Is Use-Based Pricing a Bad Thing?

Posted by Brad McMillan, CFA, CAIA, MAI

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This entry was posted on Mar 5, 2015 2:31:00 PM

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use-based pricingTo finish up the discussion of the economic context of net neutrality that I started in Monday’s post, let’s take a look at the second half of the issue. Monopoly power, which I discussed in yesterday’s post, is a problem—but maybe a short-lived one. If you take away the monopoly part of it, is charging more for some users really all that bad? Not really.

The effect of limited resources

The interesting thing about use-based pricing is that, absent monopoly power, it usually comes to pass only when resources are scarce. Let’s take another look at the wired phone system for some examples.

Back in the day, there was genuinely limited capacity on the phone lines. With fewer circuits, able to handle only one call at a time, it made sense to charge by the minute and to charge more for calls that went farther and tied up more circuits. Yes, kids, long-distance charges were a real thing! Anyone calling was using limited resources, and there was general acceptance (or at least resignation) that you paid for what you used.

In came technology

This changed when the technology did. When wireless came in, computerized switches and many more channels made access less scarce—and use-based pricing less defensible. When AT&T was a monopoly, it held the line on pricing. But when it was split up, one of the successor companies, Sprint, broke the price model by eliminating long-distance charges. Since then, we have also seen the caps on minutes disappear. With no scarcity of the resource, use-based pricing was eliminated by competitive pressures.

This works the other way as well. Consider the costs to drive in downtown London now. Before, just like here in the U.S., anyone could drive downtown whenever they wanted, and traffic was terrible! Demand (drivers) outstripped supply (roads). To solve the problem, the U.K. started charging cars when they drove into London at peak periods. With higher prices, demand (which is to say, traffic) went down. By using technology, a scarce resource was allocated to those who were willing to pay for it.

Technology to the rescue?

With net neutrality, the trend is clearly on the side of technology increasing supply. Absent monopoly power, we would expect—economically—to move away from a use-based pricing model as supply increases. But despite the relative scarcity of bandwidth here in the U.S. compared with that of other countries, we have never really had a use-based pricing model. The attempt by the cable companies to impose such pricing is pushing back against the underlying economic forces—and the cable companies know this.

By trying to move to use-based pricing, cable companies are attempting to monetize scarcity while they still can, which will not be for long. In fact, I suspect this attempt will accelerate the shift away from cable companies and to alternative providers. In this case, from a consumer viewpoint, technology is coming to the rescue. Of course, that’s provided monopoly power does not stop it. This will be the real issue to watch in the net neutrality debate.

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