(co-authored by Peter Matthaei)

Not so many moons ago, the only meaningful way to offer a service for cellphone users was through the Value-Added Services (VAS) channels that the network operators provided.  These include SMS, USSD, interactive voice response (IVR) and carrier billing (where the user can pay for mobile content from their airtime).

It was a great first step that helped to kick-start the mobile revolution by allowing a wide range of third-party services to make a phone into something more.  Something more personal, perhaps, by allowing users to purchase ringtones and wallpapers.  Something more useful, perhaps, by letting users look up the numbers for a business simply by sending an SMS.  Something fun, perhaps, by offering an SMS dating service.

In fact, the network operators in South Africa were amongst the first in the world to adopt the VAS model.  It has contributed to the huge growth of the mobile market in South Africa, and in many ways ensured that South Africa was far ahead of places like the USA in the sophistication of the mobile services offered.

But the cellphone industry is moving, literally and figuratively, at the speed of light.

What’s the difference between buying a ringtone via the mobile web using a bankcard or mobile wallet and buying a ringtone via premium-rated SMS?

Price.

The latter will always be more expensive. Period.

Why? Because the mobile operators will always take too much revenue share. In SA, MTN keeps about 40%, Cell C about 30%, and Vodacom about 20%. The weighted average is 29%.

Compare that to Visa and MasterCard who take between 1% and 7%.

And the networks will stay the same for a very long time. Why? Because they are accustomed to operating profit margins of 20% plus. The moment they retain less than 20% they dilute their profit margins, and by definition they become less “profitable.”

And the analysts don’t like that, so in spite of actual profit going up due to higher revenue, the share price will be smacked.

And the CEO of the mobile operator will watch the value of his share options plummet.

Therefore, no CEO (that I can see) will make any changes to the status quo. Even though by dropping their fee to 1% they would become the largest financial institutions in South Africa virtually overnight due to the power of the prepaid distribution channels…

So content supplied via premium-rated SMS and USSD and online-billing-services and IVR (29% mark up) will always be more expensive than content provided by mobile web services (5% markup).

Slowly but surely the shift from the VAS model to apps and mobile web applications is happening.

The VAS model globally was disrupted massively by the arrival of the iPhone and its ecosystem.  The iPhone is designed primarily for data access.  Voice, SMS and USSD are more like “apps” on the iPhone rather than the core around which the device is built.  It was very clear that Apple did not intend to have their device be shackled by the VAS model.  Applications are bought using credit cards or vouchers (not carrier billing!) through the App Store.  Instead of making SMS (or MMS) the preferred way of sending communications, the iPhone nudges people towards sending e-mails.  Instead of letting app developers use SMS to communicate back to their users, the iPhone provides push messages.  Instead of relying on getting a user’s location from the cellular network (which cost about the same as sending an SMS), the phone has a built-in GPS.

The trend is clear: the iPhone wants to move users and service providers away from SMS, MMS, USSD, carrier billing and network-based locations towards data.  Firstly, this is great for users and service providers alike, because mobile data is ten times cheaper than voice and around two thousand times cheaper than SMS.  Secondly, this ensures that service providers can roll out their products globally without having to worry about integrating carrier billing and SMS on hundreds of different carriers, each with a different standard, costing structure and regulations.

Apart from this freeing the service providers from the extortionist fee structures of the carriers, it also saves significant development costs.  Plus, being able to launch a service globally (either as a native app or a mobile web application) allows services to achieve much greater scale than was previously possible.  Better scalability means lower operating costs, meaning cheaper services for users.

The irony is that while local mobile service providers advertise ridiculously overpriced mobile content subscriptions – often amounting to R15 or R20 per day (!) – on SABC 1 to South Africa’s poorest consumers, on my iPhone I can get an incredible range of content and services through my browser or the app store for free.

The carriers argue that value-added services follow open market principles and hence if prices are too high, it’s because consumers are willing to pay those high prices.  There is merit to that argument, but it’s not the full story.  One of the biggest problems with the VAS model is that there is no easy way for consumers to discover services.  Hence, the VAS model relies heavily on TV and above-the-line advertising, which is expensive and in turn pushes up the prices.  Also, service providers cannot easily differentiate themselves on quality of service.  This is partly because consumers find it hard to discover services and partly because the technology is very limiting.  The result is that the only way to grow revenues is either through more, expensive advertising (which drives up prices) or by trying to extract more money from users for the same service.  Both ways are heavily used within the VAS industry and both end up being horrible for the consumer.  The most common tactic to extract more money from consumers is to try to trick people into a subscription service and make it very hard for users to get out of such subscriptions. This makes the VAS industry the only commoditised industry where prices have increased as more competitors entered the market.

Of course, while iPhone gets the credit for its massive disruption in of the mobile industry abroad, locally we’ve had a similar disruption in the form of MXit long before the iPhone was a twinkle in Steve Jobs’ eye.  The huge success that MXit has experienced in the local market is largely due to the fact that it succeeded in providing users with a (comparatively) rich and diverse experience using data channels instead of VAS channels.

Google’s Android smartphones offer very similar functionality to an iPhone.  Android is growing at an incredibly rapid pace due to large numbers of cheap handsets on offer.  Very soon, Android devices that are cheaper than the magic $100 price point will enter the market.  At that point, the line between a “smartphone” and a “dumbphone” will start blurring and then fading.  With non-carrier controlled app stores and powerful mobile browsers, most of the pieces will be in place for the retirement of the VAS model.

All that still remains to be found is a ubiquitous low-fee payment method to replace carrier billing for people without credit cards.  On that day, the old-school premium-rated services will be over. Game over insert coin.