Defining Consumer Choice in a Converged Network Economy

by on September 6, 2005

Last week the California Public Utilities Commission supported a statement of policy in favor of “standalone DSL.” Standalone, or “naked” DSL is when DSL service is provided without local phone service. The PUC said it voted to support a policy of “consumer choice.” But when the a la carte preferences of regulators and some consumers conflict with the bundled prerogatives of technology providers and other consumers, which policy should win out?

Policymakers should resist the urge of forcing communication providers to unbundle their products. And while the California PUC’s policy statement has only the force of persuasion, not law, the premise underlying the statement is still wrong. Bundling is clearly a good thing for the vast majority of consumers. It’s not gouging. It’s not unreasonable tying. Instead, it’s just another example of the way that communication products will be packaged in a world where telephone networks compete against cable and wireless networks.

Why Bundle?–The Economics of Digital Technology

Standalone DSL seems to be an innocuous concept. And it is, if unbundling is what the market prefers. But industries dominated by communication networks and digital technology products are characterized by economists as “declining cost industries.” Laying wire for telephone networks and manufacturing a music CD or movie DVD has average production costs that decrease with each new unit produced. Other declining cost industries include airlines, entertainment, pharmaceuticals. In all of these industries, the challenge is similar: the amount one must charge to pay for overhead is small compared to the amount one must charge to remain viable.

New technology products often require significant upfront investment with high research and development costs. Despite high initial costs, once software products or communication networks have been developed, the cost of reproduction or connectivity–the “marginal cost”–is miniscule. Incorporating large upfront costs into a product’s price is a challenge because determining how much to charge over marginal cost is extremely difficult in practice.

Nobel Laureate Ronald Coase of the University of Chicago long ago noted that a declining cost industry must find some way to finance itself. In his 1946 article, “The Marginal Cost Controversy,” he explains that there are two main ways to achieve the necessary level of revenue–via creative multipart pricing or through some form of government subsidy. The government subsidy approach inevitably entails government regulatory and/or price controls, as there are no “free” subsidies. The market approach works by price differentiation and product bundling.

Bundling–It’s Not a Dumb Idea

The idea that any communication services can be broken into discrete elements and sold piecemeal is a dumb one–literally. It is an idea premised on the belief that networks are “dumb pipes” with no added value other than connectivity. It could be this way. Japan, as one example, touts its one ubiquitous wireless network as a way to promote interoperability. But its network was developed with substantial government involvement. In the U.S., we rely on private companies to build out networks and therefore we must allow them the flexibility to recover costs so that we avoid the government subsidy approach Coase describes. Bundling is one such cost recovery approach.

Back in the day of the AT&T monopoly, connectivity was king. The service was the connection itself, along with the operator or repair services to help you connect and stay connected. But the future is not the bundling of different forms of network connectivity, such as local phone service and broadband Internet access–it is the bundling of connectivity with content.

Ultimately, content drives the demand for bigger bandwidth. And it is some amount of control over content that consumers will ultimately cede to network operators so that we can affordably see increased bandwidth and richer content delivery.

Other Competitors are a Check on “Unreasonable” Tying

Bundling provides industry with ways to recover costs, which is not a bad thing in a competitive industry. The current and future prospects for consumers are one of empowerment, not helplessness. In a world where networks compete against each other for similar communications services, the market will help ensure consumer welfare.

Should we (for we are all consumers) fear “limited choice?” No, because paradoxically, we will benefit by allowing network providers the ability to customize their networks in ways that differentiate their service against other competitors. This form of competition is every bit as important as the kind of competition that exists between non-network industries such as supermarkets, dry cleaners and office supply stores.

It is sometimes hard to be against “choice.” But how–and at what level of product offering–choice is defined is best left up to a competitive marketplace–not federal or state regulators.

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