Building A Telecommunication Services Financial Model

Building A Telecommunication Services Financial Model

In an increasingly connected world, telecommunications continues to remain the bedrock of society. In developed countries telecommunication is ubiquitous, be it over fixed telephone services, cellular phone services or internet and IP telephony services. In developing countries, the penetration of telecommunication services into the general population is often used as a key indicator of economic development.

However, whilst the core proposition of the need for communication remains, the industry is subject to technological change and the business models of charging tariff rates for traditional forms of communications such as fixed and cellular phone services is under threat, most noticeably from internet enabled telephony services that are able to operate at significantly lower cost, and are therefore able to pass on their savings to consumers.

Sources of Revenue To Consider When Building A Telecommunication Services Financial Model

Telephony service providers typically derive their revenue from individual consumers by way of 2 main sources: voice calling revenue and data service revenue. There are also other ancillary revenue sources such as directory services, wholesale circuit provision services, etc, but these will be parked for now so that we can concentrate on the key revenue drivers.

Voice calling revenues are typically modeled by simply multiplying a call tariff rate by the number of minutes to derive the gross voice calling revenue. Tariffs differ considerably according to the locality you are calling to or from, both domestically and internationally. Clearly tariff discounts, free calling minutes, bundled services and special rates will also need to be factored into the calculation of voice calling revenue in a financial model, but these vary between providers and should be accounted for on a case by case basis.

Data service revenues are typically accounted for in telecommunication services financial modeling by multiplying, again, the data tariff rate by the number of data units used. Data units will differ from one data service to another. For instance, short message services may be accounted for on a per message sent basis, and mobile internet services may be accounted for on a per kilobyte transfer rate basis. As with voice calling revenue, data service revenue also need to factor in rate discounts, free data services, and other bundles and packages.

In addition to voice calling and data service revenues which operate on a tariff rate card basis, a telecommunication services provider may also charge a flat sign up fee and an ongoing minimum monthly charge fee (with or without a minimum subscription period of say a year or two) to consumers for usage of these services, and should be factored into any telecommunication services financial model.

As a mass consumer product, telecommunication services typically have millions of individual consumers as customers, and hence careful modeling of a customer / subscriber base is usually required in a telecommunication services financial model. When modeling a subscriber base for a yearly financial model, be sure to differentiate between subscribers who sign up at the start of the year, end of the year, or anytime in between, as they each will have different revenue profiles that needs to be annualized.

Competition between telecommunication service providers operating in the same territory is also normally very stiff, and churn is used a key metric to measure the number of customers who switch into a provider (termed the churn-in rate) and those who switch out to another provider (termed the churn-out rate). Churn rates, along with estimates of its likely scenarios, is typically factored into the calculation of a subscriber base in a telecommunication services financial model.

Main Operating Costs To Consider For A Telecommunication Services Financial Model

Network maintenance costs, typically contain the costs required to operate and maintain a telecommunication services network. This will vary considerably between a fixed telecommunication network and a cellular / mobile telecommunication network. For a cellular telecommunication network, there will be costs involved in operating base transmission stations (BTS) for the onward propagation of radio waves required to carry voice and data signals, and may involve both upkeep costs as well as rental costs for the surrounding land required to physically host the (typically thousands of) BTS across the territory of operation. Leased line costs are also another major cost item in network maintenance costs, and are incurred as cellular services operators are required to rent existing high bandwidth telecommunication cables that enable the operation of the BTS network. Most of these costs can be modeled on a unit cost per BTS basis for simplicity.

Billing costs are another significant cost item in a telecommunication services financial model. In order to ensure a proper and efficient sales billing and collections cycle for the millions of customers that a telecommunication service provider often has to serve, resources are required to develop and operate sophisticated IT billing systems, manage paper invoices, collect payments from various payment touch points (such as online, check, cash, ATMs, etc)

Staff costs are also a major cost item in a telecommunication services financial model, it being a highly customer intensive business with a high degree of customer interaction required in pre sales as well as post sales, and also an extensive telecommunication infrastructure to operate and maintain.

Marketing costs, as the telecommunication services business is normally extremely competitive (especially in fully liberalized markets), many providers invest significantly in marketing and branding campaigns to differentiate their offerings and gain consumer mindshare. Marketing costs are often dimensioned on a per subscriber basis, and can also be termed customer acquisition costs.

For cellular service providers, cellular handset discounts and subsidies are also a key cost item that should be accounted for in a telecommunication services financial model. Handset discounts / subsidies are sometimes classified as a customer acquisition cost.

Key investments, depreciation and amortization

Operating a telecommunication services business is often highly capital intensive, with significant investment required to purchase large scale telecommunication service transmission networks that can run into billions of dollars. Hence a good financial modeler should carefully account for the need to perform detailed capital expenditure analysis when building a telecommunication services financial model.

Some of the major capital expenses, using a cellular services provider as an example, includes purchases of base transmission stations (BTS), which increases incrementally as the number of subscribers and the geographic network coverage of the operator expands. Mobile switching centers (MSC) are also another major expenditure item, MSCs are required to ensure the smooth and efficient controlling of subscriber calls to ensure that they are patched through correctly to their intended calling party. Again, MSC costs increase incrementally as the customer base of a provider increases. Billing system costs and customer service management system costs are also major capital investments, as sophisticated IT systems and software are required to operate the often large scale requirements of these systems to serve and manage millions of customers.

Most capital expenditure items in a telecommunication services financial model can be dimensioned on a per subscriber basis, as the operating capacities of most equipment are scaled according to the number of customers and voice or data traffic that is required to be handled.

Depreciation and amortization for a telecommunication services business is normally per standard accounting practices, and done according to the useful lives of the assets in question.

Key Metrics To Consider When Building A Telecommunication Services Financial Model

There are a wide variety of metrics that can be used to analyze a telecommunication services business in a financial model, and we highlight a small number of key business related metrics for reference:

ARPU, or average revenue per user, which as its name implies is revenue scaled and dimensioned on a per customer level, often used for competition comparative purposes or as an indicator to the sales performance of a telecommunication services business.

Churn, as discussed earlier, is an indicator of the loyalty of a telecommunication services’ customers, or its ability to attract customers from competing providers.

MOU, or minutes of use, used to measure the amount of calling minutes that customers utilize a telecommunication network for.

Customer acquisition costs, typically used to measure the efficiency of the business’ sales and marketing efforts

Billing cost per subscriber, an indicator of the efficiency of this overhead expense.

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One Response to “Building A Telecommunication Services Financial Model”

  1. Interesting bit.Am employed by an Internet Service provider and am building a financial model to assist in budgetary control,variance analysis, management accounts and to do the draft financial statements in preparation for the annual audit.I would like more information in this regard.

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