Verizon's Tiered Data Pricing Plan Is Good Economics

Those who use more data on their cell phones should pay more.

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Mr. Hahn is director of economics at the Smith School, University of Oxford and chief economist at the Legatum Institute. Mr. Passell is a senior fellow at the Milken Institute and the economics editor of the Legatum Institute's Democracy Lab. They are co-founders of Regulation2point0.org, a web portal on regulatory policy.

You probably heard this one (or some variant) back in Econ 101: Suppose you're the commissar for bread in some socialist paradise, and another apparatchik has already announced how many tons of flour you can bake this week. If you set the price of bread so low that everybody decides to buy extra—a tempting idea—supplies will be rationed by the length of the queue in front of the counter. Or maybe the bakery will try to satisfy demand by reducing the size or the quality of the loaves. But what's certain is that bakeries can't sell what they can't make. So, one way or another, the price cap is going to leave someone disappointed. 

As goes the market for bread in Russia in 1972, so goes the market for Internet services in America in 2012? The digital divide crowd wants to limit monthly fees so telecoms can't charge more for larger, faster downloads or more reliable service. But the market can't deliver more bandwidth than the capacity on hand, so some sort of limit has to be placed on individual use when the airwaves are jammed. Hence we think wireless service providers need the flexibility to charge by the gigabyte if they are to avoid "throttling" data-hungry customers—rationing by another name. Indeed, with demand for wireless bandwidth doubling every year, and thereby bumping up against the bandwidth capacity at peak-use hours, the switch seems both desirable and virtually inevitable.

Nonetheless, it's proving no easy matter for the telecoms to make the transition without alienating customers—or inviting intervention by regulators who understand the political appeal of one-price-fits-all. And here, Verizon Wireless's new pricing model may be the spoonful of sugar needed to make the medicine go down.

[See a collection of political cartoons on the economy.]

A little background. Cell phones used to be just that—mobile telephones that could also send short text messages that piggybacked on voice communication. But the "data" tail is now wagging the "voice" dog; it just doesn't take much capacity to move the latter. E-mail, GPS, video, and a zillion other apps on smartphones and tablets now consume most of the bandwidth available to the wireless telecoms. Verizon is thus offering a carrot: unlimited voice and text messaging (which don't cost much to deliver) in return for customers' agreement to pay for data services according to their use.

Does this mean your monthly bill will go up? Depends on how you use wireless. If your idea of a good time is talking with mom for 90 minutes a day, this is a great deal. On the other hand, if you're addicted to watching Netflix on your iPad during those daily train commutes to Manhattan, get ready to pay.

This still looks like a winning marketing strategy to us: Almost everybody is enchanted by the all-you-can-talk concept, and most of them have yet to discover the joys of watching Game of Thrones on their Androids. It looks like good politics, too. Cheap access to wireless voice communication has come to feel like a right of citizenship, but hardly anybody is claiming the same goes for watching kittens' antics on YouTube. Most important, though, it is good public policy.

[Read the U.S. News Debate: Should Probable Cause Be Required for Police to Use Cell Phone Location Data?]

Markets work pretty well in allocating bread to those who value it most. There's every reason to believe that markets can do an equally good job of allocating scarce bandwidth to customers who are hungry for data, be it for video clips on Facebook, traffic reports, or the aforementioned kittens. In this case, regulators just don't have a good case for second-guessing them.

That said, an important footnote here: One reason wireless bandwidth is becoming a scarce commodity is that Congress and the Federal Communications Commission haven't allowed the telecoms to bid away spectrum that now lies idle or is devoted to services of lesser value. Those who worry that wireless bills are on their way up—a distinct possibility since the use of wireless devices is heading through the roof—ought to spend less effort conjuring ways to control the demand for bandwidth, and more to increasing supply. And for the moment, anyway, the ball is still in Congress's court.

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