Usage-based pricing: A step up in fairness and effectiveness

It is a truth universally acknowledged in the world of economics that a good or service that is ”free” to the user (after a flat-rate fee to access it – which may be zero – has been paid) will be consumed in much greater quantities than if it was priced in proportion to the costs its use imposes on society. This is the reasoning behind charging patients co-payments and deductibles, for example; doing so reduces the likelihood of individuals visiting the doctor for trivial conditions, and the likelihood of doctors ordering costly and unnecessary tests. Such common-sense pricing mechanisms are ubiquitous in all sectors of modern economies. Except, that is, when it comes to the Internet and the digital economy that it supports. Here, flat-rate pricing is still pervasive, and usage-based pricing models are commonly deemed “unfair.” However, not even these markets are immune from the economic realities of “free” or unmetered resources.

When usage-based pricing is ok in the digital world – and when it is not

A little over a year ago, Microsoft announced that subscribers to its paid Office 365 Home and Personal services would get unlimited cloud storage on its OneDrive service. Unsurprisingly, some subscribers took Microsoft at its word, using in excess of 75 TB of space (the average is currently around 5.5 GB). This appears to have caught Microsoft off guard, as earlier this month, it capped OneDrive accounts to a maximum of 1 TB of storage. It is also revised the limits for its capped plans, replacing 100-GB and 200-GB plans with a 50-GB plan, priced at $1.99 per month. Presumably, additional capacity can be purchased if a user requires it. As Microsoft requires around $1,800 of raw disk capacity to meet the needs of 75-TB subscribers, it seems quite reasonable that such users should pay more than those prepared to cap their usage at 1 TB. Furthermore, why should more modest users be required to pay $6.99 for a 1 TB plan if a 50-GB plan costing $1.99 suffices? It should have been no surprise to Microsoft that “unlimited” offers promote such binge behavior. This is precisely the problem faced by ISPs offering “unlimited” or “uncapped” Internet access plans – such as Verizon, which had a customer infamously download 77 TB of data a month. ISPs have responded by imposing “fair use” terms, throttling the traffic of their heaviest users and, importantly, introducing a variety of capped plans that allow fixed-line users to tailor their Internet bills to their usage habits. Most notably, however, they have faced a barrage of accusations of acting deceptively and interfering with individuals’ Internet freedoms – and have even been threatened with FCC intervention. By comparison, the response to Microsoft’s shift to usage-based plans has been much more measured. Usage-based pricing, it seems, is extremely objectionable when applied to moving data, but merely moot when it comes to storing it.

An “unlimited” world is an inefficient, unsustainable or anti-competitive world

Economics, however, does not distinguish between the merits of unmetered plans for moving or storing data. There is rarely a case for unrestricted, unpriced access to or use of any resource. Even those held in “common pools” are subject to some form of rationing other than “first in, best fed.” Disk space and deployed fiber-optic cable capacity are neither unlimited nor costless, just like fresh water, unpolluted air, or uncongested freeways. Unlimited or unmetered pricing of these resources inevitably leads to a “tragedy of the commons”: available capacity is used up faster, or the resource becomes more congested or more polluted than if a usage-based tariff is charged. Those who appropriate more of the resource, or those who use it first before it gets more congested or polluted, benefit more than those using it less or later. As all pay the same price (zero or a fixed fee), there is an effective wealth transfer from the lesser and later users to the larger and earlier users. The solution in all cases is to use a price or quota (and sometimes both) to ration resources more equitably. Furthermore, in competitive markets, flat-rate, unmetered pricing becomes unsustainable. Assume two providers, A and B, offer flat-rate tariffs of X to a population of consumers, who exhibit either Low or High usage. On average, it costs each provider that same amount per user – X – to meet demand, so they break even. With flat-rate pricing, Low users pay more per unit used than High users, so in effect are subsidizing the high users’ usage. Suppose now that A offers two prices – L, less than X, that covers the costs of Low users and H, greater than X, that covers the costs of High users. B continues to charge X to all users. Low users from both providers will now find it preferable to buy the metered service from A. High users at A now face a higher fee, so will switch to B. B ends up with all the High users, but if it continues to charge X, it will make losses. Thus, B must raise its flat fee if it wishes to break even. If it wishes to prevent losing consumers to A then it must also charge a low-use price L. Usage-based pricing now becomes the competitive norm. Ironically, flat-rate pricing is sustainable in the long run only if all providers elect to act anti-competitively – that is, by colluding NOT to introduce a metered tariff! The above example also illustrates why, when usage-based pricing is introduced, those who stand to lose the most are heavy users, who currently enjoy a cross-subsidy from light users. Usage-based pricing frees light-usage consumers from the burden of providing that cross-subsidy. To me, paying for what you use – and not for what your neighbor does – seems like it would be far more “fair” than the status quo. The example also sheds light on whose voices will be most strident in calling for the retention of flat-rate pricing. Calls to lock in flat-rate tariffs with regulation are little more than lobbying, meant to limit pricing competition and preserve the benefits enjoyed by a subset of existing users at the expense of others. Arguably, the more muted reaction to Microsoft’s usage-based pricing for data storage may be because – thus far – the FCC’s powers do not extend to regulating data storage markets.

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