One of the biggest long-term trends in the communications business is the tendency for connectivity services to constantly drop towards “zero” levels. That is arguably most true in the capacity parts of the business (bandwidth), the cost of discrete computing operations, the cost of storage or many applications. But one can see this clearly in voice pricing, text messaging and even internet access (easier to explain in terms of cost per bit, but even absolute pricing levels have declined).
When you hear the phrase “dumb pipe,” that is a reflection of the near-zero pricing pressures that exist within the connectivity business, and which have emerged since the end of the monopoly era, and as the digital era of communications has progressed. Simply put, a range of forces conspire to enable lower prices. Moore’s Law leads to lower network and CPE costs, and ways to enable use of millimeter spectrum that was not commercially feasible before.
Optical fiber, microwave, even new access methods all enable lower access and transport costs, and therefore ability to push prices down. Competition now plays a role as well. Use of internet protocol means vastly-lower network interfaces. Open source means lower software costs. So competition and powerful new technologies are at work.
In large part, marginal cost pricing is at work. Products that are “services,” and perishable, are particularly important settings for such pricing. Airline seats and hotel room stays provide clear examples. Seats or rooms not sold are highly “perishable.” They cannot ever be sold as a flight leaves or a day passes. So it can be a rational practice to monetize those assets at almost any positive price.
That happens in telecom as well. Since the incremental cost of selling the next bit or unit of capacity, prices tend to fall to marginal cost, over time. And if the marginal cost is close to zero, retail prices tend to fall towards zero. Consider the way U.S. consumers now are offered postpaid mobile packages. A device or user gets access to unlimited domestic texting and voice (and often some amount of international access) or one relatively affordable fee, perhaps around $20 for each user account after the first. That is reminiscent of the way local calling services once were priced in the U.S. market: one flat fee for access, and then unlimited use.
Whether marginal cost pricing is “good” for traditional telecom services suppliers is a good question. In principle, the sunk costs must be recovered, eventually, to recoup the investment in the original network and prepare for investment in the next-generation network. Some might question whether marginal cost pricing allows for that to happen. Such “near zero pricing” is pretty much what we see with major VoIP services such as Skype.
Whether the traditional telecom business can survive such pricing is a big question some might ask.
In principle, marginal cost pricing assumes that a seller recoups the cost of selling the incremental units in the short term and recovers sunk cost eventually. The growing question is how to eventually recover all the capital invested in next generation networks.
Product life cycles also play a role in the push for near zero prices. As we have seen, in developed markets people use voice services less, so there is surplus capacity, which means it makes sense to allow people unlimited use of those network resources. The same has proven to be true for messaging.
That was why it once made sense for mobile service providers to offer reduced cost, or then eventually unlimited calling “off peak.”
Surplus capacity caused by declining demand also applies to text messaging, where people are using alternatives. If there is plenty of capacity, offering lower prices to “fill up the pipe” makes sense. And even if most consumers do not actually use those resources, they are presented by value propositions of higher value
Internet access, meanwhile, is approaching saturation. As crazy as it might seem, could a shift of internet access demand to mobile mean stranded supply on fixed networks, and therefore incentives to cut prices to boost sales volume? We shall see.
Marketing practices also play a big part, as the economics of usage on a digital network can be quite different than on an analog network. And some competitors might have assets they can leverage in new ways.
In 1998, AT&T revolutionized the industry with its “Digital One Rate” plan, which eliminated roaming and long-distance charges, effectively eliminating the difference between “extra cost” long distance and flat-fee local calling.
Digital One Rate did not offer unlimited calling at first, but that came soon afterwards. In the near term, lots of people figured out they could use their mobiles to make all “long distance” calls, using their local lines for inbound and local calling only.
With unlimited calling, it became possible to consider abandoning landline service entirely. Again, the point is that marketing practices also can, at times, push prices in a near-zero direction.