Internet Pricing: The Next Policy Frontier


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In the past few years, broadband providers have begun shifting toward tiered service plans (sometimes known as usage-based pricing) that offer customers a fixed amount of data each month for a fee. On average, less than 2 percent of users exceed the most commonly-used tier of 300 GB; nearly 80 percent of consumers never exceed even 50 GB per month.

Nevertheless, some critics such as Public Knowledge and the New America Foundation are concerned that this trend may bring higher prices and reduced service. Most recently, NAF analyst Benjamin Lennett asked whether tiered service plans are a plot by cable companies to eliminate Internet-based competitors such as Netflix, which alone generates one-third of all North American download traffic.

But a closer examination shows these concerns are largely exaggerated. Usage-based pricing is not inherently anticompetitive or anti-consumer. Rather, it is an alternative method of spreading costs across a network’s customer base. Unlimited plans are popular because they are simple and predictable. But this simplicity masks significant inequality. Heavy gamers and peer-to-peer file sharers spend much more time online and consume more bandwidth than the grandmother who simply checks her email. Yet in under an unlimited plan, both pay the same monthly rate, which hardly seems fair.

Under usage-based pricing plans, consumers who value the network more pay more. Economists call this price discrimination, and despite its sinister-sounding name, it is a relatively common phenomenon. Airlines routinely charge different rates to students and businessmen; movie theaters charge the average movie-goer more than children or seniors; car dealers give a better deal to consumers who haggle. In each case, two customers face different prices for the same product, based on their willingness to pay. The practice is common and uncontroversial.

But critics claim that tiered pricing for broadband service is somehow improper, because heavier users do not cost companies more than lighter users. Rather, they claim usage-based pricing exists primarily to pad profits. Lennett states that cable companies earn a 97 percent profit on broadband service, citing industry analyst Craig Moffett. But this claim is incomplete (as Moffett himself notes in the next sentence of his report), because it reflects only the daily costs of running the network while ignoring the substantial fixed cost of building the network.

Broadband providers have invested over $200 billion in private capital in the past decade to build our nation’s networks. Moreover, Internet traffic is expected to triple by 2016, driven by Netflix and other bandwidth-intensive services. This means the industry will continue to invest over $30 billion annually to expand and upgrade those networks. When one examines return on invested capital—which Moffett and others argue is a better indicator of financial health in capital-intensive industries—broadband returns are much less impressive and lag companies like Apple and Google.

Thus, while it’s true that, as Lennett claims, the marginal cost of an additional gigabyte of data is pennies, this fact is irrelevant to the question of how to price broadband service. For broadband providers and other capital-intensive industries, the challenge is designing a pricing model that spreads those fixed costs intelligently across the customer base. Lennett’s preferred unlimited flat-rate model is one solution, but a relatively inefficient one. As the FCC has noted, flat-rate pricing forces “lighter end users of the network to subsidize heavier end users.” Usage-based pricing shifts more of those costs onto those who use the network the most.

Tiered plans can also help make broadband more affordable to low-income consumers. FCC Chief Economist Steve Wildman argues that tiered pricing may facilitate cheaper entry-level broadband plans for customers who cannot afford more expensive unlimited plans. A 2010 study of OECD countries showed that residential broadband plans with data caps averaged $164 per year less than similar uncapped plans.

Critics also fear that data caps are designed to protect legacy cable services from Internet-based video competitors. Lennett highlights the 5GB/month Essentials Internet plan that Time Warner Cable is currently test-marketing. He did not note that TWC also continues to offer an unlimited data plan, which will be the plan most consumers choose. TWC’s unusual capped plan targets very light users. Comcast’s 300GB/month plan is more representative of the typical tiered pricing system. Under this cap, a customer could stream 130 hours of HD content on Netflix each month, the equivalent of two feature-length movies each day, or 1000 hours of non-HD content without concern. This tier does not impact average households, but rather online gamers, file-sharers, and others with very heavy bandwidth demands.

Nonetheless, critics may be correct that some broadband providers have incentives to limit data consumption to harm competitors. This is called a vertical restraint on trade, and is governed by antitrust law. Of course, not all broadband providers have video affiliates: Qwest (prior to its merger with CenturyLink), for example, offered tiered plans but did not sell cable service, and Verizon offers cable service without limits on monthly broadband data consumption.

But antitrust law protects competition, not competitors. Our goal should not be to protect Netflix’s profit margins. It should be to protect consumers by promoting competition among video providers. Vertical restraints on trade may be harmful or beneficial to consumers, depending on the context. For example, AT&T’s exclusive agreement to carry the iPhone gave it an advantage over Verizon and other competitors, but this vertical restraint ultimately helped consumers by jumpstarting a sleepy smartphone industry and igniting the mobile broadband revolution.

Ultimately, concerns about tiered pricing are misplaced. The real problem is market power, and more specifically, the abuse of market power in ways that hurt consumers. If a company with market power adopts a particular pricing scheme that harms consumers, regulators can and should use antitrust law to stop the practice.

But we should be wary of calls to change existing law simply to protect favored companies like Netflix. Netflix is not inherently good, and the cable industry is not inherently evil. Rather, they are competitors with different business models. The law should not pick winners and losers among corporations, especially in such a dynamic marketplace.

Daniel Lyons is an Assistant Professor of Law at Boston College Law School.

Image: nicemonkey /

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