Thursday, March 19, 2020

Transit Pricing Illustrates "Near Zero Pricing" Conundrum

One of the few core assumptions I always have used in my analytical work concerning the connectivity business is near zero pricing is a foundational trend for all connectivity products, as it tends to be also for computing products. Consider internet transit pricing, for example 

Back in 2014, Cloudflare estimated the cost of wide area network bandwidth as being lowest in Europe, in large part because so much internet traffic used peering rather than transit. 

Two years later, in 2016, costs had dropped. The Middle East has the lowest WAN costs, and costs in other reasons had dropped significantly. Where Australia’s costs were as much as 20 times higher than Europe’s costs, two years later the Australian costs were six times higher than Europe’s costs. 

None of you would be surprised if transit prices continued to fall. Transit to Sydney, for example, had declined to about $5 per Mbps, where back in 2014 prices had been about $100 per Mbps. 

Perhaps for every problem there actually is a solution, though perhaps sometimes the answer is not what we might prefer, expect or want. Back around 1995, I ran into one of those problems.

The context was voice pricing trends. To make a long story short, the problem was a confluence of trends that all seemed to suggest voice revenues were headed south. The process of deregulation and privatization of former monopoly networks was one such early trend.

But in addition to competition, technology trends all suggested prices would drop. Among those trends: optical fiber, microwave transmission, Internet Protocol, client-server architectures, Moore’s Law and declining microprocessor and storage costs. I cannot recall whether I believed at the time that mobile communications would put pressure on voice pricing as well.

The phrase near zero pricing came to mind. The imponderable, at the time, was what would become of telecom service providers if their core product--voice--actually reached a point where retail prices were very low, very close to “zero.”

The concept would reappear about 1999 and 2000, when the phrase “bandwidth wants to be free” was bandied about. The key concept is that prices do not actually have to drop to actual zero; prices simply have to drop to “nearly zero.” If that happens, the revenue model for nearly every business has to shift. 

What was once a revenue driver becomes something more accurately described as a “feature.” The whole point is that technology makes “near zero pricing” in any number of contexts a foundation for business strategy. The key point is not that prices actually hit zero, only that they drop so precipitously that access to computing and memory no longer are constraints to what can be done.

But that’s a problem for incumbent providers who have built substantial businesses on scarcity, either scarcity of bandwidth, processing or memory. And that was the conundrum when asking what impact near zero pricing would have for telcos.

So far, the industry has dodged a bullet by creating new core revenue drivers to supplant voice services that no longer can support the industry’s business models. Mobility and internet access are key cases in point. But prices for bandwidth show the same drift to near zero that we originally saw in long distance and voice pricing. 

Marginal cost pricing is an important principle in many markets, including growing parts of the telecom business. 

Products that are "services," and perishable, are particularly important settings for such pricing. Airline seats and hotel room stays provide clear examples. Seats or rooms not sold are highly "perishable." They cannot ever be sold as a flight leaves or a day passes. So it is rational for an airline to price seats at whatever price it can get shortly before a flight departs. Or at least, that used to be the case.

These days, airlines are more likely to attempt to raise “just before departure” revenue in other ways, such as selling upgrades to roomier seats. 

Whether marginal cost pricing is “good” for traditional telecom services suppliers is a good question, as the marginal cost of supplying one more megabyte of Internet access, voice or text messaging might well be very close to zero.

Such “near zero pricing” is pretty much what we see with major VoIP services such as Skype but also increasingly for bandwidth products in general.  Whether the traditional telecom business can survive such pricing is a big question.

“Forward pricing” is related to marginal cost pricing, where suppliers price at the incremental cost of producing the next unit (marginal cost) or at some future cost when scale is obtained (forward pricing). 

In some part, the value of becoming a platform is precisely a solution for “pipe” sales in many industries. Platforms are alternative business models. They are not necessarily built on selling a particular product, much less products whose prices tend to trend inexorably towards zero.

No comments:

"Digital Transformation" Will be as Hard as Earlier Efforts at Change

New BCG research suggests that 70 percent of digital transformations fall short of their objectives.  That would not surprise any of you fa...