Interviews with Digital Media Thought Leaders

Fallacy of Useage Based Internet Pricing

Podcast Audio | Posted by Phil Leigh on March 2, 2012

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philblueheadshot Recently Time-Warner cable announced it’s once again testing subscription plans that bill Internet subscribers based upon the bandwidth they consume each month. They call it usage-based pricing. Others, such as the editors for The Wall Street Journal, like to call it consumption-based pricing.

Either term implies Internet Service Providers (ISPs) can justify charging subscribers additional fees for incremental bandwidth, just as electric utilities routinely charge users based upon the number kilowatt-hours consumed. But there’s a key difference the ISPs don’t bother to explain.

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Specifically, electric utilities must not only deliver power, they must also generate it. In contrast, ISPs such as CATV and telephone companies generally must only deliver bandwidth.

Electric utilities deliver power to our homes thorough a network of conductors, seldom needing replacement. Typically there’s a large cost to build the network and small annual expense to maintain it by repairing breaks, aging, weather, and other damage. The average home uses 15,000 Kilowatt-Hours (kwh) annually. The incremental cost to deliver it over the network of conductors is negligible. The big cost is generating those 15,000 kwhs.

Generating household electric current typically requires a generator repeatedly rotate a magnetic field through a coil of wires, or vice-versa. Just how much work is required becomes evident in some science museums where visitors may ride a stationary bike whose pedals turn an alternator coil to illuminate a light bulb. The average person tires-out within minutes.

That’s why electric utilities build large generator stations, powered by steam engines. The steam engines use a variety of fuels including gas, oil, coal, or nuclear. The essential point is that there exists a direct cost associated with generating each additional Kilowatt-Hour.

In contrast, ISPs don’t generate bandwidth. They merely deliver it. By analogy the ISP is like a closed pipe network, delivering water around the system at varying speeds determined by subscriber requests. Generally, the limiting factor is not the size of the pipe, but the capacity of the pumps. Certainly, such is the case for ISPs with fiber or coax.

Assuming the pumps have a capacity of 100 gallons-per-minute the operating cost variance is negligible whether at 10 gallons or 100 gallons-per-minute. When the system starts to demand more than 100-gallons-per-minute, the network operator must buy new pumps, which requires incremental investment. However, the ISPs don’t tell us that the cost of the pumps is dropping by fifty percent every two years. Put another way, in two years a new 200 gallon-per-minute pump can replace a 100-gallon-per-minute pump at the original price. In five years, the operator could buy a 600-gallon-per-minute pump for the same price.

In short, while higher usage requires more capital investment to deliver bandwidth, it is a false analogy to assert the operator needs more revenue to create bandwidth. Most importantly, the rapidly declining costs of transceivers implies the ISPs operating profit is more than enough to fund investments in future delivery capacity and retain a healthy profit margins. In point of fact, Time-Warner Cable once revealed that its profit margin on ISP service was around 95%.