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Why don't cell phone companies price per minute?
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.
Posted by Tyler Cowen on November 4, 2007 at 07:08 AM in Economics | Permalink
Comments
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.
Posted by: Grant Gould at Nov 4, 2007 7:35:55 AM
AT&T: $0.25 per minute (though you have to pay up front and your money expires if you don't use it fast enough)
Posted by: Archit at Nov 4, 2007 7:48:01 AM
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?
Posted by: AnonymousLibraryStudent at Nov 4, 2007 7:55:57 AM
Our perception when we finally got cell phones last summer was that competition was still pretty weak. Of the four major carriers in this area, my wife eliminated one for providing her insanely bad service in the past. Of the three that were left, only one actually had coverage for my in-laws' house. In practice, that meant only the one carrier provided coverage for one of the top three places we are likely to be at any time, and of course my in-laws already were using that carrier, making the most common long distance call for our phones free if we also went with them. Their deal wasn't great, but those two details made it unbeatable for us.
Then, of course, there are all the details you only learn after you've signed up. Like sure, this carrier had coverage at my parents' house -- but thinks they live in Canada. (And they've dropped their plan which would give cheap coverage for Canada, our usual vacation country of choice.) Or that they used software to cripple our fancy phones so they could charge us extra if we wanted to do anything fancy with them. But of course none of that changes the basic logic of going with this carrier, and you're subject to huge penalties if you leave a carrier within two years.
So the end result is our service is pretty sucky, but still probably the best deal we can get for our needs.
Posted by: Sol at Nov 4, 2007 8:28:01 AM
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.
Posted by: rjh at Nov 4, 2007 8:58:48 AM
From a business standpoint, bundling of cell phone usage into per month, rather than a per minute basis, makes sense as the cost of service (and price to consumers) has plummeted over the years. It allows for higher prices to be charged while concealing how much the price has dropped for the basic service, which a good percentage of consumers might otherwise opt for if the pricing for service was more transparent.
In effect, what the consumer sees is that they used to only to make a certain number of calls each month at say $50 five years ago, but now, for the same price, they can make more calls, can text, e-mail, access Internet, etc. What they don't see is that if they had selected an equivalent package to what they had five years ago, they would be paying $5 per month.
I suspect it's actually much less than that these days - the fixed costs for establishing infrastructure are largely sunk now.
The other aspect to consider is that pricing cell phone service in the U.S. has more or less standardized around the per-month basis. Consumers expect to see this data and base their purchasing decisions around it. For the cell service companies, that imposes a certain amount of risk in presenting their billing on a per-minute basis. The first company that does it will either have to present their plan in both formats (so consumers can easily compare their plan with others) or risk being cut out of consumer consideration since most won't do the math to find out if the options are less costly.
Either way, changing over to per-minute billing is a costly proposition - increased marketing costs (from the menu change) and potential loss of revenue from those who can't tell if a per-minute plan is a good deal when comparing it to the per-monthly billing that all the other companies use.
Unless all the companies do at the same time, it simply won't happen, particularly if the competition for new customers among them has increased. They could survive the increased marketing cost, but not the potential loss of revenue.
Posted by: Ironman at Nov 4, 2007 9:16:44 AM
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
Posted by: apex at Nov 4, 2007 9:57:43 AM
Some of the arguments here may echo what Andrew Odlyzko and Clay Shirky said years ago, making the case that micropayments on the Internet would not catch on.
Posted by: at Nov 4, 2007 10:02:15 AM
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.)
Posted by: John Thacker at Nov 4, 2007 10:08:51 AM
Text messages! How can they possible cost .15 apiece, with a $5 (33 sms) unlimited option. In fact, recently 3 major carriers simultaneously (within a month or so) raised their price from .10 to 15! Unbelievable!
I can think of only a couple rationales:
* Cheap text messages steal demand for data/email services [ie, me in this case]
* Lack of competition makes text messaging a cash cow luxury item
* Closely related, carriers subsidize deliberately handicapped phones (restricted bluetooth/connectivity for transferring camera pictures, for example) and make up the difference on luxury users.
* 256 characters is really worth .15
Posted by: NE1 at Nov 4, 2007 10:09:48 AM
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.
Posted by: luispedro at Nov 4, 2007 10:47:37 AM
I think that what we see in the cell phone biz is what pervades most "competitive" industries. Mostly there are profitable procedures and ways of doing business that everyone in the industry informally agrees to abide by.
Thus in the car rental business you cannot just pay for the gas that you use. You must either fill it up yourself or pay for a full tank. Thus when you buy a house, you have to pay all sorts of "time honored" fees. Thus when you arrive early at the airport, you generally have to pay a fee to leave on an early flight despite the fact that the later seat that you are giving up is more valuable than the currently empty seat that is about to leave. etc etc
Over time, these fees usually break down but not always. As long as everyone has a space at the trough, there is not much change. It is only when one of the players starts to get desparate that change comes.
This is why every business that I have ever been associated with has fled in terror from competitive markets. It is extremely hard to make any kind of serious profit in a competitive environment. Clearly "per minute" pricing would be far less profitable.
Posted by: RobbL at Nov 4, 2007 11:17:56 AM
aah good old Industrial organization puzzles. Tirole's Book is a good place to start looking in such issues.
Posted by: rahul at Nov 4, 2007 11:25:07 AM
I use a prepaid phone. Because my phone is mostly off (unless I have made prior arrangements to receive a call) it is far cheaper. I am properly incentivized to minimize my call minutes.
Staying in touch is vastly overrated.
Posted by: RJ at Nov 4, 2007 11:37:52 AM
* 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.
Posted by: guest at Nov 4, 2007 11:46:32 AM
I've no idea what my calls cost, they're so cheap on my British "pay as you go" tariff. The handset was free, too. I am, however, very careful to make a call at least once every six months because otherwise they are entitled to take my tariff away.
Posted by: dearieme at Nov 4, 2007 11:59:10 AM
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.
Posted by: Espen at Nov 4, 2007 12:16:59 PM
I for one prefer my monthly plan with essentially unlimited usage to any per-usage fee. It is worth a small premium to have a predictable expense rather than a wildly fluctuating one.
Posted by: djg at Nov 4, 2007 12:34:34 PM
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.
Posted by: Anja at Nov 4, 2007 1:07:06 PM
I think Apex has it exactly right. Consider that the standard American cell phone plan offers unlimited weekends, unlimited nights, and unlimited calling to other people on the same cell network. (And unlimited nationwide coast-to-coast roaming, with Canada and Mexico added for a nominal fee. Just see what it costs when you go from France to England.) That's because the marginal cost of those minutes is basically zero.
What does cost money, marginally? Well, billing and acquiring and servicing a customer, all considerably higher than zero marginal cost. And then, presumably, peak daytime usage of the phone would have some marginal cost as it approaches the capacity of the cell system, which hurts other customers as well as the reputation of the provider.
Other reasons that monthly plans may be more common in America:
* wider availability of credit in America, which means less need for pre-pay;
* phone owners in America pay for incoming calls, which they may have less control over.
* the actual price of cellular service is America is much lower in absolute terms (remember all those "unlimited" minutes) and so much lower in relative terms that most Americans find the cost of measuring each marginal minutes too high to be worth any savings.
Posted by: secretivek at Nov 4, 2007 2:07:00 PM
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!
Posted by: Alex F at Nov 4, 2007 2:51:24 PM
In oligopolistic competition, no company wants to rock the boat by introducing consumer-favorable pricing schemes that will "ruin" everyone's profits.
Posted by: Half Sigma at Nov 4, 2007 4:58:44 PM
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.
Posted by: John Scott at Nov 4, 2007 10:08:21 PM
Quest at 1146 am nov 4 said that 256 character messages are worth (cost?) $0.15.
Considering that Sprint charges me something like $0.07 per minute of calling over my limit, I find it really hard to believe that a text message is the equivalent of a 2 minute call.
I find that really hard to believe. Even factoring in an enormous overhead per message, a single text message can't take any significant bandwidth. Do you have any references about the cost or difficulty of text messages on our existing cell networks?
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