Apr 23, 2013

M2M service provider metrics

This note is part of my occasional series dealing with business metrics for the M2M sector. On this occasion I examine a few operational benchmarks for an M2M service provider. In this case, I have drawn on data for Numerex in the US which is one of a few publicly quoted entities in the M2M market.

Numerex was established in 1992 and has focused on wireless connectivity since 1999 after divesting its wire line business to BT. The company recently passed the 2m connections milestone during Q1-2013. While this connections base is small in relation to the M2M business units of the large mobile operators (many of which fall in roughly the 5–10m range) it serves as a useful reference point for business planning, performance benchmarking and investor due diligence insights. These are highly topical in the present climate where companies are expanding their M2M operations; this earlier post on building a billion dollar M2M business, for example, has been the most read item on this site in recent months.

The main driver of revenues for an M2M service provider is the base of connected devices and the revenue from each device as shown in the Chart #1 below (I use the ARPU label for convenience of notation). Numerex’s base has grown consistently over the past few years, at a compound annual rate of 27% which is broadly in line with industry analyst expectations for the overall market. At the same time, ARPU has declined at an annual rate of 9%. This decline is tolerable since the faster pace of growth in the base of connections has resulted in rising top-line revenues.

Numerex’s business model includes a hardware component which also contributes to top-line revenues as shown in Chart #2. Interestingly, the company generates a contribution from the sale of devices.

I have made several assumptions from the published Numerex data to estimate the number of new connections in each quarter. This is then used to quantify the average revenue per device and the associated gross margin. This analysis indicates that Numerex has found a way to bring device costs down over time (hence lowering barriers to adoption) while still generating a contribution margin over most of the recent quarters of operation.

Using the same figures I derived for new connection sales, I also looked at a couple of operating cost trends. Chart #3 deals with two cost categories: sales and marketing; and other costs that encompass administration, engineering, bad debt and depreciation.

Sales and marketing per new connection was initially volatile but appears to have stabilized at around $20 per new connected device. This suggests that Numerex was fine tuning its business model around the 2010 period. The stabilization of operations combined with improving economies of scale also shows up in ‘platform running costs’ which are now trending at about $10 per connected device per year. These data points are useful for connection life-time value analysis and business model optimization as I have written about here.

I will note that the calculation of sales and marketing expenditure per connected device is an artificial one. This is because the impact of sales and marketing spend in a given period will show up in contract wins at some later point in time. To explore this point, Chart #4 shows the total spend on sales and marketing for each given quarter. It also shows the number of new connections for the period that occurs two quarters later. This visual correlation suggests that there is a 6 month lag in seeing the benefits sales and marketing expenditures. The coming quarters will be interesting to study in light of the fact that Numerex has recently trimmed its sales and marketing expenditure.

Overall, investors seem to appreciate Numerex's business given that its stock has handsomely outperformed the NASDAQ and S&P500 since 2009.

While the data points above are specific to Numerex and its business model, they do hold some relevance to the M2M business units of other organizations. Specialist M2M service providers with a comparable base of connections can assess whether their operations have been optimized and are repeatable to the extent that they enhance marketing effectiveness, support costs and business profitability.

The business dynamic is slightly different for mobile operator business units which benefit from factors such as more visible brands as well as existing enterprise customer relationships with attendant cross-selling opportunities. The challenge is to leverage these strengths into cost effective sales without 'overpaying' in marketing and sales costs. At the same time, the operating costs of supporting the installed base need to feed the benefits of scale economies to the bottom line and also into business unit value.

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