54-Good Market Share. Fast Growth. No Profits. Why?

Price Leaders, low-end competitors depending on low prices to attract customers, thrive in comfortable markets. Even there, they must maintain a tight customer focus and cost discipline to maintain decent returns. Their market shares are usually limited because their Performance package is notably less robust than those of the industry leaders. As prices fall and margins come under extreme pressure, these Price Leader competitors usually fail or are purchased by a stronger competitor. Here is a Price Leader that has managed to thrive as industry prices fall continuously from comfortable levels. Can they keep it up?

Posted 10/20/08

Cogent Communications sells inexpensive, all purpose, digital connections to the business community. Today it carries 17% of all internet traffic. This is comparable to companies like AT&T, Verizon and Level Three Communications. Its revenue this year is on pace to grow by 19%. That all sounds good until you realize that the company expects to lose $25 million this year on the $220 million in revenue it expects. What is the problem?

Cogent is a low-end competitor. (See the Symptom & Implication, “Low end products are gaining share of the market”, on StrategyStreet.com.) We have studied several hundred of these competitors and we characterize Cogent as a Predator Competitor (see “Turmoil Below: Confronting Low-End Competition” on StrategyStreet.com). A Predator Competitor offers a product with functions equivalent to those of the industry’s leaders, whom we call Standard Leaders, but at a lower price. They can do this because they can achieve a distinctive cost-advantage over the Standard Leaders. The company sells what it calls a “dumb pipe.” Its pipe works as well as anyone else’s pipe, but the company has a less well-known brand name and presence in the market. It is a little harder for a buyer to buy from it. Its cost advantage comes from its ability to assemble its network by obtaining the networks of other failing competitors at very low prices. And, of course, the company depends on low pricing in order to gain its market share.

Cogent got into the business in 2001, when the going cost for high capacity data transmission was $300 per megabit per second. Cogent’s initial price was $10. Today, the market price to move a megabit per second is about $20. Cogent charges a lot less. It advertises itself as the “home of the $4 megabit”. The company is certainly cheap. It offers discounts of 50 to 98% off the price of data transport services that the better known companies offer.

The company doesn’t make money because its price discounts are too great. Our research suggests that Cogent could offer discounts beginning at 25%, and ending well before 50%, and still enjoy high rates of growth. These lower discounts would yield better profitability. That is, until the industry Standard Leaders respond and reduce the price gap they have with Cogent. As we have seen in other markets, the Standard Leaders are very reluctant to reduce prices, even to stop a low-end competitor like Cogent.

So Cogent could take some pressure off itself by reducing its rate of discount to something like an average of 33%, rather than the 80% discount they seem to be offering. Cogent is almost certainly going to have to raise its average pricing because it will have difficulty financing growth in its capital intensive business. It does have $30 million of free cash flow today, but its market cap is only $400 million. This supports an asset base with a replacement cost in excess of $2 billion. Not good enough for the next round of growth.

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Update 2022:

The company is a small player in the industry. It’s most recent 2021 sales were below $600 million per year. It has grown steadily though slowly over the last few years. Its recent growth rates are around 5% per year. It has continued with its service strategy to connect to 2 types of endpoints: data centers and large multitenant office buildings in large cities.  A part of its success depends on offering low prices. For the most part, they buy unused fiber from failing companies rather than use their own capital to build it. This reduces its capital intensity. It is profitable and continues to operate in this highly fragmented market.

A change in your price, either up or down, can be a difficult decision to make. HERE is a way to think about it.

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Update 12/25

The IT backbone and transit industry is becoming a difficult place to make money, primarily because of declining prices. Cogent is gradually losing share in the overall industry though it has areas of real strength. At the same time, the industry leaders are holding their share and profit positions by exploiting their superb Reliability reputations to offer quality-based contracts and to expand into related services. All the other competitors are starting to struggle under the pressure of commoditizing prices.

We examined six competitors in this industry. In rough order of market share these include Verizon Business, AT&T, Lumen, Arelion, Zayo and Cogent. AT&T and Verizon are competing on Reliability with their well-known brand names and reputations along with Function benefits such as managed services and bundles solutions, which smaller competitors cannot offer. These two leaders command the industry’s Very Large and Large customer segments. Lumen has also been a leader but has fallen off as the industry leaders squeeze it from the top and followers squeeze it from the bottom. Its Reliability reputation could not compete with the two industry leaders, and its offerings could not compete with the specialized Function, Reliability and lower prices of the industry followers. The industry followers, including Zayo and Arelion compete in the industry on Reliability of performance and peering quality along with Function advantages in fiber depth and with lower prices than those of the industry leaders. Cogent has migrated into more of a Stripper Price Leader (Offering low prices in return for fewer Function, Reliability and/or Convenience benefits). It offers simple products and contracts for very low prices.

Industry prices are posing profit difficulties for most competitors. Prices have fallen significantly and continuously in each of the last five years. These prices leave little room for companies to make decent profits. Today the price level of Verizon, AT&T and Lumen have converged at low levels. Price is becoming a commodity. For comparison purposes, we compare competitor low-end pricing in 2020 to that of 2025. Verizon has gone from $1.20 per Mbps to $0.45. AT&T from $1.00 to $0.45. Arelion from $0.70-$0.30. And Cogent from $0.50-$0.20. Cogent is regularly pricing 25% to 40% below the industry leaders. These low prices are squeezing the industry. Verizon and AT&T hold on to their premium pricing with their unique Reliability and Function benefits. The second tier competitors are seeing their returns on investment falling.

Cogent, too, faces profitability problems and the long-term risk. It has been able to create variable but decent average returns by focusing tightly on specific price sensitive customer types, by keeping utilization of its asset base high, and by maintaining its low cost structure through discipline and through acquisition of failing competitor assets. It faces longer-term challenges as market prices continue to fall, and fewer competitor assets are available for purchase. The next few years will challenge Cogent mightily.

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