Prediction: Failure rate will be high for low-cost MVNOs

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With the recent launches of companies such as FreedomPop, Republic Wireless, Ting, RingPlus, Solavei and more, there seems to be a growing number of mobile virtual network operators in the U.S. wireless market. Most of these companies are promising inexpensive mobile data and voice services, often at a fraction of the cost of similar services being sold by traditional operators.

These new MVNOs are able to keep their costs in check by offering full-price handsets, instead of subsidizing phones for their customers. They are also eliminating a lot of their customer acquisition costs by forgoing traditional marketing and advertising channels and instead relying upon social media to spread the word about their services. 

Will these new MVNOs succeed? Historically, most wireless resellers have struggled to survive. In fact, if you look back five or six years in wireless history you will find it littered with several high-profile MVNO failures such as  ESPN Mobile, Disney Mobile, Helio and Amp'd Mobile. 

Those splashy virtual operators were intent upon delivering specialized content and services to a niche audience such as sports lovers, urban youth or tweens with deep-pocketed parents. Most were well-funded by their parent companies or investors and none were offering low-cost services. Instead, they inked custom handset deals, opened retail stores and, in the case of Amp'd Mobile, built a studio in Los Angeles just to make video content for their subscribers.

Of course, those MVNOs are no longer in business. Some had success attracting customers but none had enough volume to turn these endeavors into profitable businesses.  

One of the few success stories in the MVNO space is América Móvil's U.S. TracFone unit, which sells service using the TracFone, Straight Talk, Safelink, Net 10 and, most recently, Simple Mobile brands. TracFone's services are billed as low-cost options for consumers and do not require long-term contracts. The company ended the second quarter with 20.3 million total subscribers, making it easily the largest U.S. MVNO.  

But I have my doubts about this new generation of MVNOs and their ability to get traction in the market. I'm not convinced that consumers, who have been conditioned to getting subsidized smartphones, are going to pay $300 or more for an unsubsidized device. And I'm not alone in my opinion. John Byrne, research director of wireless infrastructure at IDC, agrees. "Even if you can show a customer that over the course of a 2- or 3-year period they will save money with an unsubsidized phone and a lower monthly fee, there is still the challenge of getting over the initial sticker shock," Byrne said. "It is definitely a tough sell in a market that is so used to getting their phones for free or for very cheap."

Of course, some of these MVNOs will attract customers who have unlocked smartphones from other operators and are at the end of their two-year contract. I'm sure there are some consumers who will be tempted to switch to a low-cost service provider. However, I find that most people want a new smartphone every two years. Once again, I think the lure of the subsidized smartphone is too great.

Byrne also noted that despite TracFone's success in the MVNO space, the company's margins are thin--somewhere around 12 percent EBITDA margin compared with 45 percent or more for the traditional operators such as AT&T Mobility (NYSE:T) and Verizon Wireless (NYSE:VZ). Byrne noted that most MVNOs will not have the scale of a TracFone, with its 20.3 million subscribers, and that means their margins will be even slimmer.

Nevertheless, Byrne said he does believe there are MVNO opportunities that will crop up once more operators have deployed LTE. For example, he said that Clearwire (NASDAQ:CLWR) may have a lot of extra capacity on its planned LTE network, which would make it very motivated to offer deals to MVNOs so it can get more traffic on its network.

The MVNO market is very cyclical. Every five or six years we see a crop of new entrants into this space. I suspect that by next summer we will already have a few failures among this new generation of wireless firms. I'll be anxious to see which companies are still around in August 2013. --Sue