Prepaid wireless outpaces contract services

Cash-conscious consumers are flocking to prepaid month-to-month wireless phone service in lieu of contract-based plans.

A study released by the New Millennium Research Council, a Washington, D.C.-based think tank, last week said new prepaid wireless customers exceeded the number of new contract subscribers that signed up for service in the fourth quarter of 2009. This is the first time that prepaid services have outsold post-paid or contract services, the group said.

New prepaid cell phone subscribers accounted for almost two-thirds of all 4.2 million cell phone subscribers that U.S. carriers added in the fourth quarter of 2009. The prepaid market grew 17 percent during the quarter to 54.4 million subscribers, up from 46.3 million during the same time a year ago. Meanwhile, contract-based cell phone subscribership grew only 3 percent over the same period.

According to the report, one out of every five of the 285 million cell phone subscribers in the U.S. now use prepaid phone service.

"Thanks to the recession, the U.S. cell phone marketplace continues to undergo fundamental changes that will just get bigger as the economic downturn deepens," Jose Guzman, the NMRC project's coordinator, said in a statement. "What is different from a year ago is the explosion in new 'all-you-can-eat' and unlimited prepaid deals as low as $30 and $45 that will remain attractive to consumers long after the current recession is over."

These inexpensive prepaid plans could force big cell phone providers, such as AT&T and Verizon Wireless, to slash prices on contract service plans to keep consumers from defecting. Prepaid services are typically less expensive than contract plans.

As prepaid providers, such as Leap Wireless and MetroPCS, move into offering wireless broadband data services, big operators may also be forced to drop prices on those services as well.

Bigger wireless providers have already begun to react. Late last year, AT&T and Verizon Wireless began offering daily and weekly prepaid 3G wireless service for laptops. Prepaid niche players, such as Leap Wireless and Virgin Mobile, which is now owned by Sprint Nextel, had been offering prepaid wireless broadband for a while.

Prepaid providers are also starting to get more cutting edge devices. For example, Leap is expected to get a touch-screen, Android-based smartphone from Kyocera this summer.

Prepaid cell phone plans, which have been very popular in Europe and other parts of the world for several years, allow consumers to buy a phone at full retail price, without committing to a contract, and pay for service in advance. By contrast, post-paid services require consumers to sign a one- to two-year service contract, and their usage is billed on a monthly basis. In exchange for signing a contract, wireless operators often subsidize the cost of the phone.

Market shift
For years, the post-paid business model has dominated the U.S. cell phone market, providing strong growth for U.S. wireless operators. Meanwhile, the prepaid market in the U.S. has been largely left to consumers who are young, price-sensitive, or considered credit risks. While all of the major cell phone operators offer prepaid services, smaller operators, such as Leap Wireless, MetroPCS, and Virgin Mobile USA, have largely dominated this market.

Now, it looks like the tide is turning. But making money from prepaid services isn't easy. And some of the smaller players still struggle with large competitors.

But some of these issues may be related to network coverage. Leap Wireless just announced it has expanded to have nationwide coverage, largely due to new roaming agreements. The company has suffered from high churn rates, or the rate at which customers dump its service. In the fourth quarter, the company had a churn rate of 4.7 percent, up from 3.8 percent during the same quarter a year ago.

While major wireless companies will still compete in the prepaid market, they may do so begrudgingly. The reason is that prepaid customers typically generate less than half the value of post-paid subscribers over time, analysts have pointed out. On average, prepaid customers generate less revenue per month than post-paid customers. They are more likely to switch back and forth between service providers. And they typically use more network resources, averaging around 2,000 voice minutes per month compared to about 1,000 minutes per month, than post-paid customers, according to Craig Moffett, a Sanford Bernstein equities analyst.

This means that wireless operators are likely to push their more expensive smartphones and service packages on consumers in an effort to keep their average revenue per user up.