companies also have achieved better results if they had not indulged in price wars? No. The subscriber base of the 3 companies discussed above increased at a compounded rate of 37% from 2008-2012 (Table 1). It would be reasonable to attribute this change to the falling prices given that the economy was performing poorly during this period. Again taking into account the assumptions made in deriving Table 3, the revenues of A and V in 2013 could be demonstrated by the following table:
|Situation||V reduces rates||V doesn’t reduce|
|A Reduces Rates||( 2068, 1400)||(2068, 984)|
|A doesn’t Reduce||(1590, 1400)||(1590, 984)|
Table 5 shows the approximate monthly revenues (in Rupees Crores) of the two firms under different situations with respect to price. In the above table both the Nash equilibrium (the action point from which no company has an incentive to deviate given the action of the other company) as well as the ideal equilibrium is for both companies to reduce rates. Thus the telecom industry didn’t necessarily suffer due to price cuts, at least in terms of revenues. However, this strategy would have remained profitable as long as the price elasticity of the industry’s demand remains greater than 1. In 2012, a rise in prices (indicated by ARPU) led to an increase in the three companies’ revenue. Thus, this year marked an end to the telecom industry’s price-cutting strategy.
Why is it that the automobile Industry in India, another oligopoly, has not faced similar price wars? It is so because companies cut prices only if the price-cut doesn’t result in economic losses for them. Return on assets is already low in automobile industry (about 10%). The telecom industry has also had very low (9-10%) returns during the past 2 years. This also explains why that the effect of game theory has disappeared in 2012 and 2013. Young Industries (such as e-commerce) earning economic profits may witness a similar price-cutting and erosion of economic profits in the future.
Narottam Garg is a current PGP - 1 student at IIM Ahmedabad.