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Flexible pricing means lower prices or higher bandwidth

By 3 September 2009 5 Comments

To be perfectly honest, I’ve never personally liked metered Internet service or usage caps.  While I’ve come to the conclusion that some level of usage caps are necessary because broadband networks are shared and affordable, and that intelligently managed networks can operate with far less restrictive caps, I still hate the more restrictive usage caps like the 40 gigabytes (GB) usage cap that Time Warner proposed.  And while I have protested these restrictive usage caps in the past, I never thought that it would be a good idea to have such business models made illegal.

I used to debate some of my economist friends on why I thought metered pricing or more restrictive usage caps were a bad idea, but I couldn’t honestly say that my opinion was entirely objective.  My dislike for usage caps stems from the fact that I am a heavy broadband user and an uncapped broadband service is very beneficial to me since everyone else pays a little more so that I can pay a lot less on my broadband service.  But beyond self interest, I can’t make a good argument why the majority of broadband users who don’t need to transfer a lot of data should subsidize my Internet requirements.

Usage caps means lower prices and higher adoption rates

Until recently, I’ve always rationalized my distain for smaller usage caps by ignoring the fact that I’m being subsidized by the majority of broadband consumers.  However, a new study from Robert Shapiro and Kevin Hassett at Georgetown University is forcing me to reexamine my personal bias against usage caps.  Shapiro and Hassett found that flexible pricing where heavy broadband users pay more for broadband and light broadband users pay less actually helps to bridge the digital divide.  The study predicts that by the year 2017, only 79.4% of households making less than $30,000 a year would sign up for a single-tier broadband service where everyone gets the same usage cap.  With flexible pricing where consumers have the option of purchasing cheaper service with lower usage caps, Shapiro and Hassett estimate that adoption in lower income households can rise to 98.5%.  While these adoption rates are estimates, I think the conclusion is sound because it is obvious that lower income households will be more likely to subscribe to broadband if they didn’t have to subsidize heavy Internet users.

Smaller usage caps can be traded for higher bandwidth

More recently, building our colocation server for Digital Society has made me realize that usage caps not only has the potential to lower prices, but it can also facilitate higher bandwidth performance.  Case in point, Digital Society pays $50 per month for colocation service with a 100 Mbps Internet circuit, and at least $20 of that is for rack space and electricity.  How is it possible that we can get 100 Mbps of bandwidth for ~$30 when 100 Mbps of dedicated Internet bandwidth in colocation facilities normally costs $1000?  The answer lies in usage caps, which cap us to 1000 GBs of file transfer per month which means we can only average 3 Mbps.

Note: Some people have asked me why broadband doesn’t run this fast with this kind of usage cap at this price of $30.  The answer is that this is not broadband where the ISP has to install miles of cabling to your house and maintain it.  Instead, you bring your 1.75 inch high computer to the ISP and pay them another $20 a month to power and house it in addition to the $30 of bandwidth.

We are effectively buying fractional ownership of a high performance 100 Mbps connection that allows us to burst to 100 Mbps when we need it but still stay below our 3 Mbps average because of the idle time.  If usage caps are made illegal as some are proposing now, we would no longer have this flexibility and we would be forced to purchase a 3 Mbps Internet connection with no contracted usage cap.  But we would still be living under the exact same usage cap because the connection can only deliver 1000 Mbps even if we were to use the connection at full throttle nonstop.  But the reality is that we would average well below 1 Mbps because web traffic is idle much of the time anyways, and this would be far less desirable than the fractional ownership of a 100 Mbps Broadband connection where we would be able to burst and average 3 Mbps.  So the irony of a regulation intended to “protect” the little guy from “unfair usage caps” would actually force our small organization onto the permanent slow lane.

The irony of a regulation intended to “protect” the little guy from “unfair usage caps” would actually force our small organization onto the permanent slow lane

There is ample evidence that usage caps allow higher bandwidth performance per dollar in broadband services.  Most of the OECD nations employ much smaller usage caps in the 5 or 10 GB range while some Americans protest the 40 GB plan that Time Warner proposed.  But because those countries are selling fractional ownership with smaller fractions, they can offer a higher connection rate in exchange for lower duty cycles at the same price levels.  This is advantageous to the vast majority of users who don’t need a lot of gigabytes, but they do want high burst performance.

For example, business users don’t consume a lot of gigabytes but they do want that occasional 10 MB email attachment to come flying through on a service that favors higher bandwidth over larger usage caps.  Web surfing is by definition a very low duty cycle application and it prefers higher bandwidth over large usage caps.  Even gamers who normally require low bitrates (less than 80 Kbps average) for their online games might at most need to download a few GBs a week in new games or software updates.  The typical gamer would benefit from services with high bandwidth, low latency and jitter, and moderate usage caps.

Of course, the fear from most consumers is that they’ll get stuck with some massive overage bill if their kids start downloading movies with P2P or if a virus takes over their computer. The other fear is that they’ll be kicked out to the street if they exceed their usage caps. This was certainly my big concern with any type of usage cap system, but I think these concerns are manageable if there are safety mechanisms that limit the overages. Time Warner for example implemented maximum overage charges, and there were ready to wave a month of overage charges so that customers have a chance to change their usage patterns or purchase a plan with more usage allowance. Another way to allay these concerns is to forgo overage charges altogether and just implement 128 Kbps throttling once the daily allowance is reached. That way, consumers get a fresh usage allowance the next day and with their full contracted burst speed until they exceed their caps again at which time they drop to 128 Kbps again.

For consumers who need to download hundreds of gigabytes, they would ideally have the option to purchase lower bandwidth or lower priority bandwidth with a larger usage cap at a moderate price.  For consumers who want high usage allowances and high bandwidth, they can pay the premium price for the premium service.  While consumers should have the right to purchase the all the service characteristics they desire, they have just as much right to skip the service characteristics they don’t need so that they don’t have to subsidize other customers.  A “right” should never be construed as an entitlement to service subsidies. Most importantly, flexible pricing not only delivers broader broadband adoption, it gives businesses and consumers the ability to buy higher performance services.