Tuesday, May 26, 2009

Internet by the Byte

With significant contributions and analysis from Kasie R. Jean.

Many existing industries follow a pay-per-use pricing structure. Cell phone companies typically charge by the minute and taxi cabs charge by the mile—why should Internet usage be any different?

Time Warner took the pay-per-use approach recently when it announced a pilot pricing model for its broadband Internet service. The new tiered billing system resembles that of most cell phone plans: households choose one of five levels ranging from 5GB ($29.99) per month to 40GB ($54.90) per month (or a yet to be priced 100GB per month) with a $1 fee for each GB over the chosen plan.

For flat-rate customers, Internet bandwidth is like a common resource—everyone can use the Internet as much as they want, but when one person uses a lot of bandwidth, that slows down the service for everyone else. This is a practical example of what economists call “the tragedy of the commons.” The argument claims that heavy Internet usage imposes a negative externality on all users who share a provider. In order to control its product quality, Time Warner tried a tiered pricing plan in hopes that it would discourage large bandwidth users from bogging down the service’s speed. By adding a cost, Time Warner caused consumers to internalize the externality imposed by heavy Internet usage under the flat-rate scheme.

So, what's the downside? There isn't one, unless you happen to be a consumer whose usage puts you in a tier that's priced above the current flat rate. More and more people find themselves in this group as the Internet’s functionality expands. Nowadays it is not uncommon for consumers to work from home, stream episodes of TV shows that they missed, download music, or play video games through their PC console on systems such as the Xbox or Wii. Streaming and downloading are a surprisingly quick way to run through your monthly GB quota in a matter of days.

Suppose that you used to pay a flat rate of $39.99/month with Time Warner. Under the new pricing system, this same monthly fee would entitle you to only 10 GBs/month. A few movie downloads and streamed TV shows later, and you will already have run through your monthly usage allotment and will be stuck paying overage charges for routine Internet tasks.

It's not surprising that the trial runs of the tiered pricing system caused a major uproar among Time Warner users. Under the proposed new pricing, any users consuming more than 10GB’s per month will be paying more for essentially the same service (though access might be faster if the new policy is a successful deterrent to over-use of bandwidth). If Time Warner decides to go through with the pricing switch nationwide, only the very low bandwidth users will actually benefit from it, which will potentially cause a mass exodus from Time Warner to other services.

Discussion Questions

1. Under the newly proposed pricing model, is the overage fee always something consumers should choose to avoid? If you knew you would consume exactly 8GB of bandwidth next month, what is the least cost way to purchase it? Construct a graph that shows the least cost way to consume at any monthly usage.

2. Switching costs play a significant role in the market and pricing structure of an industry. How do switching costs affect Time Warner’s ability to change its pricing scheme with current users?

3. How do consumer preferences and alternative Internet services affect the decision to choose one service or another? Which consumers would prefer a tiered pricing system over a flat rate system?

4. Suppose the new pricing goes into effect. Since video streaming is bandwidth intensive, how might a website (like YouTube) or a service (like Xbox Live) be able to keep its current users?

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  • At 8:47 AM, July 17, 2009, Blogger Curt said…

    You're making a cell phone analogy when it is more appropriate to make one to roads instead. Or electricity. Because cell phone costs are an oddity as far as infrastructure goes. (infrastructure being a means of distribution or transit).

    A study of the costs and profits of cell companies would show you (I have a lot of data on this) that we would all be better off with flat rates. Like government, much of cell money is wasted. An almost unconscionable amount is spent on advertising. Customer service is terrible. Customers are not valueable because of compensation plans that favor customer swapping (a misdirection of resources). There are false subsidies (preventing users from using a technology on one network or another), and choice-limiting contracts, and heinous overcharges equal to an entire year's contract if you simply exceed your estimate of use. (this is similar to the argument against the damage of uninsured critical health care for example)

    The value in the market is customer choice and innovation. The value in the pricing system is to manage conservation of resources. But there is no value in conserving communication or information, or even entertainment. In fact, the opposite is true. We should make information as consumable as possible.

    The market's competitive innovation argument does not necessarily apply well to infrastructure. (and this is from a radical anarchic libertarian). It argues freedom and efficiency for capital by individuals within a state, rather than the competitiveness of a state against other states. It also means that possession of geography is open to exploitation as a tax or penalty on production, rather than as contribution by the increase of production.

    For these reasons and a host of others, I originally found your question to be a 'trick' question, of asking for, and assuming, a false comparison. But, I'm sure quite a few people fall into that trap.

    There is no scarcity to internet bandwidth. It's a cheap, competitive, educational form of infrastructure that helps us get past the limits of geography, where geography is simply a friction.

    if there is any reason for social infrastructure, then the internet would be it.


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