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ZappChai Weekend Irani: Reliance Jio, IUC drama, and the future of Indian telecom

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Last week Jio, the telecom giant who has taken the nation by storm, announced a rare set of negative news. Reneging on its promise of lifetime free calls, it announced that it would now charge outgoing calls to non-Jio phones at 6 paisa per minute to recover the costs of interconnect charges paid to other operators. Shareholders in its beaten up competitors took the news rather well, with Airtel jumping 12% and Vodafone Idea jumping 17% on the day.

In this article we decode what IUC is, why it is such an issue, and what the move by Reliance could signal for telecom competition, and you as a customer. We also try to gauge the impact the move will have on customers, regulator, and competitive behavior in the months to come.

Firstly a brief history on IUC (Interconnect usage charges). Interconnect usage charges are charges that telecom operators have to pay to each other for using the other party's network. When a Jio user calls an Airtel user for 10 minutes for example, Jio will have to pay Airtel 0.6 rupees under the current interconnect charges. The interconnect usage charge used to be 14 paisa per minute back in 2017 when TRAI (India's telecom regulator) slashed the rates by more than 50% to 6 paisa per minute. The move was a very strong negative for the then three industry incumbents (Idea, Vodafone, and Airtel) who lost close to 10% of their annual revenue because of the move. [Vodafone: 8.0%, Airtel 10.0%, Idea 10.2%]. The plan was to drop the charges to zero come January 2020, which would again have been a deadly blow to the already suffering incumbents, but TRAI recently launched a discussion paper seeking views on deferring the rate reduction.

Which raises the question, why is TRAI doing this? One major difference between Jio and its competitors is the customer cohorts the two have. While Jio has only 4G customers, its competitors have a lot of 2G and 3G customers still with them. Regulators had thought that with the greater spread of 4G adoption the two incumbents would be able to gain a larger proportion of 4G customers thereby reducing the inherent imbalance between them and Jio, but that hasn't happened. A move now to reduce the IUC charges to zero now, will have a tremendous financial impact on the two other players in the market because of the directionality of calls. To make matters worse both Airtel and Vodafone Idea have a tremendous amount of debt on their books, and are constantly ceding market share to Jio. The 800 odd crores that Jio pays them via interconnect charges is therefore a welcome reprieve. With competition in the telecom space dying like flies, it becomes important in someway to help protect the competition that remains.

Let us now hear Jio's side of the argument. Jio over the last three years has risen to meteoric heights capturing the market on the back of extremely cheap data and lifetime free calls. With a balance sheet unencumbered by any previous spectrum bidding and a tonne of oil business money, the firm set its eyes on capturing the promising Indian telecom market. The (minor) downside of its extremely attractive pricing was that its outgoing calls became significantly higher than its incoming calls. The 2G and 3G users on competitor networks had to incur relatively high charges for outgoing calls, which led to more calls from Jio to competition than the other way around. This is verfied in the outgo of around ~850cr from Jio to its competitors per quarter.

Jio even went as far as to argue that many of the current 2G and 3G users on competitor networks gave missed calls to users of Jio. Jio users who until now had free outgoing called back, causing a sharp cash outflow to its competitors. To back their claims they mentioned the close to 300 million missed calls they got every day. This not only means less revenue to it via IUC charges that its competitors would have to pay, but also an outgo at their end when, in most cases, their users call back. The "missed call epidemic" is thus hurting Jio two fold. In a response to the issue Jio had initially slashed its outgoing call ringer (the duration the phone rings before it gets disconnected) for calls on competitor networks from 45 seconds to 20 seconds, in a weird attempt to increase missed calls on the competitors networks forcing their users to call back! The 45 second ringer duration has has a 45% acceptance rate, which falls by 20% when reduced to 20 seconds. Upon some backlash the time was increased to 25 seconds.

And then it came out with its trump card, charging customers the interchange directly every time they call competition. For Jio in isolation the move will have two major impacts. On the upside it will ease its financial outflow, by moving one cost head from themselves to the customer. On the down side its offerings are now not as competitive as they used to be vs competition, with the customers having to bear a higher cost.

But the more interesting implications, are ones outside of the firm. The move to keep the 6p/minute charge on its customers has been viewed by some as Jio trying to strong arm the regulators, by effectively keeping the charges present till the IUC is removed. This to me seems unlikely. Infact it might just be playing right into what the regulator wants to happen.

Why would the regulators want the customers to pay a higher bill one might ask? Well, because a slightly higher bill now is preferable to a very high bill 5 years later. And that is exactly what could have happened if Jio continued to undercut its competition into perpetuity. As it gains market share competition around it will continue dying. A lot of smaller players have already seen this fate, and we have been effectively reduced to a market with 3 serious private players (Jio, Vodafone Idea, and Airtel) and one public player (BSNL). If Jio were to continue gaining customers on the back of pricing, it was very likely that more of its competition would die, effectively ending up in a pseudo monopolistic duopoly. In a market like this, where barriers to entry are high, Jio would have free reign to raise prices as they wish, which is a bad scenario for everybody. Well, everybody but Jio.

In my view what this move does is signal a situation in which even the market leader has conceded that playing on pricing is a bit too costly for their kitty. The implementation of the IUC charges increase the effective bill for its customer, and while Jio has tried to offer some consolation in terms of extra free data, the customer will still care about his monthly payout, which for most users will increase.

That leaves the last player in the game, the competition, Airtel and Vodafone Idea. Let's look at what options lie ahead of them now, and then see which one makes sense. This is a complex exercise in that we are effectively in a three player repeated game (one where all players can see their oponents prior move and change their reaction accordingly), with a fourth the regulator also adding some zing. But it is also simple, in that there are only two things the firms can do from here. One is raise their tariffs, and the second is drop their tariffs or keep them unchanged.

Lets look at the case where both Vodafone Idea and Airtel raise their tariffs, in reaction to Jio raising tariffs. The most immediate benefit of the move will be increased near term profitability. What it will also signal to Jio, who undoubtedly would be tracking both their new customer acquisition as well as existing customer churn diligently is that the competition is signalling a truce as well. Vodafone Idea and Airtel will continue losing customers to Jio, but they will improve their margins as they do, atleast in the short term. If attrition to the two continues even after Jio's price hike, it will give Jio greater confidence to raise prices in the future, and the telecom market in India will see better pricing in the days to come. The regulators will in all likelihood see the improved profitability figures post the hike along with an inability of the incumbents to acquire 4G users and decide to scrap the IUC post 2020 as planned, at which point Jio's effective bill falls and it gets a new fresh wave of customers. An important thing to note is that the long term picture is still bleak for the competition in this scenario, but they will atleast have a momentary reprieve. The market will probably react positively to this scenario though and stocks of both players will probably jump if this scenario plays out, as sell-side starts churning out reports of a "Market repair theme in telecom", but it will infact be the continuation of a slow death by a thousand cuts for the players.

Which brings us to our most interesting case, and something that will make the seven minutes you spent reading the article to this point worth it. What this move by Jio has done is given both Vodafone Idea and Airtel the rare chance to go on the offensive. This is extremely counter-intuitive given the pain the incumbents are in, but the scenario that makes the most sense from a long term wealth creation perspective. There is clearly discontent amongst Jio users post the move, discontent that will in all likelihood increase as they get their higher bills over the next few months. These are the coveted 4G customers that both players of the competition would love to have, not only because of the higher telecom ARPU they'll bring in, but also because these are high value customers that you can also cross sell your other services to (on demand content for example). In short it is an extremely good idea to acquire these customers. If both Vodafone Idea and Airtel are able to synchronize advertisement campaigns targeting Jio combined with a drop in prices/maintaining pricing at current levels in plans that 4G users would want to buy, they would be able to acquire some of Jio's existing customers, as well as improve their hold of their existing customers. The price drop scenario will probably not happen due to the sheer difficulty of implementing it in the current market scenario given a combination of their financial health, and market and stakeholder reaction to such a move, but a stable price scenario (i.e. not matching Jio is certainly possible). This will hurt in the short run ofcourse, but if done right the firm acquire some very high value customers. Jio will probably detect the pattern soon enough as it would be tracking new adds and churn with a hawk's gaze post the move, but with a commitment to keep IUC charges going till the regulators drop it as well as the lack of a outright offensive by the competition, replying in kind will be easier said than done. The only option they will have at their hand is increased data pack sizes, something that the competition can match with low and limited cost increases. With flat prices, improving competitive dynamics, and a greater intent shown by competition to acquire 4G customers, the regulator now also has leeway to delay the price increase to 2021 and beyond, which is an added benefit to the struggling incumbents. This is a very high risk path to take ofcourse, and something that will take supreme grit to execute, and will see a very harsh reaction from most external players, markets included. But the choice here is between perpetually bleeding customers, to bleeding some money in the short term but signalling to Jio that the long term market share should be at 33-33-33, not at 50-25-25 that Jio currently seems to have in mind. It helps to keep in mind that Reliance wants to spinoff and IPO its retail and telecom business in the not so distant future, and would thus be willing to play the money bleeding game for far less time than most people estimate, and the inability of the incumbents to sustain a longer period of lower prices might be exaggerated, with the Voda-Idea group having sufficient resources to stay in the game atleast for the next three to four years post it Indus tower and fiber asset sale, and Airtel with a much stronger balance sheet to be able to sustain much longer.


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That's it from our side for this week! Have a great Sunday!



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