1. Describe the cost behavior in the wireless industry. What are the implications of this cost behavior for cost-volume-profit (CVP) relationships?
The term cost behavior is used to describe whether a cost changes as output changes. In this case the costs are tightly shielded. In order to describe the cost behavior of the industry, we have to study the process that results in cost incurrence. Based on the information in the AT&T case, the industry features a high proportion of fixed costs in relation to acquiring spectrum and building a network. Variable costs are relatively low and, in the case of text messages, are very low. The cost structure in the wireless industry is dominated by fixed costs, so the contribution margin ratio is high. The high fixed costs and large contribution margin ratio result in a relatively high percentage increase in profit. The greater the proportion of fixed costs in a firm’s cost structure, the greater the impact on profit will be from a given percentage change in sales.
The wireless industry has high operating leverage, because of high fixed costs and low variable costs. Therefore, the industry has a high ability to generate an increase in net income when sales revenue increases. “Text messages did not use any extra spectrum – once the carrier had paid the cost of the underlying infrastructure and storage equipment. Any revenue received by the provider on incremental text message usage is almost pure profit”. So, we can assume that, the cost does not change as the output changes. As far as I understand, the costs are incurred when the message is actually sent, and all these cost are very low.
2. What are the key cost drivers? Can a cost driver be used to continually raise prices?
1. Number of text messages per minute
2. Number of cell towers per area covered
3. Number of databases needed for a certain volume of messages 4.
Number of customers
5. Number of cell phone plans
6. Number of terabytes
7. Number of devices
The choice of the cost driver in this industry is not obvious, and the cost behavior pattern can depend on the cost driver selected. In this case the key cost driver is the number of text messages sent/received per minute.
Yes and No. It depends on the cost behavior of the business. If the business has high variable costs and low fixed costs then the organization is more effected by a change in the volume. If the business, like in AT&T’s case, has a high rate of fixed costs with minimal variable costs (we assume that they are at the low end of the range of volume per fixed costs because their profit margin is high) then a change in volume will have little to no effect on the actual costs incurred.
3. 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 text messaging business? [Consider per-use pricing and package pricing]How strong a relationship should exist?
Channel cost$.0008641 (.07/81) = using voice messages as a reference which cost $.07 cents a minute. There are 81 text messages/minute transmitted per channel.
Billing cost .0017283 (.0008641 x 2) = assume billing costs are twice as much as wireless costs
Data base cost.0002857 (10M/35B) = AT&T would carry approximately 1% of worldwide text traffic of 3.5 trillion (35B) in their database which costs ~ 10 million dollars Storage cost .0000003837 (13,430/35B) = Worldwide text storage is 1,343 terabytes. AT&T would carry 1% of this storage = 13.43 terabytes. Cost of storage is $1,000 x 13.43 = $13,430. To get the per text cost divide this by 35B. Total cost per text$.002878
Gross Profit Margin = Gross Profit divided by total revenue $.20 per messageplan of $5 for 200 messagesplan of $15 for 1500 messages (.20 – .00278)/.20(.025-.002878)/.025 (.01 – .002878)/.01 =99%= 88%= 71%
4. How strong a relationship should exist between the prices charged to a customer for a good or service and the cost of providing that good or service?
We think that companies should calculate their break-even point for their goods and services and to charge the prices according to that figure. This way, they can make sure that their price covers their expenses. In case of AT&T’s text messaging they are charging much more than the cost. But because there are only four national carriers in United States and they control 90 percent of the market, and text messaging had become widely popular, they can afford high prices. They are considering the demand of the service and pricing the product according to demand and supply.
5. 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 fastest growing wireless industry is text messaging. This also reflects the earlier comment that demand for messaging far exceeds supply, therefore driving prices up. Even though it costs less to transmit a text message than data, it is still seen as a very low cost to the average customer. The customer feels like they are getting a good deal because they are using the text messaging more than the data messaging. Part of the wireless industries revenue is from the sale of the devices. Even the cheapest cell phones have the capability to send text messages.
Since the company is not making as much of a profit off of the device (cell phone), they are making up the difference in charging more for the text messages. In addition, since voice messaging is being replaced by data messaging, both text and email, almost all cell phone chains are developing their own version of an IPhone or smart phone. To compete with these other chains, AT&T must charge the lowest price possible for their data to entice customers to buy their products over the competitors.
6. As we move to a service economy, can we expect to have more or fewer businesses with cost behaviors similar to those in the text messaging sector? Explain.
I would assume we would see more businesses with cost behaviors similar to the text messaging sector. The reason being is the service industry tends to have more fixed costs that don’t increase linearly with the increase in service. The fixed costs tend to be step-fixed costs, whereas they can maintain services within a certain range up to a point in which they have to increase the fixed costs. The variable costs tend to be minimal since they often don’t have the manufacturing costs of direct materials and direct labor.
After a service industry covers the basic operations, less money is needed as sales rise. Once the fixed costs are paid, the expense of processing additional sales is so little that the profits will grow faster than the revenues. The precedence has already been set in multiple service organizations, particularly internet companies. They have shown that once you achieve the hurdle of covering your basic fixed costs, the increased volume of service is very profitable.
7. What should management of wireless firms seek to do now?
AT&T should invest in improving the company‘s wireless broadband coverage and its performance. They can improve network coverage by adding cell towers, laying faster fiber-optic cabling, adding capacity to cell sites and upgrading current cell sites to improve internet speeds. By enhancing the network, they can carry a larger volume of data traffic. This will allow them to accommodate more customers and therefore increase their profits.