1. [10 points] Describe the cost behavior in the wireless industry. What are the implications of this cost behavior for cost-volume-profit (CVP) relationships?
Cost behavior is how a company’s costs change given a change in that company’s activities. Variable costs are costs that change proportionately with the changes in a company’s activities. In contrast, the costs that do not change with a change in a company’s activities are known as fixed costs. In the case of AT&T, costs are focused primarily into the fixed category. This means that as the company’s activities shift, its costs remain relatively unchanged. This combination of high fixed costs and low cost variable costs gives AT&T and the rest of the industry a large amount of operating leverage. The high operating leverage of AT&T means that the company utilizes a higher risk strategy which leads to higher profits as volumes increase. Essentially, as long as AT&T maintains a volume that covers at least its fixed costs, any additional volume translates into profit. This works both ways however, if volume decreases below the threshold for covering fixed costs then every decrease in volume yields proportionately equal losses. According to the case, there is little cost associated with text messaging. The case states that text messaging has an incredibly low variable cost, estimated at only a few cents per text. So basically, once AT&T has covered the cost of the required infrastructure to facilitate text messages, any revenues garnered from text message and virtually pure profit.
2. [5 points] What are the key cost drivers? Can a cost driver be used to continually raise prices?
A cost driver is the root cause of why a cost occurs. For AT&T and the wireless industry there are several cost drivers. The most obvious ones in this case would be the number of texts sent per minute and the number of customers handled by the carrier. However, there are many more. These include the number of cell towers in the area and the amount of database storage needed for handle the messages. In addition, individual cell phone plans and how many devices that are currently handled by a carrier in a given area are cost drivers. The primary cost driver used for the purpose of determining costs in this case is the amount of texts per minute.
In this case, with its high fixed costs and low variable costs, any given change in volume will have little effect on costs. So, for AT&T, the cost drivers are unlikely to raise prices. However, this is not the case for all industries. If a company has high variable prices and low fixed prices we would expect the opposite.
3. [15 points] What does it cost AT&T to send a text message?[Consider costs of the channel, billing cost, storage cost] Based on this cost, what is AT&T’s profit margin as a percentage of its short message service (SMS) text messaging business? [Consider per-use pricing and package pricing]
The case states that the average cost per voice minute is $0.07. From this the case determines that the equivalent amount of texts that can be sent, given the data transmission rates, is eighty-one. Thus the cost per text can be calculated as:
$0.07 / 81 = $0.0008641 per text
This, however, is not the total cost of a text. We must also factor in the costs of billing, databases, and storage. The case estimates the cost of billing at twice that of the wireless costs. Therefore we calculate the cost of billing as:
$0.0008641 x 2 = $0.0017283 per text
Database costs are estimated to be $10 million and AT&T is expected to carry 1% of the 3.5 trillion in world traffic. Knowing this we calculate the cost of storage as:
$10 million / ( 3.5 trillion x .01) = $10 million / 35 billion = $.0002857 per text
The cost of storage is assumed to be negligible in the case. However, I felt that it would still be interesting to calculate the cost. The case states the cost of storage to be $1,000 per terabyte and that worldwide traffic requires 1,343 terabytes of storage. Given that AT&T carries only 1% of the traffic storage costs can be calculated as:
($1,000 x (1343 Tb x .01) / 35 billion = $13,430 / 35 billion = $0.0000003837
The combined cost of sending a text is thus:
$0.0008641 + $0.0017283 + $0.0002857 + $0.0000003737 = $0.002878
To calculate the profit margin, we simply divide gross profit by total revenue. We will take into account the profit margins for three of AT&T’s data plans. The per message plan which charge $0.20 per text, the $5.00 for 200 messages plan, and the $15 for 1500 messages plan.
Per message plan: ($0.20 – $0.002878) / $0.20 = 98.56%
$5 plan: (($5.00 / 200) – $0.002878) / ($5.00 / 200) = 88.49% $15 plan: (($15.00 / 1500) – $0.002878) / ($15.00 / 1500) = 71.22%
4. [5 points] How strong a relationship should exist between the price charged to a customer for a good or service and the cost of providing that good or service? Explain.
It depends largely on the profit goals of any given company and can vary wildly depending on a number of factors such as whether a company is nonprofit or not. In the case of AT&T, the price should at least cover the cost of the product in order for the company to break even. Any amount greater than that will translate into profits. AT&T should price their products based on the supply and demand of the given products. For text messaging, the demand is massive and AT&T gauges their prices accordingly. However, I feel that a degree of morality should be taken into account. I
know that in the business world morality is generally ignored in search of profits. But with text messaging, they are metaphorically printing money for themselves. The cost of sending a text message is infinitesimal compared to what they charge their customers. The sad truth is that as long as we remain willing to pay their price for the service they will continue to charge it.
5. [5 points] Why is the price that AT&T charges to transmit a kilobyte of data via text message so much higher than the price charged to transmit a kilobyte of data via a Smartphone?
The price of text messaging is higher than simply transmitting data by smartphone largely because of supply and demand. The wireless industry prices their products based on demand. Currently, the demand for text messaging is high and still growing. Because of this prices remain high. Perhaps if the average consumer was more aware of the cost of texting this would change their preferences and cause the price to ultimately drop. Texts are not the only source of revenue for the wireless industry. For example, the industry also experiences revenues from sales of devices such as cell phones. The industry prices their devices in order to compete with others in the industry and this leads to low prices in the device market. The revenue from texts is used to offset the loss of potential revenues in the device market.
6. [10 points] What should the management of wireless firms seek to do now?
Wireless firms should seek to improve their infrastructure to increase the capacity and efficiency of their networks. This would allow the firms to handle a larger amount of data and improved rates. This would, in turn, increase the amount of customers that the firms could service and would increase the firm’s revenues. In the case of the wireless industry, an increase in revenues would likely lead to proportionately large increases in profits. The most efficient ways to improve the wireless infrastructure is to add additional towers and storage capabilities. According to the PCIA, revisions in networking policies would also help to achieve this goal. By allowing the wireless industry access to existing support structures such as towers, buildings, water tanks, and utility poles, the need for constructing expensive cell towers could be eliminated. In fact, the new generation of antenna systems no longer require the construction of older cell towers and are designed to be attached to the previously mentioned pre-existing support structures.