Guy's Economics and the Internet Blog

The price of being online

It has never been easier to check the prices of products online, either by checking on retailers' web sites directly or by making use of price comparison tools such as Froogle or Kelcoo. Where can I get the cheapest flight to Athens in July or the best value mp3 player?

But a curious paradox is that one thing that it is quite hard to check on is the price of being online (Internet access ). Kelcoo does give comparative figures for broadband access in the UK - you can compare what is available in different price ranges (£10-20 and £20-£0 per month) or by download speed (512K, 1 Mb, 2Mb or 8Mb) - but of course there are a number of complications. Some offerings have a set up charge, some have a monthly download cap (ranging from 1Gb to 30Gb). Most packages bundle Internet access with other services, in themselves often desirable (e-mail accounts, spam filtering and blocking services, free web space, parental control tools etc.) but making it hard for users to work out the true cost of Internet access itself, as opposed to all the other add-ons. Then there are a couple of other things to look out for with this kind of subscription service. Lock-in and price discrimination against existing users. You might find that new users are being offered the same package that you have, but at a lower price.

These are some of the things that I look at in the lecture on Internet access pricing on my course on the Economics of the Internet at the University of Portsmouth. I start by considering why these days most Internet access services are based on a flat-rate charge. You will pay the charge whether or not you actually use the Internet during the month - you don't get a refund if you go away on holiday and don't use your home Internet connection. And you don't have to pay more to use the Internet at peak times when everyone else wants to use it than in the middle of the night when there is little if any congestion. What happens instead is that you may find that congestion slows down response speeds at peak times and you get in a queue with others who are also trying to gain access to scarce bandwidth.

A number of economists have argued that we should have some kind of "smart market mechanism" or "responsive pricing" scheme that would make users pay more at peak times to compensate for the negative externality that is imposed when you crowd out other users. As long ago as 1993 Mackie-Mason and Varian made a case for smart pricing which would take account of the "marginal congestion cost". But as Greenstein (2001, 2004) notes, such schemes have typically remained interesting theoretical proposals rather than practical propositions. In practice there are a number of reasons why both consumers and ISPs prefer flat rate charging systems. From the consumer's point of view a flat-rate charging system makes it relatively easy to make comparisons between different providers (although I argue above that it often turns out not to be as simple as it sounds, it would be a lot more difficult to make comparisons if some charges incorporated peak rate premiums). With a flat-rate you know in advance what you have to pay and so you don't need to worry about keeping track of how long you have been online. Providers too know in advance what their revenue stream will be and there is no need for them to monitor use or issue complex bills. Of course this kind of flat-rate pricing isn't limited to Internet access. As Odlyzko (1999) reminds us the Paris Metro has a similar pricing system. You pay the same for a ticket for a short journey or a long journey.

It can also be argued that consumers do have a choice between slow and limited dial-up services and high-speed always on but more expensive broadband services. Someone who only wishes to use e-mail and do a bit of web-browsing may be happy enough with the former type of service, while someone who wants to view video clips or regularly download large files would need the latter type of service.

Which brings us to what might at first be considered the strange recent decision by AOL to offer boadband and dial-up services for the same price to its subscribers in the US [see Jesdanun, E-Commerce Times 23rd February 2006]. Indeed from early March AOL is increasing the price for dial-up subscribers to the same fee that broadband users must pay. Clearly they are more interested in driving dial-up users onto broadband than gaining any benefits from segmenting the market and maximising their subscription revenue. The reason for the push is that there is evidence (from the Pew Internet & American Life Project) that broadband users spend more time online than dial-up subscribers. And AOL can get more money from advertisers if the advertisers feel that they are reaching a bigger audience and with greater regularity. So we must remember that the ISP's business model isn't just about getting the maximum number of subscribers, or even the maximum amount of subscriber revenue. It is about extracting the maximum total income from all sources (subscribers and advertisers).

An interesting footnote to the new AOL pricing strategy is that AOL will permit those subscribers who don't want broadband to continue on a lower-priced dial-up scheme - but as Anick Jesdanun notes, they are not advertising this option and unless dial-up subscribers specifically request that they have this type of subscription they will automatically be switched to the new more expensive service.

References

[1] Greenstein, S (2001) Pricing Internet access. IEE Micro 5-7. April pp5-6.
reprinted in Greenstein, S (2004) Diamonds are forever, computers are not. Economic and Strategic Management in Computing Markets. Imperial College Press/WorldSci Books.
[2] Mackie-Mason, J K and Varian, H R (1993) Pricing the Internet. Paper presented at the conference "Public Access to the Internet", JFK School of Government and in Kahin B and Keller J (eds) Public Access to the Internet, MIT Press, Cambridge MA.
[3] Odlyzko, A M (1999) Paris Metro pricing for the Internet. In Proceedings of the ACM Conference on Electronic Commerce (EC-99) pp140-147.

Other links

[1] Anick Jesdanun, AOL to charge same prices for dial-up, broadband E-Commerce Times, 22nd February 2006.
[2] Guy Judge, Web page for The Economics of the Internet (ENET) course .

posted by Guy @ 6:18 PM