It’s an age-old marketing pitch, “try it risk free!” The catch, you have to cancel within some specified time, often 30 days. It has been used in the publishing space for years, particularly by magazines, like Time Warner’s (TWX) namesake Time. It has been used in the services space, too, particularly in technology services provided over the Internet, such as Salesforce.com (CRM). However, Verizon’s (VZ) offer of a free FiOS trial is a bit different because of the large outlays the telecom must make to set up a new FiOS account.
The results of this trial offer could be very profitable or very costly, and only time will reveal the outcome. If it works, more such offers could surface in the broadband space. If it fails, Verizon shareholders will likely share the company’s pain as earnings don’t match market expectations or, in a worst-case scenario, it is forced to post a loss. That the company is making this tactical offer is a statement about the competitive state of the broadband space, into which cable companies, such as Cablevision (CVC), Time Warner Cable (TWC), and Comcast (CMCSA), have been aggressively pushing.
In the magazine world, such a free trial offer isn’t a big deal. Printing just one more copy of Time or a newspaper, such as The New York Times (owned by the company of the same name; NYT), costs virtually nothing. Delivery costs are relatively small, too, often including bulk postage or a home delivery service that was likely driving by a new customer’s home anyway. So a large number of trials with few takers for these products still allows for profitability. In fact, that is the expectation—lots of trials and few takers.
With a web based service company like Salesforce.com, the costs are likely to be even lower, as one more person using an application is virtually free to the company. So the more trials the better, as even a fractional number of takers will likely lead to large profits.
The business model in the publishing and web services space is that once a company covers its stranded costs (such as printing), almost all of the additional revenue drops to the bottom line. This is obviously great for earnings, but it requires a material base of business. That base of business is a notable barrier to entry, though in some cases, particularly on the web, the barrier is receding as computing costs fall. (The downside to the model is that once sales drop below the break-even point, losses pile up quickly.)
Verizon’s effort, however, is fundamentally different. It costs the telecom almost $1,400 to set up a new customer with FiOS. For the most part, this expenditure can’t be recovered. Even a small number of cancellations can turn this experiment into a quick failure, which is probably why the company has historically required contracts with large cancellation fees.
Indeed, assuming that each new customer pays Verizon about $1,700 a year ($142 average revenue per FiOS customer a month for 12 months), it would take about 10 months to recoup the installation costs from one new customer. That back of the envelope doesn’t include any advertising costs. If the conversion rate were 50%, meaning that for every two trials one person stayed on as a customer, Verizon would be giving up about 20 months worth of revenues for each new account. Conversion rates for free trial offers in the magazine and newspaper spaces tend to be fairly low, so the math could get ugly for this Verizon sales effort pretty quickly if it isn’t well received.
The goal, clearly, is to get new customers and keep them for a long time. The “stickiness” of providing customers with multiple products is a great help on this front. However, the offer is designed to bring uncertain customers to the company—these are the very types who could quickly justify canceling if they are unsatisfied for any reason. This could make spending $1,400 on each customer a relatively large risk.
This risk remains even though each new FiOS customer spends roughly 80% more per month than a traditional wireline customer ($142 per month versus about $78). So while the effort will create what some might call a higher quality (or at least higher paying) customer base, anything less than a 50% conversion rate makes the effort an expensive gamble.
In the end, the company has a reliable core customer base, solid free cash flow, and a strong balance sheet (taking into account that telecom companies tend to be highly leveraged), and could easily handle the costs if this sales effort falters. Still, a failure here would likely nick earnings at a company that is already out of favor on Wall Street. It could also be a sign of management desperation as it attempts to gain more traction with a multi-billion dollar corporate transformation with only a 25% penetration rate after more than five years on the market. In the end, this could be the bigger news.