David Pogue (via Kottke) asks:
Why doesn’t someone start a cellphone company that bills you only for
what you use? That model works O.K. for the electricity, gas and water
companies — and people would beat a path to its door.
Of course many companies will charge you by the minute. Overseas, per minute plans are more common yet. The puzzle I think is why the standard American plan is per month, with perhaps a non-convex minutes cap, rather than per minute.
The most likely answer combines price discrimination with consumer misjudgment. If the company puts a very high marginal per minute price right at the cap, some consumers will, in self-deceiving fashion, think they are getting a good deal but then chat themselves into near-bankruptcy. For the other consumers, you are forcing them to buy minutes as part of a bundle. It is well know this can be an efficient means of price discrimination across high-value and low-value demanders; see my earlier post on cable bundling for a full explanation of the economics.
Why doesn’t competition break down such schemes? First, cell phone competition has become more intense only with number portability in the last few years; we can expect pricing schemes to continue to evolve. Second, the cost structure of the company may have more to do with marketing than with the cost of supplying extra miniutes. So "marginal cost pricing," or the nearest approximation thereof, may involve "per customer" charges (a fixed monthly fee) rather than "per minute" charges.
Of course they’ll let you opt out of all of this if you pay a high enough per minute charge, thereby reimbursing them for the fixed cost they paid upfront to recruit you. That all said, if you go to Western Union and buy one of those cards with minutes to Sierra Leone, it seems that true marginal cost pricing reigns, subject of course to some probability of a fraudulent or difficult-to-use card.
As someone peripherally in the mobile phone business (for my sins) I can say that it sure looks like you’re on the money from where I sit. See, for instance, data plans — with a few odd exceptions, they’re all even more extreme than the voice plans in the free-to-a-cap-then-comically-expensive mode. Because it is functionally impossible to resell data plans the way prepaid cards do voice plans, the market tolerates this sort of price discrimination to an even greater extent.
Prepaid is simply the only way out of this mess, and the carriers know it — that’s why in Europe where prepaid is common they lobby for more and more “security” restrictions on prepaid SIMs. Like the airlines trying to prevent ticket resale by lobbying for ever-stricter ID requirements, the carriers know that the only way to preserve price discrimination is to strangle the secondary market.
STi Mobile: 10 cents per minute, plus a $3 per month service fee. I’ve used them for years and have never had a problem with them. If you’re not one of those people who walks around with your phone glued to your ear all day, it’s a great deal. *But* you have to buy your own phone. I suspect that the “give away the phone with the service plan” model has more to do with what you’re talking about than the cost of marketing and recruiting customers—the cost of a phone has to be larger than the cost of marketing per customer, doesn’t it?
A further complication is that the cost of providing cell service is almost entirely fixed. There is a trivial extra per minute electricity use boost while talking. Everything else is unrelated to actual minutes used: towers, transmitters, switches, etc. It is only when the load reaches capacity that the provider must decide to make another capital investment, or provide degraded service and risk customer loss. In this environment a monthly fee per likely capacity required is much closer to the underlying cost structure than a per minute charge. Providers will prefer this.
Many users also place a value on predictable costs. This means that they would rather pay a higher predictable amount than an unpredictable amount with a lower average cost. It greatly simplifies cash flow management, etc.
Nom, the reason is “Because the mobile phone industry has a different cost structure than electricity or gas”. Basically, with electricity and gas, you primarily pay for what you consume, which incurs variable costs that are passed on to consumers.
For a mobile phone network operator, the network is mostly fixed costs – it doesn’t matter how high your utilization is, the cost stays – relatively – fixed.
If you look at that cost structure, free-to-a-cap is actually a very good model, as it reflects your costs in your prices. High “over-the-cap” charges also help you, because they actually DO cost you more money, because you need to increase network capacity, leading to high investment costs. And since that cost structure holds for all mobile phone providers, you see similar pricing structures.
apex
Apex and rjh have it. It’s the same reason that cell providers have free off peak (nights and weekends) minutes as well. Minutes used at non peak times are essentially free to the providers.
The marginal cost of a minute is zero, so long as the total load stays within capacity. So the customer pays the fixed cost of marketing etc. plus a fixed cost for amount of network capacity. Makes sense.
An interesting economic discussion is the effect of regulations, common in most other countries, of the caller paying the entire call fees, like on landline phones. One obvious effect on the consumer is a higher per-minute charge for calling cellular phones than landlines in other countries. Another effect has been more rapid adoption of the text message alternative. (The latter, I think, is also boosted by the more common use of public transportation. Texting gains some real advantages on public transport, where voice calls are rude but it’s easier to look at one’s phone. People might drive and talk with some danger, but driving and texting is even worse.)
Having moved from Europe where, at least where I’ve lived, per-minute was the only thing available (or per-minute plus monthly fee), I much prefer the US system.
aah good old Industrial organization puzzles. Tirole’s Book is a good place to start looking in such issues.
* 256 characters is really worth .15
You nailed it. Existing cellular networks were not engineered to support text messages: they were added on as an afterthought (and we’re stuck with the existing system for compatibility reasons), so they use a lot more capacity than you’d expect from a sane design.
Cell phone service is high fixed cost and strong network externalities (it is free to switch a call inside your network but you pay termination charges outside.) This forces you towards a fixed subscription price with price penalties for calling subscribers outside the network. If all telcos priced per minute, and per minute only, they would price toward marginal cost, and compete themselves into the ground.
One of the differences between the US and Europe when it comes to cell phones is that in Europe, the technology (GSM) was pretty much defined before competition took off with deregulation. Consequently, takeup was faster than in the US because interconnect and roaming agreements were withing the standard technology. The fact that fixed-line telephony was expensive in Europe and cheap in the US, plus geographical differences (higher pop. density in Europe) also helped. I suspect the fixed-price-with-some-minutes-included, which dominates in the US but is not seen much over here, stems from the differences in competitive evolution.
There’s a paper by Michael Grubb on cell phone contracts and how the scheme exploits consumers’ biased anticipation of their own usage patterns. Abstract is here: http://www.mit.edu/~mgrubb/ , but the introduction in the paper is more informative.
I’m going to second the call to read Michael Grubb’s paper. Tyler, there’s an actual economics research paper (with theory and data) that attempts to answer this precise question, and does a pretty damn good job!
American cell phone companies are no longer in price competitions. No longer is the lowest price, or the best coverage the way to go. Simply because company A undercuts company B doesn’t mean that A will get more customers. Why? Its very simple, its all about who has the coolest phone. Who has the thinnest phone or the best gadgets or the biggest screen or the best camera or the most music space. A phone is no longer a phone. And since cell phone companies no longer charge the consumer based on actual cost of minutes, the consumer is just paying higher and higher prices for better technology. I don’t know about you, but all I need is a phone that can call and text that is it. Everything else is just extra weight that I have to pay for. It just doesn’t make sense.
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These aren’t hypothetical questions. You can just read an earnings report and figure out the economics. That’s why these Cowenian deductive exercises are so useless.
There is already several companies that already do this prepay phones and charge by the minute. I believe AT&T and STi do these. Cellphones make a huge monoply on pricing by minutes and not price per minute. Cell-phones can make money off their text messages. Not many of these Cellphone companies make money off their minutes. Text-messaging is the source of their income because they can charge 10-15 cents per text and this causes people to go over numerous times. Minutes are not as of importance such as roaming and text messaging.
Almost every carrier has a pay-per-the-minute plan. The are typically called pre-pay and you buy a certain number of minutes and can talk until they expire.
As much as consumers claim that this what they want, they jump to conventional (monthly) plans as soon as they are allowed to.
There are two possible reasons that I can see.
1) The per-minute plan is more expensive. Carriers subsidize the phones and want to have some assurance that they are going to get their money’s worth out of it. Consumers jump to conventional plans to save money.
2)The pre-pay plans are designed for credit poor consumers and the customers know this. They switch to the conventional plans because it means that they have “made it.”
3) Consumers like insulation. They don’t want to have the variability of paying what they use, the want a predictable bill each month. This is the one that appears most likely to me, with some mix of the above playing a part. Of course, I say this knowing that a significant number of customers pay for a bigger plan than they actually use. (i.e. paying for 1000 minutes when 500 would do)
http://leeiwan.wordpress.com/2006/10/12/changes-dialing-long-distance-to-a-cellular-phone-in-mexico/
Do you ever wonder why do we have to pay to make AND to RECEIVE a call? weird, right? When will the USA public catch up to Mexican informed public that didn’t stand for it, and had a law changed Nov 4, 2006? When will we call upon cell phone companies to not charge us both ways?
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the way out of these costly ripoffs is to get a prepaid phone. check out the TracFone’s celldefense.com
best plan in the us for value outside the big company’s grip!
I don’t think anybody can afford to enter on a market like we have now.The big companies will never allow such thing.Although I must say it is a great idea.It is like Internet Yellow Pages.Somebody created long time ago and now if you try to build something similar you might end up in a court.
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