Is Verizon Right to Sacrifice Subscribers for Profits?

By Markets Fool.com

By most accountsVerizon had a pretty good quarter.

Continue Reading Below

The company was off slightly from the same period last year reporting $1.02 in earnings per share compared with $1.15 per share and 84 cents in adjusted EPS (non-GAAP) in the first quarter of 2014. One the wireless side, revenue was solid increasing by 6.9% year over year, but there were some red flags when it came to the company's subscriber numbers.

Though Verizon remains the top wireless provider with 108.6 million total retail connections, according to CFO Fran Shammo who spoke during the company's call with investors, it did lose some customers.

"Postpaid phone net adds were a negative 138,000 as the smartphone adds were more than offset by a net decline of 385,000 basic phones," he said. "Additionally, net prepaid devices declined by 188,000 in the quarter."

It's not that Verizon showed a slight dip for the quarter, it's the reasoning behind it. And whether the company can maintain both its profitability and its user base in the face of increasing price competition fromT-Mobile,Sprint, and nowGoogle may well hinge on this decision.

What is Verizon doing?
Essentially the company has decided to not become involved in the pricing wars which are being led by T-Mobile and Sprint. Instead, the company has elected to focus on "maintaining a disciplined approach with a focus on retaining high-value customers," Shammo said.

Continue Reading Below

The CFO explained further later in the call in response to a question from Brett Feldman, a Goldman Sachs analyst.

If you look at prepaid just on a stand-alone basis, our prepaid retail pricing is slightly at a premium to some of the other competitors' postpaid pricing. So we are in a competitive pricing standpoint and, as I said coming out of the fourth quarter, we have to be rational and we will not chase every customer. But we are making every effort to maintain our base and keep our customers and upgrade them into a price plan that's fitting for them.

Shammo continued by acknowledging that this plan could cause the company to continue to lose subscribers.

We are not satisfied with any losses, but then again, we will not chase every add either based on just cheap price. So I think that's the balanced equation that we showed in the first quarter.

After being prodded in a follow-up question from Feldman, Shammo took an even harder line when it can to customers who put price first.

What I would say is if it's a customer who is just pricesensitive and does not care about the quality of the network or is sufficient with just paying a lower price, then that's probably a customer we'renot going to be able to keep on the Verizon Wireless network.

Essentially Shammo made it very clear that Verizon will continue to sell the idea that quality comes at a premium price and be willing to let customers who put cost over everything else leave.

This may be a bad idea
Verizon has stuck to its quality if worth paying for mantra for a number of years, and it used to make sense. As a wireless market leader, along withAT&T the company did, at one point, have a much better network than Sprint and T-Mobile, its lower-cost rivals. Recently however that advantage has shrunk and while the top two companies do have better networks, their upstart competitors have dramatically closed the gap as was demonstrated in the RootMetrics Mobile Network Performance Review for the second half of 2014.

Source: RootMetrics

"While Verizon and AT&T top the charts, all networks are getting better," said the report. "We saw improvements across the board in data speed and data reliability, which are fast becoming keys to everyday mobile experience. The biggest improvement stories belong to T-Mobile and, especially, Sprint with its marked call improvement."

Verizon is making a mistake
T-Mobile's fourth place score would have actually beaten Verizon's first place score in the same study for the first half of 2014.

Source:RootMetrics

Verizon had a network advantage as recently as early 2014, but the lead it has now is not enough to base its business around charging more for quality. T-Mobile and Sprint have made vast improvements which make it so that most customers do not sacrifice quality for cost savings if they switch. Add in the wild card that Google's new Fi wireless service can access both Sprint and T-Mobile's network and selling quality seems like an increasingly bad idea.

Verizon has ridden this strategy as far as it can go. By sticking with it, the company is likely to see further declines and it's possible the bottom will fall out.

It's time for Verizon to change and embrace the reality that its days of charging more are over. It just may take its 100-million-plus subscribers a while longer to catch on, but ultimately they will.

The article Is Verizon Right to Sacrifice Subscribers for Profits? originally appeared on Fool.com.

Daniel Kline has no position in any stocks mentioned. He enjoys Fran Shammo's name because it makes him think of the ShamWow which is not nearly as absorbent as the commercials claim. The Motley Fool recommends Goldman Sachs, Google (A shares), Google (C shares), and Verizon Communications. The Motley Fool owns shares of Google (A shares) and Google (C shares). Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.