Should Smart Communications pursue a market penetration strategy by targeting the low-income segments (D & E segments)

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Question:

Should Smart Communications pursue a market penetration strategy by targeting the low-income segments (D & E segments) or should the company pursue a market development strategy with a focus on existing customers? Why?

CASE STUDY:

Smart Communications Inc. (A)

Introduction

In early 2003, Smart Communications Inc. was the Philippines' leading wireless services provider. Smart’s success had largely been due to its aggressive pricing, innovative market segmentation, and clear brand identity. The company used its extensive digital GSM network to provide superior coverage and connectivity and various value-added services. Smart held 45% of the market while Globe Telecom (Globe) controlled 40%. Sun Cellular was a distant third. Between 1998 and 2003, Smart had been recognized five times as one of the ‘Top 10 Philippine Companies in terms of Corporate Leadership’ by the Far Eastern Economic Review.

During the mid-1990s, few analysts had believed that the Philippines could become a player of any significance in the mobile sector. Due to high levels of poverty it was thought that only 5% of the population could ever afford cell phones. The experts felt that if the number of Filipinos using cell phones ever reached 15%, it would be a tremendous achievement. It was assumed that cellular phones would continue to be luxury items with a limited market consisting of business executives, professionals, government officials and high net-worth individuals. But between 1999 and 2002 Smart had challenged the analysts’ assumption through the launch of a series of innovations that targeted middle income earners. By the end of 2002, the number of mobile phone users in the Philippines had increased to 15.2 million. Smart had 6.8 million subscribers and Globe had 6.6 million subscribers.

But by early 2003, analysts were again questioning the sustainability of increasing market penetration given that most consumers in the upper and middle income levels already had mobile

phones. A report by research consultancy Barkawi & Partners suggested that industry saturation would now peak at approximately 25% by 2008. Analysts pointed to the fact that some 51 % of the population survived on US$2.00 per day or less, and that more than 65 percent of the population lived in rural areas where usage of mobile services was limited or non-existent, even where network coverage was present. Quite simply, said the analysts, a very large segment of the population would be unable to afford mobile telephony.

Smart CEO Napoleon L. Nazareno wondered if it might be profitable to serve the massive but still untapped pool of consumers at the ‘bottom of the economic pyramid’, or whether his company should focus on pursuing opportunities to increase revenues from existing customers.

The Philippines

The Philippines was ruled by Spain between 1565 and 1898, before the US took control. The Islands became independent in 1946. The 21-year rule of Ferdinand Marcos (1965-86) was characterized by economic mismanagement and martial law. Democracy was restored by Corazon Aquino (1986-92). Under Fidel Ramos (1992-98) and Joseph Estrada (elected in May 1998) the democratic tradition grew stronger. In January 2001, Estrada was removed in a civilian coup backed by the military and replaced by his vice-president, Gloria Macapagal Arroyo, who was re- elected in May 2004.

The Philippines is marked by great disparities - in ownership of assets, in income, in manufacturing technology and in the geographical concentration of economic activity. In 2002 the National Capital Region (NCR) around Manila contained 14% of the population but generated more than one-third of the country’s GDP. Income per head in the NCR was nearly ten times that in the poorest region. A wide gap also existed with regard to human development. The index score for the Sulu province was about one-half of the national average, and just over one-third of that for the NCR.

Socioeconomic breakdown in the Philippines fell into five categories A, B, C, D and E. The A, B and C segments were upper, upper middle and lower middle income families, while the D and E segments were lower income and below the poverty line groups. In 2000, the richest 10% of the country’s population had an income of over 23 times than that of the poorest 10%. Those living in poverty were estimated at 39.4% of the population, with the rate in rural areas put at 46.9%, whereas the poverty rate in the NCR was only 12.7%. The Philippines had a young population, 37% being under the age of 14.

Smart’s early years

A 100-percent owned subsidiary of the Philippine Long Distance Telephone Co. (PLDT), Smart launched its services in 1994. The company initially used a well-developed analog platform called TACS (Total Access Communications System), but later rolled out a cellular network with its own

nationwide digital transmission system. Smart became the second biggest cellular company with 120,378 subscribers in 1995, and by February 1997, Smart had won over 360,000 subscribers to become the Philippines' largest cellular operator.

In October 1999 Smart initiated the first of a series of innovations that would have an explosive effect upon mobile phone usage in the Philippines. Its first radical innovation was called Smart Buddy, an aggressive low-cost, high-coverage service targeting the middle and lower middle- income segments. Users accessed the offer by purchasing a P100 (US$1.80) pre-paid, text-only SIM card (the small plastic card with an inbuilt chip that is inserted into a mobile phone) that they could then use to re-load airtime for texts and/or voice communication. The cards could be reloaded by purchasing "call and text" cards in P300 (US$5.38), P500 (US$8.97), and P 1,000 (US$17.95) denominations. The company launched Smart Buddy backed by an advertising campaign that featured a man with a bat smashing glass barriers to own a cellular phone.

Smart Buddy was followed in early 2000 by the launch of a subscription-based Pricebuster Plan which offered contract customers a choice of monthly service plans going as low as P120 (US$2.16). This was followed in August 2002 by the introduction of PureTxt 100 (US$1.83), a P100 denomination, text-only card. The cards offered 10 text messages and were valid for a month, and became an instant hit. All of these services acted to broaden mobile phone usage beyond business executives, professionals, government officials and high-net-worth individuals.

By the end of 2002, the number of mobile phone users in the Philippines was 15.2 million. Smart had 6.8 million subscribers and Globe had 6.6 million subscribers. The Philippines had become the texting capital of the world, and the country's 22 million phone users sent an estimated average of seven texts a day.

Expanding the market: Serving low-income consumers

Smart’s low-cost, high-coverage marketing strategy targeting the middle and lower middle-income segments had been very successful for the company, and innovations such as Smart Buddy and the PureTxt 100 text-only card had delivered relatively low-cost propositions to a broader customer base. But despite this success industry analysts believed that the market was heading towards saturation. They pointed out that, close to 50 percent of the population in the Philippines lived below the poverty line, and mobile usage by consumers in the D and E segments (families earning an annual income of less than PHP 60,000 or US$ 1,100) was virtually non- existent.

Besides the initiatives already outlined above, Smart had introduced various innovations to increase market penetration and average revenue per user between 1999 and 2002. In December 2000 in cooperation with 1st eBank (now Banco de Oro Universal Bank) and MasterCard, the company had launched Smart Money, a service that enabled mobile electronic cash transfers. With Smart Money users could deposit money into a Smart Money account even if they did not have a bank account, and then use their mobile phone like a debit card to pay for a variety of

goods and services in thousands of shops and restaurants nationwide. Account balances were stored in a centralized host system, not in the card, reducing concerns of lost phones or the need for users to carry large amounts of cash. With the Smart Money service, customers could reload airtime to any Smart Buddy mobile phone via SMS (if they had a bank account) or at any one of thousands of Smart Money merchants across the country.

Using Smart Money, customers could also transfer money from their own Smart Money card to another for a fee of just 2.5 pesos (US$ 0.045). For example, a parent could wirelessly transfer credits from their own phone to the phones of their children, while people working in the city could transfer credits to parents or relatives living in the provinces. This concept was readily accepted in a country where the major form of hard currency earning was from remittances sent by workers abroad.

But despite the innovativeness of many of its new services, they did little to help the company penetrate low-income segments. To develop propositions to reach the low end of the market, and particularly consumers in the D and E segments, Smart recognized that it could not benchmark others in the mobile industry, as there were very few cases of mobile network operators who had successfully developed propositions for very low-income consumers. Instead, the company looked at companies that already served this segment with other products and services, and undertook its own market research on consumer buying behavior. The company soon recognized that most Filipinos from low-income segments received low weekly (and in many cases daily) wages meaning that cash flow management was a key issue.

Smart discovered that while P100 (the lowest price for a prepaid card in 2002) was not a lot of money for a consumer from the A or B segments, this amount represented a significant cash outlay for a family living in poverty. Indeed, one hundred pesos represented more than 80% share of daily income for over half of the families in the country

Not surprisingly, when Smart looked to companies such as Procto & Gamble and Unilever that served the D and E segments with fast-moving consumer goods they discovered that these firms had developed low-priced micro-packs for daily necessities such as shampoo, soaps, cigarettes and food. While these ‘sachets’ did not represent the most economical way of purchasing goods, they met the needs of consumers in terms of low purchase prices. The vast majority of these items were sold through the country’s small ‘Sari-Sari’ stores (Sari-Sari means varied in Tagalog) that survived on high turnover low-value transactions. Indeed, "tingi-tingi" or "purchasing goods in small amounts" was part of daily life. Customer surveys revealed that low-income Filipinos made an average of four to five trips a week to their local Sari-Sari store.

Sari-sari storeowners were typically small merchants with close connections to their patrons. These merchants often provided credit when their customers were unable to afford cash purchases. It was estimated that there were over 750,000 such stores in the Philippines at the end of 2002. While Smart had 50,000 resellers of its pre-paid cards, these were predominantly medium-sized storeowners and dedicated mobile resellers in towns and cities, and the company

had very limited penetration of Sari-Sari stores in non-urban areas. A significant barrier for Sari-Sari store owners in becoming pre-paid card sellers was the cost associated with stocking prepaid cards.

Smart also recognized that serving Sari-Sari stores in isolated rural areas with pre-paid cards would make supply chain management costly and difficult. Warehousing, transportation, and pilferage costs all contributed to the minimum value at which a pre-paid card could be sold profitably (estimated at approximately P100 in 2002), and most industry experts saw this as an insurmountable barrier to serving geographically isolated low-income consumers.

Smart’s consumer research revealed other interesting information. One of the major barriers for consumers to use mobile telephony had been the high cost of mobile handsets. Few of these consumers had bank accounts or an income high enough to be considered for a subsidized mobile device, so handset acquisition had been a significant barrier to usage. But since 2001, a significant development in the Philippines market had been the growth in the used handset market. Smart’s research revealed that second-hand handsets were becoming available at less than half the price of new models, drastically decreasing barriers to ownership.

The road ahead

Napoleon L. Nazareno looked out of his office towards the sprawling suburbs of metro Manilla. Was there an opportunity for Smart to serve the millions of Filipinos living in poverty, or should his company continue to focus on developing innovations and propositions for those consumers already using mobile telephony? Could any of Smart’s existing innovations allow the company to serve lower-income customers?