The net neutrality debate: Why price discrimination can be good thing

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Amongst all of the brouhaha circulating following the FCC’s net neutrality announcement, some of the most puzzling comments concern the purported  ‘evils of  price discrimination’ that will inevitably emerge if – heaven forbid – a network operator dares to charge one person a different price to move traffic over the internet than another person.   The mere fact that discrimination could occur is deemed sufficient cause by many to justify its legislative prohibition.

The ‘evils of price discrimination’ are almost always voiced by individuals fervently advocating for the necessity of universal and uncapped internet access tariffs – often to the extent that metered internet access should be legislated out of existence, so that the digital world can flourish unbounded and ‘free’, just as its instigators intended.   If one digs a little deeper, one would probably find that the vast majority of these ardent advocates currently purchase their (uncapped) fixed internet connection in a ‘triple play bundle’ alongside their cable or IPTV subscription and some form of voice telephony service.

Do these advocates realize the double standard they exhibit when calling for the prohibition of one form of price discrimination while at the same time benefiting from price discrimination that underpins the entire business case of their digital experiences?  Because ‘flat rate’ internet access and triple play bundles are simply other forms of price discrimination.  If price discrimination is illegal then surely these too must be banned?

Take flat-rate pricing plans.  Suppose A and B both purchase a flat-rate internet connection for $30 per month.  In one month, A uses 100 Gb and B 1Gb. A’s usage is more costly than B’s, simply because it causes more congestion on the network.  B pays $30 per Gb for traffic moved, but A pays only 30c per Gb.  This is clearly price discrimination, as each pays a different price for the same service.  It is strictly regressive – the less resource consumed to serve demand, the higher the price paid. The low-volume users subsidize the high volume ones, who generate more traffic and contribute to higher levels of congestion that further disadvantage low volume consumers when all must pay a higher price for flat-rate connections to finance more capacious pipes that must be installed to cope with the increased traffic volumes. This is hardly an equitable outcome – rather, it is a modern day ‘tragedy of the commons’.  The solution is, unsurprisingly, metered Internet connections (also known as usage-based pricing) –  Just like road tolls and other usage-based charges are used to ameliorate congestion and fund new routes.

Now turning to bundling.  Suppose that a retailer offers stand-alone fixed line voice and internet connections at $30 each.  Suppose B values his 1 Gb internet usage sufficiently to pay up to $35 per month for it, but values a fixed line voice connection at only $15. On the other hand, C values voice at $35 and potential internet usage of 1 Gb per month at $20. Under separate pricing, B would buy only internet at $30 (leaving a surplus of $5) as his valuation of voice ($15) is less than the price ($30).  Likewise, C will buy only voice (surplus $5) but not internet.  Suppose now that the retailer offers a bundle of voice and internet at $49, in addition to the stand-alone offers.  If B buys the bundle, his benefit is $35 + $15 = $50, less the price of $49, leaving a surplus of $1.  This is less surplus in total than buying the internet connection alone ($5), so he does not buy the bundle – he purchases only internet.  He still pays $30 per Gb of internet access.  On the other hand, if C buys the bundle, his benefit is $35 + $20 = $55 less price paid $49, leaving a surplus of $6. This exceeds the surplus from buying the voice connection alone ($5), so be buys the bundle.  The marginal (extra) price paid for internet over the price paid for voice alone) is $19. So he pays $19 per Gb of internet access. Once again, this is price discrimination – the price paid by C for exactly the same service as received by B is lower.  Ergo, bundling enables price discrimination to take place.

Indeed, bundling plans have enabled many lower-valuing individuals to purchase internet (and voice and cable tv) connections that would never have been purchased under stand-alone pricing.   Consider D, who values 1 Gb of internet at $25 and voice at $25. Under stand-alone pricing, neither would be purchased, but under bundling, both are (surplus $1).  Network operators have always used price discrimination of this form to increase the total number of connections sold, in order to capitalize on the scale economies that follow from the fact that networks have very high fixed (and sunk) costs, but low variable costs. Price discrimination is absolutely standard in all other forms of transportation – such as senior citizens paying discounted prices on off-peak bus travel, or large discounts for multi-trip tickets relative to the single ticket price – for precisely the same reasons as it is used in communications networks. Often, it can make the difference between being able to make a commercial return on a network/bus route or not, and can bring forward the time at which a network is made available, relative to non-discriminatory (and stand-alone) pricing.

So is price discrimination really an ‘evil’ that must be eliminated if the ‘net’ is to be truly ‘open’?  If it was, then the internet would be a much smaller, more exclusive and less valuable resource than the one that has emerged as a consequence of a raft of highly discriminatory pricing strategies.  The good news is that the FCC’s Net Neutrality announcement suggests that “good” (i.e. welfare-enhancing) discrimination will still be possible.  So maybe there is a legitimate case for taxing content distributors for the congestion costs that their traffic causes non-consumers in a world of un-metered internet access pricing. Indeed, it may just be the final frontier for internet ‘fairness’ for all – in the same manner as taxing polluters for the costs they cause to the economy or levying tolls to discourage costly road congestion.

 

 

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