Internet policy's next frontier: usage-based broadband pricing.

• Author: Lyons, Daniel A.

TABLE OF CONTENTS I. INTRODUCTION II. THE SHIFT TO USAGE-BASED PRICING IN BROADBAND MARKETS A. A Taxonomy of Usage-Based Pricing B. Usage-Based Pricing for Fixed Broadband Service C. Usage-Based Pricing for Wireless Broadband Service III. USAGE-BASED PRICING AS A COST RECOVERY TOOL A. Distributional Effects of Flat-Rate and Metered Pricing 1. Simple Metered Pricing 2. Data Caps and Tiered Service Models B. Recovering Costs Through Price Discrimination 1. Marginal and Fixed Broadband Costs 2. The Potential Value of Price Discrimination 3. Ramsey Pricing and Price Discrimination in the Broadband Industry 4. Price Discrimination and Increasing Broadband Penetration Rates IV. USAGE-BASED PRICING AS A CONGESTION MANAGEMENT TOOL A. Broadband Service and the Possibility of Congestion Costs B. Measuring Broadband Congestion C. Usage-Based Pricing as a Congestion Management Tool V. POTENTIAL ANTICOMPETITIVE EFFECTS OF USAGE-BASED PRICING A. Data Caps as a Vertical Restraint on Trade B. The Xfinity-Xbox Dispute C. Data Caps and Market Power VI. THE IMPORTANCE OF TRANSPARENCY VII. CONCLUSION I. INTRODUCTION

The United States is in the midst of an explosion in Internet content and applications. In 2012 alone, Internet traffic in the United States grew thirty-six percent, reaching a volume sixteen times greater than that of the entire U.S. Internet in 2005. (1) Peak-time traffic grew even faster, (2) driven by the rising popularity of bandwidth-intensive real-time entertainment such as Netflix, which by itself generates nearly one-third of all downstream traffic during peak hours. (3) And that growth will continue for the foreseeable future: network equipment giant Cisco Systems expects U.S. Internet traffic nearly to triple between now and 2017. (4) Globally, more data will traverse the network in 2017 than in every year from 1984 through 2012 combined. (5)

This steady growth in demand, and the continuing capital investment required to meet it, has prompted broadband providers to reconsider the flat-rate pricing model that has dominated the consumer Internet access market since the late 1990s. Flat-rate, or all-you-can-eat pricing, has proven popular with consumers, primarily because such plans are simple and predictable. Customers know how much they will pay for broadband access each month, and can use the Internet without worrying that excessive use will eat into the family budget. But flat-rate unlimited use can also create inefficient network operation. Because price is not tied to online use, consumers have little incentive to economize their bandwidth consumption. Moreover, network costs are spread evenly throughout the customer base, forcing light Internet users to subsidize heavier users' data-intensive lifestyles.

Broadband providers have begun experimenting with alternative pricing strategies to address these inefficiencies. This movement is most visible in the wireless industry, where the smartphone revolution grew much faster than providers expected. Smartphone use, in turn, spawned a new industry in mobile content and applications and at times has caused wireless broadband demand to outstrip network capacity (a phenomenon sometimes called the "iPhone effect"). (6) Tiered pricing has now become the norm in wireless broadband, where consumers can choose from several different pricing and service options. (7) Many residential fixed broadband providers have also explored tiered service, monthly data caps, and overage charges.

While regulators (8) and many academics (9) have largely supported this shift, many public interest groups have reacted with skepticism. (10) Groups such as Public Knowledge and Free Press, which helped lead the charge for net neutrality, have argued that broadband providers should charge customers the same amount regardless of use. (11) They fear that monthly consumption limits create artificial scarcity, allowing providers to pad profits and avoid future network upgrades. They also assert that fixed broadband providers may use monthly limits to shield their cable businesses from Internet-based competitors. (12) These arguments have found an audience at the Justice Department, which is investigating whether data caps violate antitrust law. (13) In late 2012, Senator Ron Wyden introduced a bill that would regulate and limit the practice. (14)

This article explores the trend toward usage-based broadband pricing. It finds that data caps and other forms of metered consumption are not inherently anti-consumer or anticompetitive. Rather, they reflect different pricing strategies through which a broadband company may recover costs from its customer base and fund future infrastructure investment. By aligning costs more closely with use, usage-based pricing shifts more network costs onto those consumers who use the network the most. Companies can thus avoid forcing light Internet users to subsidize the data-heavy habits of online gamers and movie torrenters. Usage-based pricing may also help alleviate network congestion by encouraging customers, content providers, and network operators to use broadband more efficiently.

As opponents of usage-based pricing have noted, data caps may be deployed for anticompetitive purposes. But regulators should be concerned primarily when a firm with market power exploits that power in a way that harms consumers. (15) Absent a specific market failure, which critics have not yet shown, broadband providers should be free to experiment with usage-based pricing and other pricing strategies, using these as tools in their arsenal to meet rising broadband demand. Public policies allowing providers the freedom to experiment best preserve the spirit of innovation that has characterized the Internet since its inception.

This article critically examines the policies underlying this shift toward usage-based pricing. Part I describes usage-based pricing generally and details its rise in both wireless and fixed broadband service. Part II analyzes usage-based pricing as a cost recovery tool, a way that a broadband provider can allocate its fixed costs across its customer base. Part III considers the pricing strategy as a method of managing broadband network congestion. Part IV examines the potential anticompetitive uses of a usage-based pricing strategy. Finally, Part V highlights the need for transparent policies and consumer education to facilitate the shift toward usage-based pricing, and offers policy recommendations to protect consumers.

2. THE SHIFT TO USAGE-BASED PRICING IN BROADBAND MARKETS

   1. A Taxonomy of Usage-Based Pricing

      "Usage-based pricing" is an umbrella term for any billing system that charges on the basis of consumption. Although Internet access providers abandoned usage-based pricing for consumers early in the industry's history, (16) it is common in other parts of the Internet ecosystem and in many other network industries. (17) In its simplest form, known as "metering," the firm charges a basic fee per unit consumed. For example, telephone companies such as AT&T and Sprint historically charged a certain rate per minute for long-distance calls. The price per minute became a high-profile point of competition between carriers. (18)

      In more sophisticated variations, companies can use metered pricing to induce particular customer behavior. Many companies offer a per-unit discount on large purchases to encourage higher-volume consumption. Alternatively, some utilities such as water companies charge a higher rate per unit after consumption reaches a certain threshold, to encourage conservation and penalize customers who draw more than their neighbors from a common pool. (19) Some electricity utilities, facing above-capacity demand during peak times, charge a different rate per kilowatt-hour for peak and non-peak electricity use, hoping to induce customers to shift nonessential consumption. (20) Similarly, wireless companies famously offered free nights and weekends to customers, partly to shift call volumes to periods when the telephone network was underutlhzed. (21)

      Companies may also adopt a two-part tariff, wherein the customer pays a fixed rate per month for access to the network and an additional fee per unit for consumption on that network. Two-part tariffs are attractive to network industries because the fixed fee ensures that all customers contribute in some measure toward common network costs, while the perunit fee recovers marginal costs efficiently, and can also shift some network costs onto heavier users. Tiered pricing is one form of a two-part tariff that is common in the wireless telephone industry. Under tiered pricing, customers could choose among wireless plans, each of which offers a certain number of minutes per month at a fixed rate. (22) Each customer receives unrestricted calling each month up to his or her plan limit, and then incurs an additional per-minute charge for consumption exceeding that threshold. (23)

   2. Usage-Based Pricing for Fixed Broadband Service

      Although residential consumers are accustomed to flat-rate unlimited Internet access, it is important to note that usage-based pricing has long been the norm in many other parts of the Internet ecosystem. Content providers often get online by purchasing Internet transit service from a transit provider. (24) Transit providers act as gateways allowing content providers to route their data to the Internet. Smaller transit providers also often purchase transit service from larger networks. (25) Transit is typically sold on a metered basis: customers pay based upon the volume of traffic they send each month. (26) Many customers pre-commit to certain volumes each month at a "committed rate", and pay an incremental rate-per-unit for traffic above the committed rate. (27) To avoid transit fees and to route content more quickly to its destination, some content providers choose instead to purchase access from private content-delivery networks such as Akamai or Limelight, which also...