• by Steve Smith , Staff Writer @popeyesm, April 24, 2006

The upcoming ad-subsidized Xero Mobile finally opened the books on its business model and advertising value proposition last week, when I spoke at length with CEO Peter Lilley. By giving college student users some free wireless airtime in exchange for viewing up to four video ads a day on their handsets, Xero's scheme enjoys the distinct advantage of being both novel and a bit audacious. But do the Xeros add up to a viable plan? Are we really at a point this early in the mobile marketing game where advertising can support an MVNO (Mobile Virtual Network Operator)? According to Xero, it really is a numbers game.

Actually, the most important part of the Xero equation is that the model does not rest solely on ad support. In fact, this will be a pay-as-you go wireless plan that is only partially subsidized by a user's daily ad viewing, which will produce a credit of so many minutes per ad. Xero estimates that for heavy phone users viewing a probable limit of four spots a day, advertising could return up to 40 percent of their monthly costs. This also means that Xero itself has multiple revenues streams: income direct from customers, from advertisers, and from handset sales. Still and all, can ad revenue and consumer interest be high enough to add up to a viable model?

"It works if you pick the demographic that advertisers are willing to pay the most for," says Lilley. By limiting its customer base to college students (school ID required) Xero will control its own marketing costs and deliver a segment that is costly and hard to reach via other media. The upfront profiling of customers also allows for ad targeting by gender, geography, cultural taste, etc. Xero estimates that typical TV media costs advertisers between 25 and 40 cents to hit each 18- to 22-year-old. They expect that for a 30-second spot on its handset, the advertiser cost will be more like 15 cents a person, or "about half the price of TV," Lilley says. We may be hearing about Xero's first ad partner in the next couple of weeks.

Xero will be selling primarily TV-like video spots, but they will not be streamed, nor will they require a 3G mobile network. The system downloads the day's ad package to a handset when not in use. This ensures that the ads will play glitch-free and that the system works with a less expensive 2.5 network if necessary. When users finish watching an ad, they press a key that confirms they saw the ad and credits their account with so many minutes of use. The advertiser only pays for ads that have been viewed. Xero has secured an unnamed MVNE (Mobile Virtual Network Enabler), which usually runs much, sometimes all, of the back-end technology and billing operations, but it is still in talks to land an actual wireless network to carry the MVNO.

The college target is also important to Xero's hopes for consumer uptake. The company likes to highlight an addressable market of over 17 million college students, but you would be hard-pressed to find one who doesn't already have a cell phone--probably one that the parents are paying for. In essence, many students already enjoy "free" phone service, so how does Xero plan to lure them? Xero's focus groups suggest that the undergrads will ditch the family plan in order to get ownership of their own phone (well, we're guessing that Mom and Dad will still pick up the tab), a carrier relationship without a long-term contract, and also get what Xero promises to be the latest, greatest, tricked- out handsets.

But 15 cents a head also only works if you deliver scale. Business plans like Xero's have an inherent weakness. They rely on an ad revenue stream that only opens up when a platform has the reach to generate serious sales. Lilley admits he learned this hard lesson at his previous company, Gizmondo, which tried and failed to deploy an ad-subsidized model for handheld game consoles. The upfront costs to consumers for the hardware was just too high to scale quickly enough for sponsors. "What I learned is that when you sit in front of advertiser[s] about ads on a device, they get excited about it... but you [still] need a critical mass," he says.

And so the most important and costly number in the Xero equation is one million. In order to ramp up immediately to sufficient scale to attract advertisers, Xero plans to give away the first one million handsets to college students. Will the undergrads take the bait? Pointing to Microsoft's Xbox 360, which pushed out 400,000 units at $300 to $400 a pop in its first 24 hours, Xero's director of marketing Mika Astrom, says, "then surely we can give away one million phones for free."

We won't know until next year whether Xero's numbers add up, which is when Lilley and Co. plan to launch. Of all the figures in this equation, however, the advertising piece may be the easiest to plug in. We are in a period of experimentation, where anything mobile has an inherent appeal to sponsors chasing a fragmenting audience. And accountability is built into the Xero model, since users really do need to watch an ad in order to click when it's over and receive their credits.

I suspect the hard part will be on the consumer side. Sure, for the first million, the handset is free, but two-thirds of the airtime minutes are not. College students will have to be smarter than many of them look to do their own math: do they save or gain enough in this deal to make the switch?

On the carrier side, we are also eager to see which of the major wireless networks decides to lease its lines to Xero, since arguably the MVNO will be giving away something that the carrier sells to its own customers. Lilley and Astrom don't feel this is an issue for the MNOs (Mobile Network Operators), because Xero is not entirely free and not directly competitive, since it addresses a market that is too costly for the carriers to penetrate themselves.

Well, maybe. Xero certainly is the most creative MVNO model I have seen, but before it succeeds, several other members of the value chain, both carriers and consumers, will have to run their own numbers in order to buy in.