Economics Strategy Policy Sep 1, 2010

Why Broad­band Prices Haven’t Decreased

Cre­at­ing the first broad­band con­sumer price index

Based on the research of

Shane Greenstein

Ryan McDevitt

After a new tech­nol­o­gy is intro­duced to the mar­ket, there is usu­al­ly a pre­dictable decrease in price as it becomes more com­mon. Lap­tops expe­ri­enced pre­cip­i­tous price drops dur­ing the past decade. Dig­i­tal cam­eras, per­son­al com­put­ers, and com­put­er chips all fol­lowed sim­i­lar steep declines in price. Has the price of broad­band Inter­net fol­lowed the same mod­el? Shane Green­stein decid­ed to look into it.

Since there are no pub­lic data on what has hap­pened to broad­band prices over the last decade, Shane Green­stein, a pro­fes­sor of man­age­ment and strat­e­gy at the Kel­logg School of Man­age­ment, and his co-author Ryan McDe­vitt, an assis­tant pro­fes­sor of eco­nom­ics and man­age­ment at the Uni­ver­si­ty of Rochester and a grad­u­ate of North­west­ern Uni­ver­si­ty, ana­lyzed the con­tracts of 1,500 DSL and cable ser­vice providers from 2004 to 2009. They found evi­dence of only a very small price drop, between 3 and 10 per­cent, noth­ing like the rates of price decrease that char­ac­ter­ize the rest of the elec­tron­ic world.

Pric­ing Pol­i­cy
It might seem like the cost of obtain­ing access to broad­band Inter­net ser­vice would be pro­hib­i­tive for many, but Green­stein notes that cable tele­vi­sion wires already pass by more than 95 per­cent of US homes, while 75 per­cent of homes are close enough to a tele­phone switch for a DSL pro­vi­sion. Any place with a pop­u­la­tion above 50,000 is not going to have a prob­lem get­ting ser­vice,” Green­stein says.

Green­stein says many observers believe broad­band prices have stag­nat­ed large­ly due to the con­cen­trat­ed mar­ket struc­ture. Oth­er fac­tors have also con­cen­trat­ed broad­band sup­ply, includ­ing economies of scale and reg­u­la­to­ry rules. In most urban mar­kets, only two wire­line providers sup­ply the vast major­i­ty of homes, and the remain­der are served by a range of wire­less Inter­net providers. Rev­enue from homes makes up 70 to 80 per­cent of rev­enue in wire­line Inter­net access mar­ket, while busi­ness demand makes up the rest.

So if you were in such a mar­ket as a sup­pli­er, why would you ini­ti­ate a price war?” Green­stein asks. With no new entries on the mar­ket, sup­pli­ers can com­pete by slow­ly increas­ing qual­i­ty but keep­ing prices the same. Accord­ing to Green­stein, qual­i­ty is where providers chan­nel their com­pet­i­tive urges.

Mean­while, once com­pa­nies have installed the lines, their costs are far below prices. At that point, it becomes pure prof­it,” Green­stein says. A com­pa­ny might spend around $100 per year to main­tain and ser­vice” the con­nec­tion, but peo­ple are pay­ing near­ly that amount every oth­er month. Green­stein says that it is not sur­pris­ing that prices were high dur­ing the build­out phase in the ear­ly and mid-2000s, since the firms were try­ing to recov­er their costs. How­ev­er, we are approach­ing the end of the first build­out, so com­pet­i­tive pres­sures should have led to price drops by now, if there are any. Like many observers, I expect­ed to see prices drop by now, and I am sur­prised they have not.”

Table 1. Adjust­ed Rev­enue for Access Markets

A New Tra­jec­to­ry
At the start of the 21st cen­tu­ry, less than 5 per­cent of house­holds had access to broad­band Inter­net as most used dial-up sys­tems. How­ev­er, broad­band soon achieved access to more homes through cable and tele­phone lines. Near the end of the decade, opti­cal fiber lines had joined the ranks of broad­band Inter­net providers. The decade start­ed out with broad­band rep­re­sent­ing just 6 per­cent of the total rev­enue from Inter­net ser­vices and that fig­ure had grown to 72 per­cent by 2006. Green­stein and McDe­vitt decid­ed to base their con­sumer price index on data from the sec­ond half of the decade, from 2004 to 2009, when the use of broad­band real­ly exploded.

They began by por­ing over 1,500 con­tracts from dif­fer­ent years and ser­vices, includ­ing both stand­alone agree­ments and bun­dled con­tracts, in which a user com­bines Inter­net with cable tele­vi­sion and/​or phone ser­vice. They found that, even though prices stayed rel­a­tive­ly con­stant, the qual­i­ty of ser­vice rose through the years — for exam­ple, in 2004 the medi­an cable modem con­tract price was about $45 with an upload band­width of 3000 bits per sec­ond, while in 2009 the medi­an con­tract cost $53 but had an upload band­width of 8000 bps. 

Green­stein says that a relat­ed prob­lem may begin to creep into the sys­tem. With only slow qual­i­ty upgrades and the ram­pant growth of stream­ing video online, most observers expect broad­band to have mul­ti­ple bot­tle­necks in its access net­works soon.

The broad­band con­sumer price index cre­at­ed by the Kel­logg researchers has some lim­i­ta­tions. An offi­cial price index would include a weight­ed aver­age, which would give more share to the biggest providers to reflect the mar­ket more accu­rate­ly. Green­stein and McDe­vitt were unable to cre­ate a weight­ed index because they lacked con­fi­den­tial data from the Bureau of Labor Sta­tis­tics about mar­ket shares.

The most sur­pris­ing dis­cov­ery, Green­stein says, is that nation­al deci­sions are being made with­out the type of data that he cre­at­ed in the con­sumer price index. As an observ­er of com­mu­ni­ca­tions pol­i­cy in the U.S., I find it shock­ing some­times how often gov­ern­ment makes deci­sions by the seat of their pants,” he says. With­out real data and sta­tis­tics, deci­sions are based sole­ly on who has bet­ter argu­ments — in essence, a debate. A bet­ter con­sumer price index will help pro­duce bet­ter deci­sions for the future of the Inter­net and its users.

Relat­ed:

Shane Green­stein blogs about this top­ic and relat­ed sub­jects in Vir­u­lent Word of Mouse.

Featured Faculty

Shane Greenstein

Member of the Strategy Department faculty until 2015

About the Writer

Katharine Gammon is a science writer based in Santa Monica, CA.

About the Research

Greenstein, Shane and Ryan McDevitt. 2011. Evidence of a Modest Price Decline in US Broadband Services. Information Economics and Policy, June, 23(2): 200-211

Read the original

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