AT&T Wireless Case – ACCT 503
1. [10 points] Describe the cost behavior in the wireless industry. What are the implications of this cost behavior for cost-volume-profit (CVP) relationships?
Cost behavior is how a company’s costs change given a change in that company’s activities. Variable costs are costs that change proportionately with the changes in a company’s activities. In contrast, the costs that do not change with a change in a company’s activities are known as fixed costs. In the case of AT&T, costs are focused primarily into the fixed category. This means that as the company’s activities shift, its costs remain relatively unchanged. This combination of high fixed costs and low cost variable costs gives AT&T and the rest of the industry a large amount of operating leverage. The high operating leverage of AT&T means that the company utilizes a higher risk strategy which leads to higher profits as volumes increase. Essentially, as long as AT&T maintains a volume that covers at least its fixed costs, any additional volume translates into profit. This works both ways however, if volume decreases below the threshold for covering fixed costs then every decrease in volume yields proportionately equal losses. According to the case, there is little cost associated with text messaging. The case states that text messaging has an incredibly low variable cost, estimated at only a few cents per text. So basically, once AT&T has covered the cost of the required infrastructure to facilitate text messages, any revenues garnered from text message and virtually pure profit.
2. [5 points] What are the key cost drivers? Can a cost driver be used to continually raise prices?
A cost driver is the root cause of why a cost occurs. For AT&T and the wireless industry there are several cost drivers. The most obvious ones in this case would be the number of texts sent per minute and the number of customers handled by the carrier. However, there are many more. These include the number of cell towers in the area and the amount of database storage needed for handle the messages. In addition, individual cell phone plans and how many devices that are currently handled by a carrier in a given area are cost drivers. The primary cost driver used for the purpose of determining costs in this case is the amount of texts per minute.
In this case, with its high fixed costs and low variable costs, any given change in volume will have little effect on costs. So, for AT&T, the cost drivers are unlikely to raise prices. However, this is not the case for all industries. If a company has high variable prices and low fixed prices we would expect the opposite.
3. [15 points] What does it cost AT&T to send a text message?[Consider costs of the channel, billing cost, storage cost] Based on this cost, what is AT&T’s profit margin as a percentage of its short message service (SMS) text messaging business? [Consider per-use pricing and package pricing]
The case states that the average cost per voice minute is $0.07. From this the case determines that the equivalent amount of texts that can be sent, given the data transmission rates, is eighty-one. Thus the cost per text can be calculated as:
$0.07 / 81 = $0.0008641 per text
This, however, is not the total cost of a text. We must also factor in the costs of billing, databases, and storage. The case estimates the cost of billing at twice that of the wireless costs. Therefore we calculate the cost of billing as:
$0.0008641 x 2 = $0.0017283 per text
Database costs are estimated to be $10 million and AT&T is expected to carry 1% of the 3.5 trillion in world traffic. Knowing this we calculate the cost of storage as:
$10 million / ( 3.5 trillion x .01) = $10 million / 35 billion = $.0002857 per text
The cost of storage is assumed to be negligible in the case. However, I felt that it would still be interesting to calculate the cost. The case...
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