Cell Tower Optimization Analysis

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The cell phone industry is one of the most rapidly changing and growing areas of technology. There is a constant flow of new ideas, knowledge, and discoveries. One of the most important developments over the next several years will be the introduction of a 5G network. This network will improve communication all around the world, supporting a greater capacity of data and lower latency. 5G will necessitate the significant investment to upgrade the equipment on roughly 150,000 existing macro cell towers with more than 300,000 carrier tenant relationships. 

Small Cells: A Critical Component of 5G

In addition to traditional macro cell towers, 5G will also require the construction of new small cells. Small cells are inexpensive, low capacity, short range equipment that are used to enhance coverage in densely populated areas to better handle network congestion. This report presents a model that helps explain the decisions that carriers need make to optimize their networks based on incremental cost to provide enhanced coverage using small cells. Additionally, it demonstrates and quantifies the extra capacity carriers can achieve from small cells based on relative population densities of a hypothetical region.

Significant impact on T-Mobile/Sprint Merger

This analysis can be used to assess the cost competitiveness of the four dominant cell phone carriers in the United States: Verizon, AT&T, Sprint, and T-Mobile. It is clear that 5G’s requirement for extensive small cell infrastructure heavily favors the carriers with larger market shares. It therefore indicates the critical need for carriers with inferior market shares, such as T-Mobile and Sprint, to merge. The conclusion of this research suggests that the T-Mobile and Sprint merger is necessary and justified, despite antitrust concerns. An FTC decision is expected by 2019.

Model Assumptions:

Cell phone tower companies use two types of cell phone towers in order to ensure coverage: small cells (relatively newer) and traditional macro cells. Range, cost, and capacity are the three key factors that differentiate these two types of cell phone towers. As shown in the exhibit, small cells have a fixed cost of roughly $30,000 to install whereas macro cells are priced at more than $500,000. Rent for small cells can be as low as $200 a year if the cell tower company can lease it on public right of way. However, this proves very difficult, and cell tower companies usually need to lease on billboards or on buildings, which cost $200 per month and $2,400 per year. Cell phone tower companies lease land in order for the construction of macro cells, which usually costs $37,000 per year. The range of small cell is 0.04 square miles whereas macro cells will cover 144 square miles. Finally, on average, small cells support 100 people whereas macro cells supports 1,200 people. This capacity assumes each person uses 8GB of data per month and therefore 96GB of data per year. The number of people supported by a macro cell and small cell would change if the consumers in their respective area used more data than the average consumer. 

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Methodology:

This optimization model analyzes the data for a hypothetical region, with communities of varying size and population density ranging from urban, to suburban to rural. The hypothetical region is 20 miles wide and 30 miles long, having an area of 600 square miles. The land encloses 1,000,000 people and based on the average data consumption of 96 GB per year, it is assumed that the total amount of data used is 96,000,000 GB per year in this region.

Assessing Small Cell Utilization: This model assumes that a carrier constructs 100 new small cells to support every 10,000 people, in each community. The communities are ranked by population density from highest to lowest. Using a range of 12,000 to 250 people per square mile, I was able to calculate the size of each community. The community sizes ranged from 0.83 square miles to 40 square miles. The data below represents the calculations for Verizon. It is crucial to consider the market share of the carrier in these calculations since the carrier will only be able to service the subscribers in that community. It is also assumed in this model that each community’s market share is representative of the entire population. Full capacity of the small cell is achieved when the carrier has 2,500 subscriber per square mile derived by having 25 cell towers every square mile each servicing 100 people. The necessary population for a specific carrier to operate at full capacity can be calculated by dividing 2,500 over the market share of the specific carrier. This is the minimum population density a carrier needs to have in order to achieve full capacity. This will lead to a utilization rate of 100%. However, small cells in communities with a population density less than the minimum needed per carrier will not be used to full capacity and therefore, the utilization rate will operate on a pro rata basis of the population density to the necessary for full capacity. The table below illustrates this capacity analysis for Verizon.

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Assessing Incremental Costs of Small Cell Additions: The additional GBs of data from the small cells shows how much extra data would likely be used based on the population densities above and beyond the base coverage provided by the macro cells servicing the area. 100 small cells can provide 960,000 extra GB, or a 1% increase in capacity, if being utilized to full capacity. That rate declines as utilization rate decreases in less densely populated areas. Cost per pop is how much the carrier pays in order to ensure coverage for each person in that community. As seen in the table below, the cost per pop rapidly increases as the small cell become less utilized. 

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Results and Conclusions from the Model:

The analysis demonstrates that as communities become less densely populated, the increase of additional data being used per small cell diminishes due to the decrease in utilization rate. The small cell is not being used to full capacity since there are fewer people in these communities. The carrier pays for unnecessary extra data while receiving no extra customers/revenue. The cost per pop for the carrier rapidly increases as there are fewer people using these small cells. Government laws ensure that carriers are prohibited from discriminating against these individuals by charging them higher prices. 

Graph 1 exemplifies the limitations for Verizon specifically. Assuming the incremental cell phone plan is $20 a month or $240 a year, Verizon can only support approximately 400,000 people (through the installation of 4,000 small cells) before it becomes uneconomic. The carriers, therefore, needs to find the optimal incremental capacity through the construction of new small cells before the overall cost per person exceeds the revenue they receive from each customer. 

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Graph 2 illustrates the maximum increase in capacity Verizon can achieve through additional small cells. Eventually the graph begins to level off as population density decreases in rural markets. In this case, Verizon can only effectively add roughly 33% of additional capacity.

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T-Mobile Sprint Merger Analysis:

There is a lot of discussion about the recently proposed Sprint and T-Mobile merger. Individuals are concerned how this merger will affect not only the cell phone tower. A decision on the merger is not likely till late 2019. The Federal Trade Commission (FTC), which determines antitrust rules, could view the merger as anti-competitive, if it is unfair to the consumer by reducing the number of dominant cell phone carriers from four to three. The FTC fears the combination of two carriers will limit flexibility and opportunity for the consumer, which will ultimately allow carriers to use this to their advantage in raising prices. However, through this model, we have discovered the T-Mobile and Sprint have strong reasons to argue for the urgency of this merger and why they should be able to overcome the FTC’s opposition. 

This model can be used to quantify the significant disadvantage Sprint and T-Mobile have in comparison to their competitors, Verizon and AT&T. This disadvantage stems from Sprint and T-Mobile’s much lower market shares than Verizon and AT&T particularly as the two carriers have to incur significant investment to build out a 5G network which requires replacement of all equipment and a rollout of small cell infrastructure. 

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Graph 3 emphasizes the disadvantage Sprint and T-Mobile. Sprint can support roughly 210,000 extra subscribers and T-Mobile can support roughly 300,000 extra users and still remained profitable. This contrasts significantly to their competitors Verizon and AT&T who can support up to 380,000-400,000 extra subscribers before their incremental margins turn negative. 

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Graph 4 illustrates the maximum incremental capacity each carrier can support with the construction of new small cells. As we can see, Verizon and AT&T are able to add roughly 30% or more of additional data capacity. Sprint and T-Mobile can add 13%-20%, which is substantially less.

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Unlike their competitors, Sprint and T-Mobile do not have the scale to build the 5G network that is scheduled to be introduced by the beginning of 2019 and thus will limit their profitability. According to the model, in order to build a 5G network, the carriers must add new equipment with 5G capability, which includes putting in new equipment on macro towers as well as upgrading or adding small cells. Since one portion of converting to 5G is building small cell towers, this analysis shows just how uncompetitive Sprint and T-Mobile are on this portion of the 5G conversion.

Given these extra conversion costs as well as other 5G costs, Sprint and T-Mobile may find it difficult to successfully compete in the future. This ultimately could lead to a question of their ability to survive. This could result in the number of dominant carriers declining to two instead of the proposed three based on the merger. This demonstrates just how critical the Sprint T-Mobile merger is for its future competitiveness against Verizon and AT&T. It also emphasizes how the merger is actually pro-competitive and not anti-competitive as the FTC may suggest. According to John Butler, it is estimated T-Mobile and Sprint’s merger would provide them with roughly 25% of the market, just below AT&T’s market share of 26%. Therefore, the result of an approved merger would be three equally strong competitors instead of two strong and two weak competitors.