ISP Marginal Cost Does Not Drive Consumer Prices

As the U.S. Federal Communications Commission opens an inquiry into ISP data caps, some are going to argue that such data caps are unnecessary or a form of consumer price gouging, as the marginal cost of supplying the next unit of consumption is rather low. 

Though perhaps compelling, the marginal cost of supplying the next unit of consumption is not the best way of evaluating the reasonableness of such policies.  

If U.S. ISPs were able to meet customer data demand during the COVID-19 pandemic without apparent quality issues, it suggests several things about their capacity planning and network infrastructure, and much less about the reasonableness of marginal cost pricing.

In fact, the ability to survive the unexpected Covid data demand was the result of deliberate overprovisioning by ISPs; some amount of scalability (the ability to increase supply rapidly); use of architectural tools such as content delivery networks and traffic management and prior investments in capacity as well. 

Looking at U.S. internet service providers and their investment in fixed network access and transport capacity between 2000 and 2020 (when Covid hit), one sees an increasing amount of investment, with magnitudes growing steadily since 2004, and doubling be tween 2000 and 2016.

Year	Investment (Billion $)
2000	21.5
2001	24.8
2002	20.6
2003	19.4
2004	21.7
2005	23.1
2006	24.5
2007	26.2
2008	27.8
2009	25.3
2010	28.6
2011	30.9
2012	33.2
2013	35.5
2014	37.8
2015	40.1
2016	42.4
2017	44.7
2018	47
2019	49.3
2020	51.6

At the retail level, that has translated into typical speed increases from 500 kbps in 2000 up to 1,000 Mbps in 2020, when the Covid pandemic hit. Transport capacity obviously increased as well to support retail end user requirements. Compared to 2000, retail end user capacity grew by four orders of magnitude by 2020. 

Year	Capacity (Mbps)
2000	0.5
2002	1.5
2004	3
2006	6
2008	10
2010	15
2012	25
2014	50
2016	100
2018	250
2020	1000

But that arguably misses the larger point: internet access service costs are not contingent on marginal costs, but include sunk and fixed costs, which are, by definition, independent of marginal costs. 

Retail pricing based strictly on marginal cost can be dangerous for firms, especially in industries with high fixed or sunk costs, such as telecommunications service providers, utilities or manufacturing firms.

The reason is that marginal cost pricing is not designed to recover fixed and sunk costs that are necessary to create and deliver the service. 

Sunk costs refer to irreversible expenditures already made, such as infrastructure investments. Fixed costs are recurring expenses that don't change with output volume (maintenance, administration, and system upgrades).

Marginal cost pricing only covers the cost of producing one additional unit of service (delivering one more megabyte of data or manufacturing one more product), but it does not account for fixed or sunk costs. 

Over time, if a firm prices its products or services at or near marginal cost, it won’t generate enough revenue to cover its infrastructure investments, leading to financial losses and unsustainable operations.

Marginal cost pricing, especially in industries with high infrastructure investment, often results in razor-thin margins. Firms need to generate profits beyond just covering marginal costs to reinvest in growth, innovation, and future infrastructure improvements. 

In other words, ISPs cannot price at marginal cost, as they will go out of business, as such pricing leaves no funds for innovation, maintenance, network upgrades and geographic expansion to underserved or unserved areas, for example. 

Marginal cost pricing can spark price wars and lead customers to devalue the product or service, on the assumption that such a low-cost product must be a commodity rather than a high-value offering. Again, marginal cost pricing only covers the incremental cost of producing the next unit, not the full cost of the platform supplying the product. 

Gigabit Services are Right on Schedule According to Edholm's Law and Nielsen's Law

U.S. home broadband customers buying gigabit tiers of service grew 35 percent year over year in the third quarter of 2022, according to Openvault. At the moment, more than 15 percent of U.S. home broadband accounts use gigabit connections. 

Also, more than half of home broadband accounts buy service in the 200 Mbps to 400 Mbps range. That group grew 100 percent year over year. 

A little more than a year ago about half of households were buying service in the 100 Mbps to 200 Mbps range, showing that Nielsen’s Law and Edholm’s Law of bandwidth supply continue to operate. 

source: Openvault 

Edholm’s Law states that internet access bandwidth at the top end increases at about the same rate as Moore’s Law suggests computing power will increase. Nielsen's Law essentially is the same as Edholm’s Law, predicting an increase in the headline speed of about 50 percent per year. 

Nielsen's Law, like Edholm’s Law, suggests a headline speed of 10 Gbps will be commercially available by about 2025, so the commercial offering of 2-Gbps and 5-Gbps is right on the path to 10 Gbps. 

source: NCTA  

Headline speeds in the 100-Gbps range should be commercial sometime around 2030. 

How fast will the headline speed be in most countries by 2050? Terabits per second is the logical conclusion. Though the average or typical consumer does not buy the “fastest possible” tier of service, the steady growth of headline tier speed since the time of dial-up access is quite linear. 

Gigabit tier subscribers hit an inflection point last year. The rule of thumb is that any successful and widely-bought consumer technology enters its mass adoption phase when about 10 percent of homes are users. For U.S. gigabit adoption, that happened in 2021. 

Some might attribute the Covid pandemic and work from home as driving the change, but adoption rates would have taken off in 2021 in any case, as predicted by the 10-percent-of-homes adoption theory. 

It also is easy to predict that 2 Gbps to 4 Gbps is the next evolution, as speeds at the top end continue to increase by 50 percent a year. Ny 2025 we should start seeing the first 10-Gbps services deployed at scale.

How Much Can 5G Device Demand Decouple from Network Access?

One curious context for 5G introduction in at least some markets is that it has occurred in the context of unprecedented conditions created by the Covid-19 pandemic. A mobile network billed as providing “much faster speeds and bandwidth” is introduced precisely at a point when workers were forced to work from home and students forced to learn at home, are not as mobile as they once were, and so arguably derive less benefit from 5G speed advantages. 

That has implications for network connectivity demand, as people at home--workers or students--will routinely connect to Wi-Fi rather than using the mobile network. 

In other words, just as we are introducing a “much faster mobile network,” people have less need to be out and about where mobile phones provide their greatest value. 

What remains to be seen is what happens when the pandemic has ended. Many observers expect permanent changes in workforce deployment, with employees spending much more time working remotely, even when some amount of in-the-office work occurs. 

Others now speculate that fewer days of work per week also could happen, with possible four-day workweeks becoming more common. 

All of those trends could reduce demand for mobile connectivity overall and reduce it at some locations such as urban cores and commuting routes. Conversely, more mobile network demand could happen in suburban locations as workers spend more time closer to home.

And, of course, some amount of former mobile traffic will shift to the fixed network (using Wi-Fi). 

Less mission-critical mobility might have other repercussions. If mobiles do not have to be used as often “out and about,” perhaps a “faster network,” while providing advantages, does not supply as much value as if users were out and about--away from home--more often. 

The one exception might obviously be business travel, when the faster speeds are likely to be more important. But business travel remains at depressed levels, for most of us. And even after the pandemic, many question whether former levels will be matched soon. Some believe there will be a permanent downward shift in business travel. 

One bit of anecdotal evidence is my own behavior working from home (which, in fact, I have done for the better part of 30 years). Most of my mobile device connectivity now is on Wi-Fi. 

So relatively rarely do I move about outside the home, and infrequently enough, that I often leave my mobile radios turned off, knowing that I can survive a few minutes of driving with no connection before Wi-Fi kicks in at the location I am going to. 

Once 5G really does offer speeds up to 10 times faster than 4G, and when I am on business travel, 5G will supply lots of value. 

Day to day, working locally, the value will be low, as I have Wi-Fi fast enough to handle my untethered device use cases, or use a direct Ethernet connection for the PC. 

With the caveat that the online poll was not intended to be representative of all users, a survey by GSMArena suggests a certain amount of decoupling of demand for devices and networks, where 5G phones are used only on 4G networks, which is sort of the same point: devices are, to some extent, more decoupled from mobile network support than they used to be. 

Some 34 percent of respondents who use 5G phones say they do not use 5G because it is not yet available. And, with the caveat that behavior is likely to change once 5G is widely available, the poll still shows that demand for phones--and phone features--is to some extent possibly disconnected from the attributes of the network the device will use. 

Some popular consumer devices are designed to be used  independently from any mobile network, using Wi-Fi or Ethernet for connectivity, others are designed to use both 4G and 5G, with a default to 4G when 5G is not available. 

source: GSMArena 

But smartphones are only partly utilitarian devices. They also are fashion. Image and personas. So some 5G phone users have purchased 5G devices even in advance of 5G networks being available, which is a new behavior enabled by handset suppliers emphasizing device features other than 5G. 

The larger question is whether substantial percentages of 5G device owners continue to behave this way--owning 5G devices that do not connect to a 5G network--over the longer term. 

The same question might be asked for customers who do not yet think they “need 5G” or do not buy because it “costs more.” Over time, those objections should cease to be relevant. 

Still, the perceived value of 5G and faster speeds could shift if remote work becomes a permanent fixture and more people are able to rely on Wi-Fi for connectivity much of the time. 

Phone features and fashion demands will still exist, though, so some buyers might find they have appetite for 5G-capable devices even when they are not so convinced they need 5G services as much as they might once have thought they did. 

Value and price packages might eventually evolve to reflect that decoupling.

Why Some Users Find 5G Unsatisfying

5G value is an issue for some users who have bought it, especially in some markets where low-band spectrum has been the way 5G is mostly experienced. But there arguably are reasons why user experience could be challenged even in markets where mid-band spectrum underpins 5G experience.

One reason is the difference between what users do--and what the networks must support--on fixed and mobile networks. Fixed networks are multi-use networks. So the obvious value in a fixed network setting is "speed" or "bandwidth" to support multiple simultaneous users.

That is not the case on mobile networks, where accounts are set up on a one device, one user basis. Even when there are multiple users on a single account, those users do not "share" a local access connection. So the advantage of "speed" is different on a mobile network.

There is no "sharing" of a single connection. Also, fixed networks support screens of many sizes. Mobile networks mostly support very-small screen devices. That shapes bandwidth demand.

Apps typically used on large screen or medium-screen devices further shape bandwidth demand. Entertainment devices such as 4K TVs will consume more bandwidth than standard-definition or high-definition viewing on very-small screens.

Mobile-connected devices supporting artificial reality are the exception, at the moment, but also are relatively rare. And even many of those use cases rely on a local Wi-Fi connection, not the mobile network.

Up to a point, bandwidth affects user experience. Just as surely, additional bandwidth does not improve experience, once a threshold is reached. Latency and jitter also matter, but users might not be able to discern such changes, or wrongly attribute the lack of perceived improvement to "bandwidth" issues.

But if 4G provides any evidence, 5G value is going to change over the lifespan of the network. 

The initial value will be “speed,” even if user experience is less changed than some will expect, even if the perceived value is the marketing value of 5G delivering data faster, irrespective of user experience value.

The value after a decade will be “new use cases” and apps, for consumers and business use cases. But that will take time. And consumers might well find there is "not much difference" between 4G use cases and new 5G apps. They have not been created yet.

The betting early on is that many--perhaps most--of the new use cases will come from enterprise, not consumer uses. 

After a decade or so, we are likely to have discovered new consumer apps as well. It just is hard to say what those mass deployed use cases will be. Perhaps nobody predicted the emergence of ride sharing as an important 4G use case. 

Few predicted turn-by-turn navigation would be important. And though streaming video and audio were foreseen, even those apps do not rely so much on “speed” as the creation of easy-to-use and popular streaming apps.

In fact, the rise of “mobile-first” apps does not depend, strictly speaking, on bandwidth improvements brought by 4G, though faster speeds are an enabler. 

That would not be unusual for a next-generation mobile network, up to a point. If nothing else, coverage is an issue, early on. Even a better network does not help if it is not “generally available.”

Complicating matters is the rollout of 5G during the Covid pandemic and many restrictions on “out of home” and “on the go” usage. Working or learning remotely, many users likely spend most of their time connected to home Wi-Fi. So even if 5G is faster, the amount of time any single user might use it is far more limited than under normal circumstances. 

Still, faster speeds should help, up to a point, with existing applications, as page loading on a 600-Mbps fixed network connection should provide some noticeable advantages compared to a 300-Mbps connection (especially in multi-user and simultaneous multi-device usage cases. 

Since 3G, the key user experience gain has been “faster mobile data access.” Sometimes that is tangible; but sometimes not so much.

An argument can be made that latency has even greater user experience impact on a mobile network. Beyond some relatively low point, additional speed might not improve user experience. We can debate what that threshold is, as it changes over time. 

If a consumer’s primary reason for buying 4G was a tethering experience closer to fixed network experience, the 4G advantage was immediately tangible. If the primary advantage sought was mobile web browsing experience similar to fixed network experience, then the advantage might well have been tangible. 

5G poses a bit of a tougher problem. When downstream 4G speeds are routinely in the 20 Mbps to 30 Mbps to 35 Mbps range, how much does experience change when 5G offers 165 Mbps? It should help, but how much?

It depends on what a user does on a phone. Web page loading will be faster, but how much faster? Ignore for the moment the authoring of a web page (optimized for mobile access or not; how well optimized). 

For fixed network access, faster access speeds have not necessarily meant that web pages are loading faster, for example. 

On mobile networks, connection speeds have improved, but mobile page load times tracked by have increased, according to the Nielsen Norman Group.

source: Nieslen Norman Group 

Of course, page and landing page loading times are not a direct function of access speed but perhaps largely an artifact of remote server performance. So access speed is not the only, or perhaps not even primary determinant of user experience. 

The build-out phase of a national next-generation network takes years, so coverage outside of urban cores will typically be an issue. In some markets, where low-band and millimeter wave frequencies have been the mainstay, users might not often find there is much mobile data performance difference.

Only 28% of U.K. Customers Able to Buy FTTH Broadband Do So

Ofcom’s latest research shows the continuing lag between broadband supply and demand. In other words, it is one thing to make FTTH or gigabit-per-second internet access available. It is something else to entice customers to buy such services.

Fiber-to-home facilities now are available to more than eight million U.K. homes, or 28 percent of dwelling units. 

Meanwhile, gigabit-capable broadband is available to 13.7 million homes, or 47 percent of total homes. But take-up of gigabit speed services is still low, with around seven percent of FTTH  customers buying gigabit services, says Ofcom. 

source: Ofcom 

Fully 96 percent  of U.K. premises have access to 30 Mbps broadband connections. About 69 percent of locations able to buy 30 Mbps actually buy it, says Ofcom. Also, Ofcom notes that “94 percent of U.K. premises have access to an MNO (mobile network operator) FWA (fixed wireless access) service.” 

Mobile operators claim average download speeds up to 100 Mbps to 200 Mbps on their 5G fixed wireless services, Ofcom says. 

Satellite services add more potential coverage. “For example, Konnect states that its satellite covers around 75 percent of the U.K. and offers commercial services on a 24/7 basis direct to consumers with download speeds between 30 Mbps and 100 Mbps, with upload speeds averaging 3 Mbps.”

New low earth orbit satellite services such as Starlink also are coming. “Starlink indicates that users can currently expect to see 100 Mpbs to 200 Mbps or greater download speeds and upload speeds of 10 Mbps to 20 Mbpss with latency of 20 milliseconds or lower in most locations,” says Ofcom. 

The point is that although we might think consumers would jump at the chance to buy either FTTH service or gigabit-per-second service, that is not the case. Only about 28 percent of households able to buy FTTH service do so, while just seven percent of households able to buy gigabit service do so. 

To a large extent, internet service providers are investing ahead of demand, rather than following consumer demand. That is one key reason why customer experience did not fall off a cliff when pandemic-related shutdowns happened. ISPs already had created excess supply. 

That is likely to be the trend virtually forever.