Thursday, June 4, 2009

Put Your Money Where the Broadband Will Be

The recent bizarro actions of Time Warner Cable help illustrate that data is in a transitional period. Like everyone else, they know that the amount of data demanded by customers is going to go up. They also realize that more and more content is going to be served online rather than over traditional channels like video or network broadcast.

For the cable industry this has the potential to be a Very Good Thing. Right now they have to pay license fees to serve content via video. Usually these fees are not made public, but a 2003 fight between ESPN and Cox gave some insight: ESPN charges $2 per customer. That is probably the highest per customer charge out there, but it illustrates that serving content isn't free--unless it's on the web.

If the cable operators can dump their license fees and serve content that requires no licensing agreements over the web then their costs can go down significantly. For the broadband providers this can work out very well as long as they can resolve the bandwidth costs.

Cable operators, and to a lesser extent, the telcos, are trying to figure out how to handle the increasingly valuable commodity of HSD. In the beginning, broadband was simply a value-add that could leverage the existing network. Their competition was dial-up and the amount of data passed was fairly minimal. But times are changing and new models are being created.

Unfortunately, the approach taken by TWC has not only been a mistake but an embarassment as well. What they are doing is trying to monetize current consumption rather than maximize economies of scale. 

They have taken a myopic view and set pricing that is wildly out of control (est. 700%-1500% markup). If a plan such as this were to be implemented it would rapidly increase churn and open up new markets to competition. Customers faced with $1/GB/mo.--the plan offered by TWC--will prompt many customers to trade speed for price.

As TWC has stated many times, they compete on services not on price. But if they price themselves out of the market, then they won't be competing at all.

The correct approach is to maximize the economies of scale by taking a slight hit now but restructuring the pricing to take advantage of future bandwidth usage. How? The cable operators can drop their price significantly, set a reasonable cap, and then charge slightly more than cost for overages. 

In my previous post I estimated that 500GB/customer/month is the break-even point for if bandwidth costs $.10/GB for the operator and the average customer pays $50/mo. Current usage barely hits 500GB, though. Few customers exceed 40GB, which means the break-even price is $4/mo.

It could work like this using the estimated pricing: [All numbers are per month] Drop the price to $15 and offer a 200GB cap. Price overage at $.12/GB. As bandwidth usage increases, tiers can be added ($30 + 400GB cap).

At $15/mo. nearly every customer will see an immediate drop in price with no apparent effect on their service. Eventually they will get a few $.12/GB overage charges as bandwidth usage goes up. Then they'll start getting more and more. At that point they may decide to move up to a new tier.

The benefits to the customer include:
  • Lower prices now
  • More control over spending (use less HSD to keep your bill low)
  • Even with high usage the pricing can work out better than current pricing
The benefits to the provider include:
  • More goodwill from existing customer base--a price reduction makes people happy
  • As bandwidth usage increases in its usual geometrical pattern the low markup per GB will start to bring in serious income
  • Reduced video costs (start dropping cable channels) can increase the value of HSD
  • The customers will have a number of years to become acclimated to reasonable pricing, rather than one day to get used to getting ripped a new one
Over time the overage charges can be lowered as additional capacity is added to the system and amortized over a span of years. Again, maximize the economies of scale.

The pricing shown above is just ballparking it, of course. The boffins who have access to the actual numbers can throw together something more accurate. But I don't think these numbers are that far off.

TWC, you have a future to confront, but don't screw it up by alienating your customer base. Your actions have prompted a lot of myths out there in the blogosphere. Also, every ISP is watching what you're doing. To the customers who think it's just TWC--consumption billing is coming whether you like it or not.

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