Saturday, April 15, 2006

Confusion Pricing

I am currently enjoying Tim Hartford's book, The Undercover Economist, so I was happy to see an article by him on Slate. The topic is cell phone pricing in the US, and why it's so complicated.

This is an area I happen to know a lot about, after having spent more time in the telco industry than I care to admit. Essentially, cellular companies have zero marginal costs to handle traffic, plus step increases in costs, plus cross-network interconnection fees, all within an increasingly competitive market.

This means that, once a cell company has set up a tower, it can handle any number of calls up to its given capacity. Once it reaches capacity, it needs to put up a whole new tower, which costs money. Moreover, if a call originates on their network, but ends on a competitors network (so, a Verizon customer calls a Sprint customer) the competitor charges them a fee.

By and large, cellular networks have not done a good job of differentiating themselves from each other. The big exception was Nextel, which built in a walkie talkie feature right from the start, made it easy to have small business accounts (so the bills to multiple numbers were combined into one), and focused on in-building penetration over wide coverage. They served the construction worker market very well, which is why none of your friends have Nextel phones (unless they are in the construction business). When you looked at their financial metrics, they looked very different from the other carriers -- they had higher customer satisfaction, higher revenue per customer, higher margins, and lower churn. Now that Nextel has been bought by Sprint, that premium has passed entirely to Nextel shareholders (and management) and I expect that stellar performance to be eroded away.

Given that cellular services are in a fairly commoditized market, they end up competing on price. Their pricing strategy, since they are price takers, are determined by their cost structure, which is why you see in-network calling becoming free (no interconnection fee) and an ever increasing nights and weekends / offpeak minutes free as well (that is when traffic is low). All customers pay for, essentially, is the ability to make calls, across networks, during business hours. Aside from that, in the US at least, cellular prices are flat-rate, all you can eat plans.

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