Economic Rationality Is Not Political Rationality

Economics is a very useful discipline for figuring out how to allocate scarce resources. In fact, economics virtually assumes scarcity. Consider the severe water drought in California, a problem that other states across the American west also have been grappling with for more than a decade.

Some 60 percent of domestic use goes to watering landscape, it often is noted.

That almost always leads to calls for reducing lawn irrigation, which is useful enough advice. But all domestic use only makes up one percent of overall water use. Most water is used for irrigation and power generation.

Agriculture alone accounts for 80 percent of California water use. So simple economic rationality would call for reducing five percent of agricultural water use, which achieves the same savings as cutting 25 percent of urban water use.  

Though it is politically difficult, it makes more sense, in terms of economic rationality, to deal with inefficiency related to the 99 percent of water usage in California, not the one percent.

That does not appear to be what is happening. Instead, California will try to reduce urban water usage (the one percent) by 25 percent. Other western states that have implemented similar policies have indeed found it is possible to make gains. People do replace lawns with xeriscapes.

You might wonder why more is not done about any similar policies related to the 80 percent to 99 percent of water users.

The political reality is that agriculture now is built on “cheap water.” So raising agricultural or industrial water prices necessarily causes higher agricultural or industrial product prices. So far, that has made some logical choices difficult to impossible to implement, one might argue.

So it is politically rational --if not terribly economically rational--to make urban users bear the burden.

That is not to argue agriculture is unimportant. But Pareto optimality still matters. Less than 20 percent of actions produce 80 percent of the results.

But this is water, and water rights have shaped the history of the American west. That hasn’t changed.

Oddly enough, in Colorado, where we have been grappling with life in a virtual desert for some time, it is illegal to collect rainwater in a barrel, for example. The theory is that the water would otherwise enter the aquifers, and somebody else already has superior rights to the water in aquifers.

Someday, not even entrenched political interests will be able to ignore economic logic. But not yet, it appears. Though political rationality is not economic rationality, it is "rational."

Are OTT App and Content Terminating Charges Coming?

India’s Telecommunications Regulatory Authority of India is asking serious questions about the regulatory framework for over-the-top applications, questions that are bound to become more pointed as 4K TV becomes more common for streaming.

And the questions suggest TRAI seriously is considering a broader application of traditional traffic termination frameworks, especially the charge for landing traffic on a receiving network.

As part of a public inquiry, TRAI is asking whether a regulatory framework for OTT services is needed now, or is a decision that can be deferred. That would be a rather necessary precondition for considering application of terminating traffic rules to OTT providers.

TRAI also is asking whether OTT players offering communication services (voice, messaging and video call services) through applications (resident either in the country or outside) should be brought under the existing licensing regime. Though, in principle, TRAI could remove regulatory burdens from incumbent suppliers, giving them the freedom now enjoyed by OTT apps, that seems unlikely.  

Though it is a contentious question, TRAI asks whether OTT competitors are affecting communications service provider revenue streams. If so, “is the increase in data revenues of the telecommunication service providers sufficient to compensate for this impact?

Among the contentious questions also is the matter of whether OTT app suppliers should “pay for use of the telecom service provider’s network, over and above data charges paid by consumers. “If yes, what pricing options can be adopted? Could such options include prices based on bandwidth consumption?” TRAI asks.

The answers to those questions will determine, in part, whether TRAI acts to “level the playing field” or change business models in ways that compensate access providers for OTT app provider imposed network costs.

The consultation might lead to hugely-important changes in regulatory regime that increase access service provider revenues and impose new costs for OTT app providers.

Among the other important implications, TRAI could move to shift revenue shares within the Internet ecosystem, supporting access provider revenue streams to some extent, while essentially raising OTT app provider costs of doing business.

TRAI asks whether “imbalances exist in the regulatory environment,” and if so, “can the prevailing laws and regulations be applied to OTT players.”

Any such rules would not necessarily shift revenue directly, but would raise OTT provider costs, indirectly protecting incumbent services because price differentials between OTT and incumbent services would narrow.  

In India, TRAI asks for input on whether termination charges should be applied to OTT app providers. That would be a huge change from current practice.

In such a new framework, sending networks (content providers, OTT services and other application providers) would pay compensation for delivering traffic to the terminating networks.

India Telecom Regulators Looking at OTT Regulatory Framework

A decade and a half after its widespread emergence, over the top VoIP and messaging continue to raise sustainability issues for regulators and business model issues for service providers in a “redefined market” that has separated “carriage and content; ” applications and access; and revenue from usage.

Whether telecommunications regulations must change to reflect the fundamental changes is an issue India’s Telecommunications Regulatory Authority of India now is considering.

The dimensions of the problem are easy enough to illustrate.

Revenue earned by a communications service provider providing one minute of traditional voice is 50 paisa (one paisa is 1/100 of one rupee) on an average, compared to data revenue earned for one minute of VoIP usage which is of 4 paisa.

The average revenue earned by a service provider for a single text message is around 16 p, when compared to 1p of data usage charges when an OTT app is used, instead.

So the fundamental problem for service providers is an order of magnitude reduction of revenue.

Still, In India, service provider overall revenue is expected to reach $46 billion to $49 billion

by 2020, up from $28 billion in 2013, TRAI reports.

Data revenues will grow from 10 percent to 12 percent in 2013 to 35 percent to 40 percent of total by 2020. That implies data revenues of about $16 billion to $20 billion in 2020.

Voice might then represent between 56 percent and 61 percent of total revenues.

Other revenues from text messaging, traditional value added services and new services are expected to remain at $2 billion between 2013 and 2020, representing four percent of total revenues.

The cloud services market in India especially the public cloud stood at $632 million in 2014, which is expected to touch $838 million by 2015 end and $1.9 billion in 2018, growing at about 33 percent, TRAI notes, perhaps representing four percent of total revenue by 2020.

In a broad sense, TRAI is tackling the tricky issue of whether robust, healthy communications networks can exist if the revenue to support investment continues to migrate away from network operators and to app suppliers.

Service providers no longer profit from most apps, and generate revenue “solely from the increased data usage,” says TRAI. The revenue implications are profound.

App providers, On the other hand, app providers require use of the communications networks and therefore impose most of current network costs, while competing directly with services sold by the service providers, TRAI also notes.

In a profound understatement, TRAI notes that “It is thus becoming clear that, in future, the provision of services by OTT players will impact revenues of network operators insofar as their current business models are concerned.”

Perhaps the biggest issue is the ever-present dilemma of how to equalize the regulatory framework. Two fundamental approaches exist: lighten regulations on incumbents or increase regulations on new providers.

Why Cable TV Operators Might Dominate High Speed Access

Comcast’s plan to offer 2 Gbps symmetrical Internet access to perhaps 18 million homes out of 21 million illustrates a relevant business principle. One often hears it said that something “cannot be done.”

The phrase has to be understood in context. It actually means a particular provider, with a particular cost structure and business model, cannot do something. A given retailer might not be able to compete with Amazon, in some product lines. A given airline might not be able to compete with another airline at a specific airport location.

But it is not true that what one firm cannot do means that all other firms are similarly unable to do so.

In fact, some have argued, for some time, that U.S. cable TV companies eventually would emerge as the dominant fixed line suppliers of communication services for consumers, as telcos--with higher fixed and operating costs--simply could not compete.

In many ways, that already has happened: telcos no longer are dominant providers of fixed network services for consumers.

At the end of 2012, incumbent local exchange carriers (telcos) had 34 percent share of the consumer voice market, 14 percent of the high speed access market and 10 percent of the video subscription market.

In fact, some might argue that cable TV operators are destined to dominate consumer high speed access. Others might argue a long-term duopoly, nationally, will exist, with Comcast and AT&T having dominant market share in different markets.

Some might argue that AT&T and Verizon have cost structure issues that will continue to hamper their fixed network operations. That is one good reason why effort and investment have shifted to mobile operations.

Telcos might not be able to match Comcast’s 2 Gbps high speed access offer easily, as they will find 1 Gbps challenging on a sustainable basis. The issue is the business model, not the technology. In competitive markets, the low-cost provider tends to win Telcos are almost never the low-cost providers.

There are obvious regulatory and business implications, almost certain to be jarring and unpleasant. 

There will come a time when it makes no sense to put handcuffs on formerly dominant telcos. There will come a time when telco cost structures will have to be slashed even more than at present.

Telco fixed network investment returns will be difficult to impossible to obtain.

TV Inflection Point Might be "A Few Years" Away, says Moody's

Cable TV companies do not face immediate revenue threats from over the top video alternatives “for the next few years,” according to Moody’s Investor Service.

Perhaps the key phrase is “for the next few years.” At some point, a transition to OTT streaming services is going to hit an inflection point, the rate of change will go non-linear, and the business will change rather quickly.

So far, the changes have been gradual. In 2014, cable suppliers lost about 1.2 million accounts, while AT&T and Verizon picked up about a million accounts. Satellite suppliers gained about 20,000 accounts. So there was a net shrinkage of about 126,000 accounts, on a base of 95.2 million.

The decline of cable accounts has been underway since 2012, the Federal Communications Commission reports.

On the other hand, late in 2013, for example, U.S. cable TV operator high speed Internet access accounts surpassed video accounts for the first time. That does not necessarily speak to the health of the video subscription business, though, as cable losses were to the benefit of telco suppliers.

A change in adoption from rather slow and linear to exponential tends to happen for adoption of most important new technologies, however. There is a longish period where it seems not too much change is happening, but then an inflection point where adoption rapidly increases.

A firm that misses the transition quite frequently begins a period of irreversible decline. On the other hand, such inflection points are common in the communications business.

Until the early 1990s, few people actually used mobile phones. But mobiles suddenly became the primary way people globally make phone calls and arguably also have become the way most people get access to the Internet.

The inflection point everywhere in the developing world seems to have happened between 2002 and 2003.

In 2000, one might still have looked at tele-density figures for Africa and south Asia and still have concluded that not much was happening, in terms of adoption. But that changed, sometime around 2004, when a growth inflection point was reached, both in terms of income and use of mobile phones.

That has direct implications for Internet access as well. Over time, the volume of smart phones, compared to feature phones, will shift dramatically in the direction of smart phones. And that will rapidly change the usage of Internet apps.

Statistics showing wide disparities in use of the Internet around the world are snapshots in time. What is equally important is the pace of change. One might have argued, based on statistics from 1990 or 2000, that many in developing regions developing regions still were not able to use phones and computers or get access to the Internet.

But an inflection point occurred in India around 2004.

One might wonder how close we now are to such an inflection point in the video entertainment business, as some studies suggest an uptick in customer churn, in a business that generally has been seeing smaller churn rates for a decade or more.

Moody's analysts said that the strength of the high speed access business, limited competition, and customer inertia would give cable operators time to adapt to the rise of new entrants to the sector.

"OTT options will take a small number of traditional pay TV subscribers, but the shift in the pay TV sector will be evolutionary, not revolutionary," said Moody's Vice President Karen Berckmann.

One advantage for distributors is that content owners are not pushing too hard for change. "Content providers are treading cautiously so traditional cable operators now have the chance to build financial flexibility and prepare in case industry fundamentals change more significantly."

Some would argue from history that is likely to happen. Change will be incremental until the inflection point is reached. Then change goes non-linear and exponential.

The danger is that an incumbent has not prepared in advance for the rapidity of the eventual shift. The greater threat is that the incumbent simply does not possess the desire and skills to make the transition.

When Consumers Shop by Price, Headline Prices Will be Misleading

It arguably never has been terribly easy for a typical consumer to read and understand a telephone bill.  

As Verizon’s explanation of taxes, fees, surcharges, and other charges makes clear, it still is tough.

And without condoning the placement of operating charges “below the line,” allowing a lower headline price to be advertised, the practice probably is not unusual in any highly-competitive industry, where people shop “by price,” and when pricing is easily available online.

Shopped for an airline ticket recently? You know what I mean. Try reading your triple play provider’s bill, especially if you are a new customer that just signed up. Try and figure out whether everything fits with your understanding of what it was you decided to buy. It might be quite hard to figure out.

For those of you with family mobile service plans, who have shifted from device subsidies to installment plans, it is possible “headline prices” for recurring service are quite attractive, compared to your former bills.

As consumers, we tend to like that. But after building in installment fees for new devices, the differences will still be visible, but the savings might not match your expectations.

Still, that’s the point. Consumers have gotten used to getting “lower prices” when shopping for any number of items and products. So what is any competitor going to do if a significant competitor starts advertising prices that appear to be lower?

A rational competitor is going to match the prices, and might use the same tactics as the firm that moved first.

That isn’t to condone practices that essentially hide costs, at least until a consumer gets further into the buying process. But highly-competitive markets, where “lower price” is a key consumer desire, are susceptible to practices aimed at producing lower “headline prices.”

That’s why there are baggage fees, seat reservation charges, meal or drink fees, video entertainment or Wi-Fi access costs that are supplemental to a quoted airfare.

Suppliers are competing in markets where consumers look early for price, after ascertaining that a certain product meets buyer criteria.

If no key competitors adopt a particular practice, others will not have to do so. But once the attack has started, responses are required.

In an era of price transparency, price really matters. And that’s why pricing “add ons” is so attractive to suppliers. It allows them to stay competitive with market-level headline pricing.

Few buyers likely think that is a good outcome. But that is what happens when headline prices are highly transparent.

Comcast to Ditch HFC for FTTH for 2 Gbps

Comcast's 2-Gbps Internet access offer, to be introduced in Atlanta and then other locations, is a watershed moment for the U.S. cable TV industry.

It appears that Comcast will use a fiber-to-the-home architecture to provide the service, ditching the hybrid fiber coax network for the first time in a mass consumer application.

That doesn't mean Comcast is abandoning HFC for most of its customers, at most locations. Much hinges on the price, and how many consumers are willing to pay what it will take to get the 2-Gbps service.  One suspects that is a rather low number. 

The new service will require replacing HFC connections with all-fiber access, and Comcast, as well as other cable TV operators, will resist "rip and replace" to the greatest extent possible. 

So, in a sense, Comcast might reasonably expect that a relatively small percentage of consumers actually will opt for the service, which will require overlaying new optical fiber drops from existing optical nodes. 

But it is a watershed moment, as Comcast would, for the first time, use FTTH as its consumer access network, at least for some customers, at some locations. 

Comcast has suggested it will  potentially reach 18 million of some 21 million homes, as 18 million Comcast consumers live within a third of a mile of an optical node.