Thursday, February 10, 2011

The History of Usage Based Billing (UBB) and why it will almost always fail

[The recent brouhaha of usage based billing (UBB) in Canada is not a new phenomena.
The famous Internet iconoclast Dr Andrew Odlyzko who is the Director of the Interdisciplinary Digital Technology Center at the University of Minnesota. has done extensive research in this area. The idea of charging users per usage has always appealed to many corporations from software rentals to shipping of coal. But invariably such plans meet with an uproar from consumers, as we have witnessed most recently in Canada. As Dr Odlyzko explains:

“While the simple utility maximization argument might favor per-user pricing in a substantial fraction of cases, what we observe in the market are repeated failures of à la carte pricing….The flat-rate Internet access plan may not be viable, since there are substantial marginal costs in providing such services, but the strong consumer preference that has forced even America Online to switch to fixed-fee pricing has to be taken into account. […] This preference is not easy to take into account in standard economic models (other than by saying, as Baumol reportedly did, that consumers derive a positive utility from prix fixe pricing), but it appears to be a major factor that will favor fixed-fee schemes, at least for individual consumers. “
While UBB makes all sorts of economic sense in that the heaviest users should pay for network utilization it puts the consumer at a serious disadvantage with respect to the incumbent operators for two primary reasons:
(a) With universal UBB it is almost impossible for consumers to do comparative shopping for the best Internet service plan. We have seen this in spades in the cell phone industry where we have a plethora of competing plans and options making it almost impossible for consumers to make the most economical choice for their particular needs. Consumers don’t have the information resources or skills to decipher which plan makes the most sense. It is unfortunate, due to regulatory capture that telecom/broadcast regulators do little to protect the consumer in terms of promoting competition or mandating simple and understandable pricing plans. What we see happen in the cell phone industry will most likely happen in the Internet if regulators allow universal UBB.
(b) Fixed price plans are like insurance. Even though consumers know they may never use their maximum bandwidth, it provides them with the peace of mind that if and when they do use a lot of bandwidth there will be no surprises or surcharges.
For more extensive analysis of the history of UBB I encourage you to look at the following papers written by Dr Odlyzko on this subject:
"Fixed fee versus unit pricing for information goods: competition, equilibria, and price wars" in First Monday in 1997,
A more thorough treatment is in "Internet pricing and the history of communications,"
Computer Networks 36 (2001), pp. 493-517,
Perhaps an even better source would be the more recent paper "Too expensive to
meter: The influence of transaction costs in transportation and communication,"
with David Levinson, in Phil. Trans. Royal Soc. A, vol. 366, no. 1872, 2008, pp. 2033-2046,
There are others that deal with this topic, if these three don't suffice, let me know.
There is also my entry on the Internet Evolution site in Feb. 2008, "Threats to the Internet: Too much or too little growth?,"


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