Why Forcible “Free Texting” Will Only Lead To Increased Poverty

``Congress, devoutly promise that all their actions are based on good intentions. But it doesn't matter: bad ideas regarding the nature and role of government breed bad results and suffering occurs nevertheless. Twisted logic, Machiavellian justifications, excuse making, and short-run benefits can never justify the removal of one iota of liberty from any one person if we intend to live in a free society.” US Congressman Ron Paul, The Economics of a Free Society

People always ask why the Philippines remain “poor”? Our reply has been “because of the lack of respect of markets, the dearth of economic common sense, the dependency culture, political hubris and the incessant pandering by authorities to buy public opinion through government intervention”.

``The problem is not that supply and demand is such a complex explanation. The problem is that supply and demand is not an emotionally satisfying explanation. For that, you need melodrama, heroes and villains”, wrote Thomas Sowell. And melodrama is what has prompted for the recent “Free Text” ruction, where in essence this is all about PRICE CONTROL.

Because of the huge profits accrued, domestic telecoms companies have been portrayed by some public officials as “villains” for not providing text messaging services for free. The assumption is that telecom companies have undeservingly been making huge profits at the “expense” of consumers (the “victims”) something analogous to taxation. Thus, the soi-disant “heroes” threatens to impose redistributive “justice” by compelling these “greedy” firms to make good free text messages as part of “social” service….or else!!!

The Survivorship Bias and Earnings Cycles

English novelist George Orwell once wrote, ``Power-worship blurs political judgment because it leads, almost unavoidably, to the belief that present trends will continue. Whoever is winning at the moment will always seem to be invincible.”

Thus before passing any generalization it would be best to examine the facts behind the issues.

For starters, the telecoms industry is a capital intensive industry; it requires Billions of Pesos in capital investments for its infrastructure rollout to be able to operate.

Yet the public or our so called “heroes” DO NOT SEE or REALIZE that the huge sums of investments DO NOT automatically GUARANTEE profits. This is why it is called as RISK CAPITAL. Nobody puts at risk his or her capital without the attendant expectations of profits or return on investments (ROI). If a venture goes wrong, investors LOSE equity, on the other hand, if they are right they deservingly REAP profits. So there is ALWAYS a TRADEOFF.

In the same way, even if the domestic telecom industry have been earning today, this DOES NOT GUARANTEE that they will NOT LOSE tomorrow or sometime in the future. Risk taking endeavor is always an ONGOING DYNAMIC because the challenge is the future. Yesterday’s performance may or may not be the same for tomorrow. The past has been perfected, but the future still needs to be ascertained.

Unfortunately people and those in power simply don’t understand this. They are skewed to only see the profits and NOT the ACCOMPANYING RISKS (called survivorship bias-the fallacy of seeing winners only), hence makes a bigoted issue out of these.

It is not always cloud 9 for the industry.

Figure 1 Ed Yardeni.com: S&P Telecom P/E Ratio

As an example, figure 1 courtesy of Yardeni.com shows of the Price-Earnings Ratio of the US S&P 500 Telecommunication sector. As you can see, the PE ratio peaked in 2000 and collapsed by more than half as the dot.com bust unraveled. This shows of how investors paid exuberantly for share prices of telecom issues in 1998-2000 in the EXPECTATIONS of the continuity of astronomic earnings growth seen in the recent past (early 90s). When reality sunk in, where expectations did not match with real earnings, prices retrenched. Until now or eight years from the pinnacle, the price earnings ratio of the US telecom companies remains depressed!

So huge profits are a permanent fixture for the industry? Think again.

Remember, earnings growth in any industry undergoes cyclicality. For instance, the wireless segment of the telecom sector, the biggest earnings revenue contributor today, is likewise subject to the innovation cycle (innovation, growth, shakeout, maturity and end phase).

As the cycle segues from rapid growth (today) to the maturity phase, the explosive pace of growth will eventually slowdown to match or track the pace of the country’s economic growth or GDP. It can only manage to sustain such extraordinary levels of growth if it is able to introduce more revolutionary innovative products which consumers will patronize. But then again, that is a risk which the industry has to bear with by spending largely for its research and development.

Telecom’s Success Formula: Competition

Another, the telecom industry operates under a deregulated environment. This means that industry firms would have to STIFFLY COMPETE among each other to be able to attract enough subscribers in order to recoup on their investments and eventually earn from it.

And how do they do that? By offering BEST POSSIBLE SERVICES at the MOST AFFORDABLE PRICES.

As the “Text capital” of the world, we are said to have been privileged with the lowest “texting” rates in the region. From the Philippine Star, `` [Globe Telecom senior vice president Rodolfo Salalima] Salalima also emphasized that the Philippines has the lowest text messaging rates in the region. Because of the various promotional campaigns being offered by local telcos, particularly unlimited texting, text-messaging rates in the country have gone down to as low as 13 to 14 centavos per message.

``This rate, he stressed, is extremely low when compared to India’s 61 centavos per text message, Malaysia’s 67 centavos, Indonesian Extelcomindos’ P1.18 per message, China’s P1.55 per text, and Hong Kong CSL’s P15.91 per message.”

Meanwhile, the penetration levels for domestic mobile have reached 51% or some 46 million in early 2007(marketreserach.com), which means more than half of the population is now connected.

Yes, the success to spread connectivity in the country today is principally due to intense competition, which has immensely LOWERED prices and thus added subscriber volume or by expanding coverage.

Economics 101 tells us that if you want more of anything you simply lower the cost and if you want less of anything you increase the cost. But as a caveat this important insight from Mr. Jeff Bezo, Amazon.com’s CEO, ``Lowering prices is easy. Being able to afford to lower prices is hard", which alternately means lowering prices has its limits. You can afford to lower prices enough to keep some profits to ensure the survivability of the company.

And this has not been an isolated or a Philippine only phenomenon but a global one as shown in Figure2.

Figure 2: ITU: Global Mobile Industry has been Powered by Competition

Where monopoly once dominated the telecom industry today competition has taken over. Because of competition which brought upon affordable pricing worldwide, in 2007 mobile the penetration level have exploded to around 49% or some 3.3 billion subscribers (news.com.au).

Enormous Capital Investments Need Huge Earnings

It does not end here.

Because the industry is technology laden, this means that it would require CONTINUOUS ACCESS to risk capital in order to EXPAND CAPACITY (think nationwide coverage, reduction of dead spots, reduced time lags from message sending to receiving, international roaming et. al.), UPDATE/UPGRADE TECHONOLOGY (think Multi-media messaging, 3G) or to INNOVATE (think WIMAX, IPTV) its infrastructure or to even CUSTOMIZE PRICING (think unlimited texting or calls) for the very same purpose of attaining viability of the project by offering QUALITY and EFFICIENT SERVICES at AFFORDABLE PRICES to attract MORE subscribers and earn profits from it. As earlier mentioned it has to also spend for considerable investments on RESEARCH and DEVELOPMENT.

Not only that…billions of Pesos of existing infrastructure is similarly subject to OBSOLESCENCE RISK-where the risk to infrastructure or extant technology becomes obsolete or outmoded!

Figure 3 Ray Kurzweil: Moore’s Law

Figure 3 from futurist Ray Kurzweil shows of how technology propelled innovation have accelerated exponentially or the “S” Curve. This means that technology based companies like those in the telecoms will have to be nimble enough to adapt to the swift advances in technology or lose subscribers and money.

In short, HUGE PROFITS are thereby REQUIRED for the UPKEEP of the capital intensive system of the telecom industry to ensure its survival. Nonetheless, what needs to be further stressed is that such profits are never guaranteed and is never static since it breathes upon the patronage of fickle consumers! Consumers like voters can easily change preferences for whatever reasons.

Consumer Sovereignty and Patriotism as Refuge of Scoundrels

When consumers subscribe to a company’s service (post paid or pre paid), this is because of the perceived satisfaction or utility derived from the services offered. They are done VOLUNTARILY and NOT BY FIAT. Consumers always have the option to terminate or transfer to other firms offering similar generic services (or more) because they see it fit according to their interests. This is called consumer sovereignty. It is unlike taxation which derives revenues by FIAT or decree. By the same token it means that earning by risk taking and earning by coercion are TWO different animals.

It is obvious that the failure to understand the dynamics of the industry is by itself a manifestation of grand myopia. Thus, the projection of the “immorality” of profits is totally unwarranted, unjustified and unfair.

Yet while pretending to serve for the best interest of the populace or consumers, this propaganda or threat to intervene via price controls actually seems more of a camouflage for punishing them.

The threats to compel free text messaging signify irresponsible statements which are wantonly absurd and have far reaching dire unintended consequences. The unfortunate part of government intervention is- “they make the rules, we the nation suffer from it”.

What possibly happens when such policies gets implemented?

Since text messaging for the telecom industry today is a MAJOR profit center, it will shift to a COST CENTER or at worst transform into a SUNK COST.

Stated differently, the telecom industry’s incentives will be overhauled overnight. Companies will either (at best) marginalize on improving on the cost center subject to subsidies from HIGHER PRICES of other services (higher toll fee for wireless, landline, data and other services) or look for other sources of revenue center (maybe via a shift towards content subscription) or (at worst and most likely path) totally ABANDON the text services altogether.

In the private sector, a nonprofit cost center can only exist when it indirectly contributes to other sources of revenues. (Think GOOGLE-it provides free search engine as a come on in order to generate significant traffic volume from which attracts advertisers-the company’s main revenue source). However, if the cost to maintain the cost center exceeds the profit potential from its major sources of revenues then it bleeds the overall operation of the company which leads to imminent closure.

Plainly said, the revenues lost from text messaging will now be recovered in the form of HIGHER prices of OTHER services. If they are not able to do so, you can kiss text messaging goodbye.

Think of it, who in the right mind would spend tens of millions or billions of capital to upgrade the network if it is non-revenue generating anyway or if it does not compliment to revenue generation?

Remember, this is NOT a government bureaucracy which can afford to subsidize one sector. In the market, revenues are derived from VOLUNTARY exchanges. In government, revenues are derived from seignorage (money issuance) or taxation-which comes out of compulsion as a subject of the state. In short, taxation is predatory-people don’t have the LEGAL option to say NO to taxes, except by tax evasion or smuggling which is punishable by law.

Put differently, in the market, people have the power to say NO to poor services by voting with their money. In government, people are NOT empowered with the same privilege. Instead we will have to bear with the inadequacy of public services because it is imposed by edict.

So applied to price controls, the choice would be having jerrybuilt or substandard services (think severely delayed text messages which may take hours, days, weeks to receive-if at all) or none at all! Besides, anything free could mean an exponential rise in usage which may vastly exceed the network capacity (systems overload) of telecom firms and thus heighten risks of a network system crash!

Moreover, because of reduced earnings, companies in the embryonic stage or with razor thin margins will simply vanish due to insolvencies.

All these combined, you can be guaranteed of even more HIGHER rates for the other residual services from the remaining service providers!

As Ludwig von Mises wrote, ``If the government fixes a maximum price for certain commodities below the level which the unhampered market would have determined for them and makes it illegal to sell at the potential market price, production involves a loss for the marginal producers. Those producing with the highest costs go out of the business and employ their production facilities for the production of other commodities, not affected by price ceilings. The government's interference with the price of a commodity restricts the supply available for consumption. This outcome is contrary to the intentions which motivated the price ceiling. The government wanted to make it easier for people to obtain the article concerned. But its intervention results in shrinking of the supply produced and offered for sale.”

Because reduced supply from policy initiated incentives equals higher prices, price controls do more harm than what is intended.

At the end of the day, the road to hell is paved with noble intentions. Free text messaging equals no text messaging and or higher cost of other communication services.

On the other hand, the only more viable way to bring down prices is to liberalize the industry or open it to MORE competition as shown above.

Aside, our authorities have another option of reducing prices: REDUCE TAXES but with CORRESPONDING DEDUCTION IN SOCIAL SPENDING. Our glib talking politicians should not only vent on the industry but should look at their own bureaucracy as a source of savings. They should consider giving back to the people their wasteful and inefficacious boondoggles in the form of pork barrel!

Nationalization Next?

So once interventionism creeps in, what’s to stop the government from going further?

The next step would probably be to put a cap or ceiling on prices of the other sources of revenue sources. This should translate to humongous losses and lead to industrywide foreclosures.

In the same manner if the government compels companies to operate free text services by bleeding them dry, the industry would simply allow itself to be taken over.

Hence, government completes the transition by effectively “nationalizing” the industry.

By nationalization, government would need tons of capital from which would come from taxpayer funding. Remember, the lifeblood of this industry requires recycling of huge capital. The assumption that government can manage the monopoly profitably is wishful thinking given its horrible track record and its LACK of resources.

As a political entity, the cosmetically rehabilitated state owned company will only be an endemic source for political appointments which will be hobbled with incompetence, abuse, corruption and other forms of capital allocation inefficiencies. It will be another potential cow to milk at the expense of consumers.

If the company will offer mobile services (at subsidized rates) under subsidies from the national government, losses accumulated will be charged to the unfortunate productive taxpayers, whom will bear the brunt of higher taxes and or higher costs of living.

If they should charge for services, given the monopoly and inherent inefficiencies, whatever services will be paid for will be at VASTLY greater prices than what it is today even at the face of dysfunctional or shoddy quality of services.

Thus, your free text becomes both a DIRECT and INDIRECT tax to consumers!

In a world where technology has helped improved the lives of people by increasing communications, connectivity, interaction and business transactions and trades by lowering costs, price controls and unnecessary intrusions by government will undo these progress. We are likely to materially slowdown, if not regress.

Ultimately all these should lead to immense lost productivity, loss of competitiveness, loss of investments, capital flight, loss of jobs, higher taxes, higher cost of living, lower the standard of living, a more intensified corruption and worst of all increased poverty.

Politics Likely A Factor-“Flexing Political Muscles”

The incumbent President is an economist, so we are inclined to believe that she is very much aware of the negative repercussions from the derring-do actions of her subordinates, unless she is a closet hammer and sickle bearing ideologue (which so far enough hasn’t been the case).

That said, it is likely that the administration could be seen as “flexing its political muscle” as a demonstration of strength that it is still a power to reckon with even as her tenure approaches the twilight (or the projection that the administration is not in a lame duck state). This is especially directed to whom she perceives as her political opponents. (Yes some of the supporters of her adversaries are stalwarts from the industry).

Yet political maneuverings will do us no good by signaling to investors of the country’s vacillation to sanctify contracts and or uphold private ownership rights. Moreover, it is this kind of interventionist culture that inhibits a market economy from flourishing, aside from the perpetuation of the state of corruption.

As the illustrious economist Milton Friedman once said, ``There is no such thing as a FREE Lunch! To paraphrase, ``There is no such thing as a workable forced free texting!

As a final thought and disclaimer, my perception of the industry is one where it has been cherry picked or where the “low hanging fruits” have already been harvested. The rapid growth phase seems likely to transit into a mature phase which should grow in line with the economy over the coming years. Thus the performance of the telecom sector should reflect the growth of the Phisix than massively outperform as in the past, in my view. As a market participant who aims for “growth” and unpopular “value”, the industry has not been much of a priority, which means I DON’T OWN any telecom issues as of this writing.