Where are the Verizon Profits?

Verizon Wireless "Rule the Air" Ad C...

Verizon Wireless “Rule the Air” Ad Campaign (Photo credit: Wikipedia)

I’ve been reading over the last few weeks about the controversy surrounding Verizon’s profitability in its wireless versus wireline business. Verizon has been claiming that it is not making very much money from its landline business while critics are charging that Verizon is cooking the books to make the wireline business look bad.

This link is a report on Verizon’s 3rd quarter earnings. In the third quarter Verizon had total revenues of $30.3 billion. This was comprised of $20.4 billion for the wireless segment and $9.7 billion for the wireline businesses. The profit story is quite skewed and they show profits of $6.9 billion for the wireless business but only $155 million for the total wireline business. If you take out depreciation to get operating margins, the wireless business made $8.9 billion for the quarter while the landline business made $2.2 billion.

In looking at these numbers as an outsider I ask myself if they make sense. I probably have more ability to judge these numbers than most people because I am privy to the books of hundreds of telecom companies that are in the same business lines as Verizon.

Verizon claims their losses for landline are so big because of all of their continuing losses of landlines. But all of my clients have been losing landlines and yet many of them are still quite profitable. Let’s look at some of the piece parts of the company to kick the tires on Verizon’s claim of low profitability:

  • Verizon has 5.2 million video subscribers. It’s a pretty well-known industry fact that these are low margin customers.
  • Verizon has 5.9 million FiOS data customers and another 3.0 million DSL customers. And 40% of the FiOS customers were buying the faster speeds of between 50 Mbps and 500 Mbps. Universally, data is a high margin business.
  • Verizon had 4.1 million voice customers on FiOS and 6.8 million voice customers on copper. While voice lines are dropping, and Verizon lost a net 432,000 customers over the last year, the margins on voice should be high.
  • Landline revenues include $3.6 billion in core and strategic services and another $1.7 billion in global wholesale. These product lines include what are the most profitable business lines for most telcos – such things as selling special access circuits, internet backbone connections and fiber connections to cell towers. Most of my clients report these business lines to be very highly profitable.

The overall operating margin for the landline business, at 23% ($2.2 billion of margin compared to $9.7 billion of costs) is very low compared to almost all of my customers. Much smaller telephone companies than Verizon have margins that are somewhere in the 30% – 40% range.

So, is Verizon just very inefficiently operated or are they cooking their books? I consider the following:

  • There is a lot of corporate leeway in assigning costs between operating divisions. I help my clients make these kinds of cost allocations all of the time and there is a wide variety of ways that you can allocate costs that will still fly with an external auditor. So Verizon has a lot of leeway to change the relative profits between the two operating divisions.
  • Verizon publicly has been trying to convince the FCC that they ought to be able to transition customers from copper to wireless. The most visible controversy has been about Fire Island off New York City that got devastated by hurricane Sandy. But Both Verizon and AT&T have made it clear that they would like to find a way to walk away from maintaining older copper.
  • On the surface the profits look too small. This either has to be the result of very inefficient operations or of allocating costs to slew profits. If the wireline business really only has a 20% margin then Verizon would be far better off to spin those businesses off to standalone regional companies who could probably double the margins within a few years.

It’s obviously very hard to know all of the facts within the books of a company as big as Verizon. But my gut tells me that they ought to be making more money on the wireline business. While Verizon claims the poor profitability is due to loss of landlines, that only comprises a small percentage of the landline business. A lot of that business comes from the very profitable business lines of supplying transport for the Internet and for cell sites.

So are they cooking the books? Probably.

Do You Know the Margins for Your Product Lines?

That sounds like a straightforward question and most businesses in the country can say yes to that question. But I find that a large percentage of telecom companies don’t know the margins on their products.

There are a number of reasons why it is important to know your margins.

  • You need to know if you are selling any product at a loss. It’s okay to consciously have a loss-leader product if selling it always also sells more profitable products. But it makes no sense to sell a product that loses money as a single product. If you have products that lose money you need to consider raising the price or stop selling the product.
  • You should be trying to sell what makes you the most bottom line. All too often I see telecom companies push products that get them a lot of revenue but not much margin.
  • Without knowing your margins you can’t understand where you need to cut costs. While raising rates is one way to increase margin, cutting costs can have the same effect.

Regulated telcos are very used to having separations studies performed that define their access costs. But these studies have no practical value to management and tell you nothing about your profit margins by product line. And many CLECs and cable companies have never done any kind of cost study.

There all kinds of studies that can be done to look at your margins. The most common are:

Fully allocated fully distributed costs. In these studies every cost in the company is distributed to products. Done properly these studies will define your gross margin (revenues minus direct costs of producing a product), your net margin (the margin after also allocating joint and common costs), and net income by product which will look at depreciation or a surrogate cost of the network layered onto your other costs.

Incremental costs. The large phone companies have historically produced TELRIC or other forms of incremental cost studies for state commissions. These studies do not calculate margins in the same way as a fully distributed cost study. Rather, they look at the incremental cost of producing one unit of the product. The main purpose of these studies is to prove that you aren’t selling products below cost, but otherwise they have very little practical value for management.

Luckily it is a very straightforward process to understand your margins. A fully allocated fully distributed cost study can be as simple as a spreadsheet that allocates every cost in your ledger to products using some logical allocator. The whole key to getting believable results is to develop the best allocators that you can find for the way your company operates.

CCG has done these kind of margin studies many times and we don’t see them being offered by a lot of other consultants. There are a ton of companies that do separations studies or TELRIC studies, but not nearly so many who do straightforward cost accounting studies that management can use. Once you have a good margin study on hand then management can begin to understand how costs affect your profits. As an example, you can quickly see what will happen to your margins if you hire a new employee or if the cost of your Internet backbone goes down. That kind of basic information is vital if you want to maximize the bottom line. Knowing your margins lets you concentrate on those things that will have the best impact to the bottom line.