|Issue No. #10||17 April 2002||ISSN: 1532-1886|
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When is Slippage and Breakage Good for Profits? by Carl Wright
On the face of it, slippage and breakage sound bad. They make me think of people falling and getting hurt and of damaged products. This must certainly result in lost revenue and profits, but it's not what happens in the sale of prepaid calling cards.
In prepaid calling card business, slippage is the practice of rounding up the the call duration to the next minute or multiple number of minutes. For example, some calling cards charge for a minimum of four minutes and then three minute intervals thereafter. This means that a five minute call is charged as a seven minute call.
Let's be specific. Let's suppose I buy a calling card to make calls to Australia. The calling card vendor says that the cost of a call from the United States to Australia is 22 cents per minute. The price per minute seems quite reasonable when look at it as 22 cents per minute, but the slippage effect changes the per minute cost as shown below.
Figure 1. Graph and data table showing slippage for an international calling card
Suppose the calling card vendor adds a connection surcharge of $1.50. Mine did. This creates the following actual costs for the call scenario.
Figure 2. Graph and data table showing slippage for an international calling card with a connection charge.
Using this slippage feature in your rate plan allows you to quote a lower price per minute while actually charging a higher average fee. Using a connection charge further increases the average per minute revenue. This helps protect telecom operator margins at a time when there are powerful competitive pressures to push down prices.
Breakage is when the owner of the calling card can't or doesn't use all of the services they bought with the card. For example, they can't spend it all because the minimum charge for their next call is greater than the amount left on the calling card. If you include a connection charge like my example above, you increase the minimum fee to start a call and increase frequency of breakage from having too small a balance remaining on the card.
A report by the Pelorus Group reported that as recently as 1998 the breakage on prepaid calling cards was averaging around 53%. This meant that only 47% of the long distance calling minutes sold were actually used. They report that since 1998, the breakage has dropped off "dramatically and rapidly".
Breakage was a beautiful thing for the prepaid calling card business. You sold a 10 dollar card, but the average user used less than 5 dollars worth of retail priced services. It has faded in importance, but it remains a part of the margin in the calling card business.
The value of the breakage phenomenon is greater than it might seem. The following explains why it matters so much.
Figure 3. How the breakage ratio increases overall margins.
If you sell $1,000,000 of calling card services at a breakage rate of 50%, you only have to deliver $500,000 of retail product. If you provide that $500,000 with no profit, you have a 100% margin on the sales. So long as you can depend on the breakage rate, you can price calls below cost and make attractive margins.
The margin I'm referring to is the amount made on the provision of services. When you have breakage, you don't have to provide all the services purportedly sold. This gives you a very valuable additional source of profit.
|With a 2% margin on the provided services:|
Figure 4. An illustration of the impact of breakage rates on total margins.
The total margins from breakage shown above are detailed in an Excel spreadsheet. The spreadsheet shows the impact of breakage on total margins over a larger range of values. The spreadsheet is Excel 2000 (version 9) format.
Telecommunications providers worldwide have been under increasing pressure to compete on the basis of price. This pressure to lower prices occurs at the same time that all the same providers need to maintain market share and margins.
Techniques like slippage (a form of rounding up usage) give marketers a technique to respond to the price competition pressure without giving up all their margin. Breakage gives a powerful reason why telecommunications providers want to provide prepaid services.
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