Tuesday, April 17, 2012

Rational Economic Behavior and the Internet: Why You Want to Pay Per Packet

Originally published in 2010.
Verizon has raised my rates since then.  Grrr.
This bolsters my argument.

It’s always dangerous to give me spare time, an Internet connection, and a calculator.  I have been thinking about this particular issue for many years — any kind of “all you can eat” model has always struck me as suboptimal, and my reaction to the growing popularity of flat rate Internet connection pricing based on connection speed is the same as my reaction when Pets.com offered free shipping on 50-pound bags of dog food back in the day: buy all you can, ‘cause this deal can’t last.

Internet customers (at least in the US) seem to have figured this out.  Their usage of bandwidth continues to grow at very high rates while flat-rate pricing is the norm. This is rational producer and consumer
behavior; there is neither disincentive to produce “fat” content or applications nor disincentive to consume them. This has been a lurking but invisible problem in the wired world, where bandwidth is relatively cheap. But the problem has become visible recently in the wireless world, where bandwidth is more expensive (because it is more scarce). We have all seen reports of wireless carriers struggling to keep up with network demand created by the latest smartphone or media application.

It costs real money to upgrade networks to keep pace with this demand, and those costs are ultimately borne by the subscriber. So in the US, we have carriers trying to raise their rates to offset increases in capital and operating expenses to the point where consumers are beginning to push back, and the shoving has come to the attention of the Federal Communications Commission, which has raised the possibility of treating Internet network providers as common communications carriers subject to regulation.

I believe that flat-rate pricing is a major source of problems for network carriers and consumers. In the carrier world, the economics are known but ignored because marketers believe that flat rates are the only plans consumers will accept. But in the consumer world, flat rates are rising to incomprehensible levels for indecipherable reasons, with little recourse except disconnection. Consumer dissatisfaction is rising, in part because consumers feel they have no control over the price they have to pay. This is driven by their sense of pricing inequity that is hard to visualize but comes from implicit subsidies in the current environment. The irony is that pay-per-use pricing solves the problem for carriers and consumers.

The Current State
Let’s do some arithmetic. I went to the statistics page on my router, where it reported that in the past 47 days I had sent and received around 15 million Internet packets. I rounded that up to 20 million,
then derived the following:

         - 20 million packets in 47 days
         - 425,532 packets/day
         - 12,765,597 packets/month

How big is a packet? Like many questions, the answer is, “It depends.”  After a little research, I determined that my average packet size was somewhere between 557 and 1,500 (an average rich-media packet size) bytes. Then I made some assumptions about my traffic:

         557 bytes (60% of traffic)
         - 1,500 bytes (40% of traffic)
         -  934 bytes (weighted average packet size)

Now I had an average packet size, and I had my packet traffic per month. So how many bits is that?

         - 7,474 bytes (weighted average bits/packet)
         - 12,765,957 packets/month
         -  95,412,765,957 bits/month

Whoa, that’s a lot of bits. Let’s scale it down to manageable significant digits:

         - 90,993 Mb/month
         - 11,374 MB/month
         - 11 GB/month

This exercise revealed that, in a typical month, I shipped about 11 GB over the Internet (the vast majority was downloaded but for this discussion we will focus on total traffic). Verizon, my provider, charges me about US $64.99 per month, or about $2.17 per day for 25 Mb/sec download speed.2 Some of you might say, “Hey, $2.17 per day is cheap.”  My response is “Compared to what”? Let’s take a look on what I actually consumed:

         - $64.99/month
         -  $2.17/day
         -  $5.85/GB transferred (actual)

Is $5.85 per GB a good or bad deal? Let’s compare that price based on actual usage to the theoretical price I could be paying if I used all of my monthly bandwidth:

         - 26,214,400 bytes at 25Mb/sec peak rate
         - 3,276,800 bytes/sec
         - 11,796,480,000 bytes/hour
         - 11,250 MB/hour
         - 11 GB/hour
         -  0.0107 TB/hour
         -  0.2575 TB/day
         - 8 TB/month

Now, all the carriers disclaim their peak performance numbers; they can be degraded by traffic congestion, phases of the moon, whatever. Let’s pretend that I could actually see the above (and, to be fair, my FiOS service has been generally reliable). That would mean I could transfer 8 TB in a month, compared with the 11 GB that I actually transferred.  That changes the transfer price dramatically:

         - $64.99/month
         -  $5.85/GB transferred (actual)
         - $0.008/GB transferred (theoretical)

Clearly, I should be consuming more. Even rounding up, the price gap between $5.85 per GB and $0.008 per GB is substantial. And herein lies the problem. Since the rate I pay is flat, everything in the gap between 11 GB and 8 TB looks free to me. But I assure you it does not look free to Verizon. If every FiOS subscriber tried to download 8 TB a month, cries of panic would echo throughout the land. A similar exercise for wireless data plans would show higher prices but a smaller gap between actual and theoretical because the theoretical limits are lower.  Some wireless carriers explicitly prohibit extended peak bandwidth use for just this reason.

A Monthly Bill I’d Like to Get
What if, instead of increasing the maximum download speeds for a flat rate, a carrier tried this: pay $0.0000025 per packet — period. The resulting bill would be:

          - $31.91 for 11 GB transferred/month
          - $63.82 for 22 GB transferred/month
          - $22,979 for 8 TB transferred/month

A pricing strategy like this might lower the monthly bill for an average customer as well as allow for some increased consumption without breaking the bank. It would provide the consumer a way to lower costs just by reducing consumption. There would be a substantial disincentive for order-of-magnitude increases in consumption; if the data were really that valuable, this would prove it. Otherwise, consumers would have to think of options:

         1. Do without.
         2. Find a way to make the data more efficient.
         3. Find a cheaper substitute.
         4. Get someone else to pay.

All these options are used by producers and consumers today and form the basis of advertiser- and business-supported messaging. There is no reason to suspect that a motivated advertiser wouldn’t pay to transmit its car ad to a serious prospect. Web site and content creators would be obliged to consider data transmission costs and build more efficient products — or offset their higher costs with direct payments, advertising, or some other explicit subsidy. Carriers could use variable pricing per packet to adapt consumer usage to network capacity variances and expansion.

This past June, AT&T, wireless provider for Apple’s iPhone, became the first major mobile phone company to stop offering new smartphone customers a single monthly price for unlimited Internet access.3 That may signal an industry shift to charges based on how much people use their phones to access videos, music, and data. AT&T expects the new pricing to boost sales. Verizon followed in July.  Newcomers to AT&T can pay $15 per month for 200 MB of data or 2 GB for $25. AT&T says 65% of its smartphone customers use fewer than 200 MB per month, and 98% use fewer than 2 GB. Just 3% of AT&T’s smartphone customers account for as much as 40% of its data traffic. With the limited airwave spectrum available for wireless broadband, other providers may switch to usage-based pricing, including Sprint and T-Mobile. Other businesses may be getting the message as well. Silicon Alley Insider recently reported on the rumored new Apple iTV with the headline, “Apple's New iTV Could Finally Force ISPs to Give Up on All-You-Can-Eat Internet Access and Jack Up Your Bandwidth Bill.”

In short, rational economic behavior would prevail in a pricing environment free of implicit subsidies. This would prove beneficial to content producers, content consumers, and the infrastructure providers that move the bits around. When I look at the problems created and looming by current flat-rate pricing — and consider the advantages of usage pricing — I believe it’s only a matter of time before usage pricing becomes the standard.

In the meantime, use all the bandwidth and transfer all the bits you possibly can. 
This deal is too good to last.

1 - Slaptijack. “Average IP Packet Size.”  
      Facebook Note, 18 March 2010 (www.facebook.com/note.php?note_id=377237673965).
2 - Verizon offers Web mail and other services for this price. For simplicity, I have ignored all bundled 
      services in this example.
3 -3  Lieberman, David. “New AT&T Smartphone Users Won’t Get One-Price Net.” USA Today
     4 June 2010.
4 -Frommer, Dan. “Apple’s New iTV Could Finally Force ISPs to Give Up on All-You-Can-Eat
     Internet Access and Jack Up Your Bandwidth Bill.” BusinessInsider/Silicon Alley Insider, 
     23 August 2010 (www.businessinsider.com/appleitv-metered-broadband-2010-8).