Although U.S. policymakers comprehensively deregulated many network industries—airlines, trucking, railroads—over the past three decades, they failed to enact as sweeping of reforms for American communications and media markets. They did, however, get two big things done right during this period. First, federal and state lawmakers and regulators largely eliminated barriers to entry and line-of-business restrictions that made new innovation flatly illegal or at least very difficult. Second, policymakers phased out most price controls and rate regulations.
These reforms have helped revolutionize high-tech markets and usher in unprecedented innovation across the information economy. Open markets and freer pricing served as a green light to digital age entrepreneurs, signaling to them that it was safe to invest in new technologies, devices, and networks.
But now some academics and regulatory activists are agitating for a return to the misguided methods of the past. Specifically, broadband data caps and usage-based pricing for broadband services havecome under fire from various quarters, and some want those free market pricing practices and business models investigated or even regulated. Data caps and usage-based pricing are methods of pricing high-speed data services that attempt to balance exploding Internet demand—especially for mobile broadband (Americans gobbled up 1.1 trillion megabytes of wireless data over the past year)—alongside future network investment needs.
Apparently eager to oblige the critics of such practices, the Obama Administration’s Department of Justice already opened an inquiry into cable industry data cap practices this summer. More generally, the ongoing war of “Net neutrality” has always raised the specter of price regulation since mandated “non-discriminatory access” inevitably runs up against differential pricing methods that carriers might deploy.
In an important new Mercatus Center working paper on “The Impact of Data Caps and Other Forms of Usage-Based Pricing for Broadband Access,” Daniel A. Lyons, an assistant professor of law at Boston College Law School, explains why a return to price controls for communications would be monumentally misguided. Lyons notes that “data caps and other forms of metered consumption are not inherently anti-consumer or anticompetitive. Rather, they reflect different pricing strategies through which a broadband company may recover its costs from its customer base and fund future infrastructure investment.” He notes that “by aligning costs more closely with use, usage-based pricing may effectively shift more network costs onto those consumers who use the network the most.”
Data caps and usage-based pricing are forms of what economists refer to as price discrimination. Although viewed with suspicion by some policymakers and regulatory-minded academics and activists, price discrimination is widely recognized to improve consumer welfare. Price-differentiated and prioritized services are part of almost every industrial sector in our capitalist economy. Notable examples include airline and hotel reservations, prioritized shipping services, amusement park passes, and fuel and energy pricing. Economists agree that price discrimination represents a sensible way to calibrate supply and demand while ensuring the fixed costs of doing business get covered.
Consumers benefit from such pricing experimentation by gaining more options while firms gain more certainty about investment and service decisions. When such pricing practices become annoying to some consumers and they show a clear desire for alternatives, it sends a signal to rivals to offer a differentiated service. Consider the example of Southwest in the airline business, which found its niche by offering flat-rate fares and no-frills service to select destinations. Yet, most of the rest of the industry depends on sophisticated yield management pricing techniques to keep seats filled. Without price discrimination, there almost certainly would not be as much competition in the airline sector, which has massive fixed costs (fuel, labor, planes) that must be covered before any flight can leave the ground.
With a similar high fixed cost problem to deal with, it is unsurprising that broadband providers have started experimenting with new pricing methods to balance the exploding demand for Internet services with the need to cover ongoing network investment. “If we want to reap the benefits of new and innovative tech products, we must be prepared to accept price discrimination at least some of the time,” notes my Mercatus Center colleague Eli Dourado in a recent blog post. “There are products that are viable with price discrimination that are not viable without it—and if we ban price discrimination like some people thoughtlessly advocate, we won’t get them.”
That is clearly true for broadband services. While some look at the relatively low marginal cost of increased data usage that any one user might impose, they ignore the other costs facing broadband operators as those firms attempt to serve a massive community of users. High fixed-cost goods like broadband networks don’t just grow on trees or fall like manna from heaven. Someone financed and built those networks, and someone has to keep building and improving them. There is no free lunch.
This is precisely why experimentation with different pricing methods and business models must be allowed to continue if we hope to ensure ongoing investment in new networks and better services. In this case, we are talking about hundreds of billions of dollars. “Most industry and political observers believe that the federal government will not be in a position to allocate that amount of money to upgrade our nation’s broadband infrastructure for the foreseeable future,” Christopher Yoo notes in his excellent new book, The Dynamic Internet: How Technology, Users, and Businesses are Transforming the Network. “The next-generation network will thus be built by private enterprise,” he says, “but private corporations cannot be expected to undertake such investments unless they have a reasonable prospect of recovering their upfront costs from consumers who are using the increased bandwidth and other enhancements to the existing network.”
Both Yoo and Lyons point out that price discrimination can help solve this problem, primarily by ensuring that heavier users cover the costs they impose on networks. Lyons notes that Sandvine, a Canadian broadband networking company that regularly measures broadband traffic, estimated last year that the heaviest 1% of downstream users account for 15.2% of total North American fixed downstream broadband traffic, while the heaviest 1% of upstream users account for almost 43% of total upstream use. “By comparison, the lightest 60% of consumers account for only 10% of total North American fixed broadband traffic.”
The mobile disparity is even more pronounced with 1% of mobile data users consuming 26.8% of upstream and 21.3% of downstream mobile traffic, Lyons notes. “By comparison, the bottom 80% of users account for only 10% of total traffic combined,” according to Sandvine. By pricing those users differently than others, costs can be more fairly covered and demand balanced over time. In turn, notes Lyons, “usage-based pricing may also make entry-level broadband access more affordable” since providers can offer lower rates to light or low-income users.
By contrast, if policymakers lock-in flat rate pricing or regulate pricing such that it is not allowed to fluctuate with demand or investment needs, then it is likely that light users (including many lower income users) will end up paying more than they need to for their overall share of network costs. If that is also disallowed through rate regulation, then network investment will suffer and further innovation will be discouraged. Something has to give because, again, there really is no free lunch.
That doesn’t mean usage-based pricing or data caps should or will be fixed in stone. Other pricing techniques and business models may prove superior later. The paramount public policy goal should be to foster an environment where ongoing experimentation is allowed so that the best solutions emerge over time in response to fluctuating broadband supply and demand. “Public policies allowing providers the freedom to experiment best preserve the spirit of innovation that has characterized the Internet since its inception,” argues Lyons. Rejecting calls to regulate data policies and usage-based pricing is the first best step toward ensuring that goal.