Netflix Falls Prey to Marginal Cost Fallacy & Pleads for a Broadband Free Ride

by on July 8, 2011 · 12 comments

Of all the shockingly naive and shamelessly self-serving editorials I’ve read by businesspeople in recent years, today’s Wall Street Journal oped by Netflix general counsel David Hyman really takes the cake. It’s an implicit plea to policymakers for broadband price controls. Hyman doesn’t like the idea of broadband operators potentially pricing bandwidth according to usage /demand and he wants action taken to stop it. Of course, why wouldn’t he say that? It’s in Netflix’s best interest to ensure that somebody else besides them picks up the tab for increased broadband consumption!

But Hyman tries to pull a fast one on the reader and suggest that scarcity is an economic illusion and that any effort by broadband operators to migrate to usage-based pricing schemes is simply a nefarious, anti-consumer plot that must be foiled. “Consumers and regulators need to take heed of what is happening and avoid winding up like the proverbial frog in a pot of boiling water,” Hyman warns. “It’s time to jump before it’s too late.”

Rubbish! The only thing policymakers need to do is avoid myopic, misguided advice like Hyman’s, which isn’t based on one iota of economic theory or evidence.

Hyman’s economic illiteracy is evident from the get-go. He tries to spook people with the headline, “Why Bandwidth Pricing Is Anti-Competitive.” No it isn’t. Usage-based pricing is used in countless economic sectors every day and it is overwhelming viewed by economists as a sensible way to calibrate supply and demand while ensuring costs are covered. But Hyman says the laws of economics don’t apply to broadband!  No seriously, he says:

Cable and telecom companies argue that bandwidth is a scarce resource and that imposing caps and overage fees will relieve pressure on high-speed networks. Families pay more when they use more electricity, these companies point out, so why shouldn’t households pay more if they use more bandwidth?  The analogy is a false one. Wireline bandwidth is an almost unlimited resource due to advances in Internet architecture. Adding more capacity is easy. The marginal cost of providing an extra gigabyte of data—enough to deliver one episode of “30 Rock” from Netflix—is less than one cent, and falling.

[…] Consumer access to unlimited bandwidth is good for society. It fosters innovation, drives commerce, and advances political and social discourse. Given that bandwidth is cheap and plentiful and will only grow more so with time, there is no good reason for bandwidth caps and fees to take root.

Oh my goodness. Really? Hyman appears to be suffering from a rather serious case of marginal cost fallacy: the belief that prices should, as a rule, equal marginal costs. The problem with such thinking is that it leaves zero room for investment, innovation, and other real-world dynamics that get conveniently forgotten as “fixed costs.”  Of course, if you begin with the truly outrageous claim that “bandwidth is an almost unlimited resource,” and “bandwidth is cheap and plentiful and will only grow more so with time,” then it’s only logical that you’d fall prey to this fallacy!

Meanwhile, back in the real world, economists and financial analysts will explain to you that high fixed-cost goods like broadband networks don’t just grow on trees or fall like manna from heaven. Yes, of course it is true that “consumer access to unlimited bandwidth is good for society.”  But the same is true of countless other goods that we’d all like to have access to at zero cost. But that doesn’t invalidate the fundamental laws of economics. Someone financed and built those networks and someone has to keep building and improving them. You’d never get anything built if you adopted the view that scarcity was a myth and that prices must equal marginal cost.

On that point, I was tickled to see in the online comments to Hyman’s piece that one gentleman asked, “what happens when you allow unlimited access at.. marginal cost?” and for another to say in response, “Answer: You turn into Greece.”   Quite right. There is no free lunch. Something has to pay the bills, including the broadband bills. You can’t just free-ride on the future forever by pretending that bandwidth is an abundant good and holding prices at or below marginal cost.

Once you understand these facts you can point out what’s really wrong with Mr. Hyman’s reasoning: He basically wants average costs for all consumers to go up so that his costs (or the costs of any high-bandwidth use or user) will never go up. Shameful!  Indeed, let’s just call Mr. Hyman’s editorial what it is: a blatant attempt to get government to impose price controls on broadband providers to favor his company. End of story.  He could have spared us all the sloppy economic sophistry and just told us that. It would have made it a bit easier to take him seriously.

P.S. Incidentally, Mr. Hyman’s one and only suggestion for how to deal with network demand/congestion is this: “If Internet service providers really wanted to manage traffic efficiently, they would limit speeds at peak times.” Interesting. I wonder how the Net neutrality crowd feels about Netflix’s new-found love of broadband throttling!


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