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June 29, 2006

Price – Who’re You Calling a Freeloader?

One of the major objections to flat-rate pricing of communication services, including Internet access, is the danger that a small percentage of users will absorb a huge percentage of the resources either degrading service or raising prices for everyone else. Providers call these users “freeloaders” even though they are paying something.   

It’s easy to make a hypothetical case for this argument; but, in my experience, freeloading is not usually a problem even when a service is unmetered.  In fact, so-called freeloaders may be important to the value of a network service.

Network engineers know that you build a network for its anticipated peak load (actually just for the xxth percentile peak load depending on what kind of reputation you want).  Since most networks including the power grid, the phone network, and the Internet have peak loads far in excess of their average load, most network resources are idle most of the time.  BTW, this is one of the reasons that WiFi modem sharing (see previous post) can work well.

Unlike the power grid which must be fed expensive power, the cost of running a communication network (other than customer service) is almost independent of how much the network is used.  Much of the cost for communications networks is in amortization of the original capital required to acquire rights-of-way and to build the infrastructure.  There are also operating costs for a network control center, maintenance, and repair costs; but these costs aren’t affected by actual usage – electronic routers don’t wear out after so many packets and switches no longer have mechanical parts subject to wear.  Electronic stuff ages and gets obsolete whether it’s used or not.

In the US (except New York City) we’ve had unmetered local phone service as long as I can remember (and I’m old).  Did some people talk more than others?  Of course.  Did this make local phone service terribly expensive or cause long waits for a dial tone? No. (In all fairness, there are both governmental subsidies and a subsidy from long distance which reduce the cost of some local service so the argument here is a little shaky).

More recent experience is with flat rate all-you-can-eat dialup access pricing which I helped to popularize when I started AT&T WorldNet Service.  I wish I could take the credit (or blame) for inventing it but I didn’t.  I just latched onto it and used the AT&T brand to popularize it.  We had plenty of backbone bandwidth available from several previous failed AT&T services but we didn’t have an unlimited supply of the ports that growl at your modem when it dials in (remember those days?).  We had to buy equipment for each port and we had to rent a line from our then rivals, the baby Bells, for each port.  Ouch.

Besides brand, one of our main selling points over our well-established rival AOL was that they were then known as “America on hold” both because of the many busy signals encountered when trying to dial into them and the long waits for customer service when you wanted to complain about the busy signals. 

We were determined that users would usually (80% of the time during peak periods) find an open port the first time they dialed in.  So we had to have enough ports.  We also engineered a pretty clever hack to bulk haul calls from one place to another as peaks hours rolled across the country.

We were far from perfect.  We did have cities where we were short of capacity.  We did find that we had to provision more than the one port for every twenty registered users we’d baked into our original business plan.  And, at first, we blamed the freeloaders, the people who stayed online tying up a port 24x7.  I forget the actual numbers but it was something like 5% of our users accounting for 50% of our use.  What to do?

Fortunately, before we took any drastic action, we looked at the PEAK hour numbers.  Turns out that there were lots of users who only showed up during peak hours.  Many were on our hourly plan but we weren’t billing them a lot because they didn’t use many TOTAL hours.  But the size of our network and the cost of running it were only affected by the peak hours used, not the total hours.  Eliminating flat rate pricing would not have solved our problem and it would have driven some of our most loyal customers away.  The so-called freeloaders accounted for a much smaller percentage of peak hour usage than they did of total usage.  Obvious when you think about it since everyone else is also using the network during busy hour.

Broadband providers don’t need to provision unique physical ports for all of their users.  They recognize this by encouraging their users to be continuously connected.  But broadband providers also have no incremental cost for actual usage.  Doesn’t really matter if you download a little or download a lot – except during peak hours.  They still have to build their networks for peaks.

In fact, this same logic holds for phone networks – wired or unwired.  All the actual costs depend on the size of the network and not its use.  That’s why we’re starting to have flat rate long distance and even international calling plans.  The only reason we have ANY metered phone plans left is that, in many parts of the world, monopolies control the last mile of access to the called party.  These monopolies CHOOSE to charge for access to this last mile by the minute because that’s lucrative – but their network costs are determined only by peak hour demand.

You could make a case for charging differently for peak and off peak access.  The difference would have to be significant to get customers to accept the complexity.  Some providers do this simply by tacitly allowing their customers to use more bandwidth than they’ve paid for except during peak periods.

You can certainly make a case for the current practice in many places including the US of gating access by the width of the pipe.  Makes sense to me to pay more for 10 meg (if I could get it) than for 2 meg.  The telephone equivalent is the single line.  You can’t use it to call for more than 1440 minutes per day.  If you know how much access you’ve sold, you can guess how much backbone you’ll need to provision.

Now back to the freeloaders that carriers love to hate.  If someone keeps an access line humming 7x24 as part of a file sharing network, she is probably doing the network operators a favor by moving files around at off-peak times so that they will be more easily accessible with shorter network paths during peak times.

She, the server operator, is certainly making the network more valuable by adding content to it that all users can access.

The first post in this series on price is about the cost of complexity.

The second post is about FON, the WiFi sharing scheme, as a great experiment in pricing.

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