Myths: Low-end Broadband users subsidise high-speed, high-end users

This is an update to a piece from May about this Myth, how its the reverse of reality, usually expressed as:

I don't want to pay for something I won't use and subside the leeches who want high-speed. I'm happy with what I've got and don't want to pay for them to freeload on me!

This is exactly wrong: the Fibre NBN makes its profits from the high-end, high-speed consumers and the premium they pay generates all the profits and subsidies the rest of us.

This cannot happen under the Turnbull Node Plan with a "one size fits all" fee and line-speed lottery, making it rack up $10-$20 billion losses in the next 20 years.

NBN Co create a fair and equitable pricing structure where the few high-end users subsidise the entry-level by at least 75% by:

• Tiered Pricing: offering real choice based on your needs and means, not a one-size-fits-all line lottery.
• People are taking-up high-end plans much faster than the conservative NBN Co plan predicted.
• Access charges will drop 20%-25% by 2021 and between 50% and 85% by 2040.
• Download volume charges are set to halve by 2021 and continue to drop after that.
• The top 10-25% of consumers pay the majority of charges, they generate the profits needed run the business, pay-off the loans and make a 7% Return on Investment. The rest of us get a free ride, which is pretty cool to me.

The Power of Tiered Pricing:
  Money for Nothing or a Fairer, more equitable scheme?

One of the big deadweights on ISP profits over the last 10 years has being forced to charge the same price for an ADSL line, regardless of the speed.

This is the same as going to a car dealer and being told "we have 6 models and all cars here cost $15,000. You'll go in a lottery for the model you get". That'd never fly. Some people would get the top-of-the-line model and be very happy, others will get a very small and cramped entry-level model.

Why manufacturers offer a range of models is so that consumers can choose, that the dealer can match supply and demand. "You want a big car with lots of features, here's our most expensive one" versus "You want the cheapest, smallest, most economical car? This is ours".

NBN Co has introduced a radical innovation into the Australian Telecommunications Industry: they allow Retailers to match supply and demand with a range of options, just like every other manufacturer.

The beauty of the NBN Co scheme is that they can charge between $24 and $150 for exactly the same physical thing.

But doesn't that rip-off customers? No, in exactly the same way as a car maker selling 6 models with near identical parts built in the same factory by identical machines and people is not a rip-off. Customers can see increased value, to them, for the extra money they pay for a higher-cost model.

If NBN Co had to charge a single price and give everyone the same speed, then what price would the charge and what speed would they deliver? They couldn't charge $24, the current entry-level, and give 1Gbps. They'd go broke, just like the Turnbull Node Plan must with its one low charge and line-speed lottery.

Just as not everyone wants a high-performance sports car or a big people-mover, every household wants a different level of broadband service and as times change, will want to change their speed to match their needs or means.

The tiered pricing not only offers entry-level customers a cheaper price, subsidised by those selecting the high-speed plan, it offers value-for-money for the people that want those higher-speeds.

A 100Mbps plan doesn't cost 8-times the $24/mth of a 12Mbps plan, it only costs $38 - a $150/mth saving to the customer, or at least their ISP.
Similarly, a 1000Mbps plan doesn't cost 10-times that $38, but $150/mth, a $230 saving to the customer.

NBN Co has adopted a very sensible and well known pricing regime that both allows them to charge entry-level customers six-times less than the high-end, but also returns exceptional value-for-money to those high-end customers by reducing their charges thirteen times on a speed basis.

That's not just fair, but makes all customers feel they've got a very good deal. They've been able to make a real choice, but just be thrown into a lottery where some are favoured and most are disappointed.


What people actually decide:
  customers love both ends of the scale.

Does this scheme work? Yes, and it is already well beyond the conservative estimates in the NBN Co plan.

NBN Co forecast, (last chart below) just 18% of customers would buy 100Mbps services and 49% would buy entry-level. The Average Revenue would be around $27 from access charges. Instead it is already at $30, 10% higher than forecast, just by allowing customers their choice of speed.

When 1Gbps is released, I expect a 10% take-up, further boosting Average Revenue to $42, or 75% more than the entry-level price. (And 250% more than I estimate the Turnbull Node Plan "one size fits all" price.)

We can also guarantee not one of those customers will be grumbling about not getting the speed they want. This is just good business. This aspect of the NBN is a "no-brainer".


Wholesale Pricing:
  What NBN Co earns and charges to ISP's.

In the charts below, I've included how NBN Co will drop real prices over time.

• The entry level, 12/1Mbps, drops from $24 now to $19.50 in 2021, and to $11.75 in 2040: 50% less in real, inflation adjusted terms.
• The current high-speed, soon to become mid-speed, 100/40Mbps, drops from $38 now to $28.10 in 2021 and the same $11.75 in 2040.
• The imminent high-speed, 1000/400Mbps, drops from $150 now to $111 in 2021 and $27 in 2040.

Note that in 2040, there's no price difference for an entry level 12Mbps service or 100Mbps and the high-speed service, 1Gbps will be just one-eight more than current entry level-pricing. That's not going to happen with the Turnbull Node Plan and it "one size fits all" pricing. They have to keep raising their prices by 3.5% every year, even to contain losses to $10 billion.

As well, NBN Co will reduce it's CVC (Volume) pricing as Average usage grows. After Average-GB/mth hits 120GB, prices will halve when usage increases four times. Sounds a lot, but NBN Co traffic is currently at 45GB/mth. If expert forecasts are correct, it'll take 1.3 years to double download volume, by 2015/6 we'll hit the  trigger volume to reduce prices. Every 2½ years after that, the price of download data will halve. This progress, if it happens, will be much slower under a "one size fits all" Node model, because people can't buy the speed they want, just take what they get in the line-speed lottery.

This forecasting says that by 2021 volume pricing by NBN Co will be one-quarter what it is today.


Retail Pricing:
 what will you, not your ISP, pay?

Those are NBN Co wholesale prices. ISP's have to add margin and pay for additional costs like "backhaul", "peering", "Tier-1 connection to the Internet", their own routers/switching and internal systems like customer records and billing. Like any business, increased volumes should bring economies of scale. The margin they need to charge to make good investor returns should decrease as they become more efficient and take costs out of the business.

As well, with a nearly "level playing field" on input pricing, you can expect competition to drive out inefficient organisations or those that don't provide reasonable customer service and good plan options.

Optus and Telstra as the large, long-standing Telcos have a privileged position: they own backhaul to almost everywhere. Their input costs will be lower, but they traditionally generate higher margins. If they are slightly more expensive than other ISP's, they'll still make very healthy profits for shareholders.

If ISP's contain their mark-ups, consumers can expect the drop in wholesale pricing to be reflected directly in their bills. If they don't, the ACCC has shown in the past a willingness to intervene.


How the subsidies work:
  Why the "Rich" subsidise the "Poor", not the other way around.

Right from the start, consumers get to choose the line speed they want according to their needs and means, not get it foisted on them through a lottery. Nobody is forced to pay more than they want, everybody can get the speed they want: that sounds like a "no-brainer" to me.

Instead of a single access line charge of $42, the average when 1Gbps is released, entry-level customers will pay just $24. Those people shelling out top-dollar are paying for that 75% discount and are doing so happily. They are getting their sports-car and loving what it gives them. If they tire of it or decide they want to pay less, then they can. This is real choice.


But wait, there's more:
  Internet charges are Access Rate plus Download Volume

There's yet another wrinkle to this story: we pay our ISP's two charges, one for the line and another for the data we download, "Volume". Usually ISP's include a carefully chosen standard amount in plans, so that customers get the same bill each month and can enjoy some predictability with charges.

On an entry-level plan, 12Mbps, you can still download 4 TerraBytes of data in a month if you want, and upload around 300GB. These plans typically include 30GB of data while a 100Mbps plan includes 500GB (0.5TB).

To download more data and it'll likely cost you $0.60/GB or $2,400 for those 4TB. Someone doing that scale of downloads is going to pay the extra $13 to go eight times faster. They'll buy 100Mbps because the extra cost is tiny.

The Sandvine data tells us something very, very interesting: "Average" users don't exist.

Just 1% of users download 10% of data, while the "low" 50% download 6.4%, that's a 75:1 difference in how much the two groups download and potentially in their Volume charges.

There is probably a correlation between high-volume downloads and high-speed access. If you're download 500GB/mth, at $0.60/GB, it's cheaper to upgrade to 100Mbps and use the quota already bundled in. That's part of the business modelling of ISP's, to choose price points and plan bundling options that are attractive and yield good returns.

I've included the chart that shows how NBN Co will reduce Volume prices as average use goes up.
Half of us contribute around 5% to downloads: all the heavy lifting, paying for Volume is done by the top 25% of users.

All users share in the reduction of Volume charges, entry-level and high-end. The high-volume, high-end users end up paying the lions share of NBN Co charges, and are happy with the deal they get.

Would you want to give the high-volume consumers a discount, at the expense of the low-volume users? I wouldn't. If you think of the volume charge as the discount already given to high-volume users, it just means you're offering the same deal to the 50% of users who consume just 5% of download. It's also much, much easier for everyone concerned to figure out what they should pay. The ISP's have a single pipe back from each Point of Interconnect, not one per customer. A common rate for all consumers makes sense.

Everybody else piggybacks on what the top-end pay: the few high-end consumers generate the bulk of the revenue and profits, the rest of us get a free ride.

Not only do those who want, pay more, they also generate the profits that turns the business from making a loss, into paying back its loans and making a 7% return on all the money put in.

Entry-level users can either ride the cost curve down and pay half what they pay now, or they can maintain a constant level of expenditure and upgrade their plan, considerably increasing speed and services. This is real choice.

I think the NBN Co tiered pricing and reductions in both Access and Volumes charges over time is a very fair and equitable scheme for everyone. It's a "no-brainer" to me.

Update [28-May-2012]: Dr Neil Gunther has analysed the Akamai data as a Time Series, albeit a small one, and initial results are that it is approximately exponential growth, but the simple scatterplot trendline underestimates the forecast. The 2014 (2 year) projections, expressed as logarithm (kbps) are around 3.9 ± 0.3 [95% CI] and ± 0.2 [80% CI].

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Sources:

NBN Co Plan, Aug-2012:

http://www.nbnco.com.au/assets/documents/nbn-co-corporate-plan-6-aug-2012.pdf

NBN Report to Parliamentary Committee, 19 April, 2013.
http://nbnco.com.au/assets/media-releases/2013/report-to-parliamentary-joint-committee.pdf

Sandvine 2013, 1st half, USA Internet usage
http://www.sandvine.com/downloads/documents/Phenomena_1H_2013/Sandvine_Global_Internet_Phenomena_Report_1H_2013.pdf

Charts:

2013 Sandvine US Traffic Distribution

2012 NBN Plan, reduction in CVC (Volume) charges

NBN 2013 report: 12Mbps AVC real price reduction

NBN 2013 report: 100Mbps AVC real price reduction

NBN 2013 report: 1Gbps AVC real price reduction

NBN 2013 report: Proportion of services by AVC speed

Dr Neil Gunther 'Rplot' of Sandvine Data Model