Friday, July 25, 2014

Hate your cable company? Economics explains why

You're gonna hate this Joseph Eid/AFP

Americans really dislike their pay-television and broadband internet providers, according to a new report from the American Customer Satisfaction Index. And the biggest companies, like Comcast, have the least-happy customers. Overall, pay television and internet companies rank last in satisfaction out of forty industries.

ASCI covers consumer satisfaction with "ISPs, subscription TV service, fixed-line and wireless telephone service, computer software and cell phones, as well as detailed findings for the top-selling smartphone brands available to U.S. consumers" and finds that the people who own the wires are the least-liked brands in the industry.

And it's no coincidence. Market competition has its problems, but it is a relentless driver of customer satisfaction. Yet ISPs and cable companies operate in industries where market competition doesn't really work. That means profit-maximizing strategies don't require satisfied customers and it leaves policymakers with really tough problems.

Why doesn't competition work for ISPs and cable?

Competition doesn't work for ISPs for roughly the same reason it doesn't work for electrical utilities, provision of urban drinking water or sewage systems, or roads and highways.

The basic issue is that before you can start providing the internet access (or cable TV or water or sewage or electricity) to houses, you have to build an enormously expensive network of physical infrastructure. That means that to have robust competition, you would need a bunch of overlapping networks.

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CTA/Flickr

But while building the first electricity generation network in a city would be enormously profitable, building the fifth would be a huge money-loser. In practice, without regulation these utility-type markets tend to generate at best two or three competitors — not exactly a monopoly but not nearly enough for the profound benefits of competition to kick in.

Why isn't it profitable to compete with Verizon and Comcast?

It's all about the difference between fixed costs (the price of building the network) and marginal costs (the price of delivering service once you've built the network).

Marginal costs are low, so once you have the network in place you can make a huge profit selling service and earning a return on the large initial investment investment in building the network.

But if you want to be the second company to provide service to a city, you need to incur the exact same fixed costs for much less reward. To gain customers, you'll have to cut prices. And if you cut prices, the incumbent will respond with its own price cuts. Your fixed costs will be the same as what the incumbent incurred, but you'll only get about half the customer base and you'll be charging lower prices.

The third entrant into the market faces an even worse problem — the exact same fixed costs, but even lower prices and fewer customers. Outside of an extremely dense area this is almost certainly going to be a losing proposition. And adding a fourth or fifth network would be even worse.

What happens to markets with weak competition?

Three things:

  • High prices
  • Price discrimination
  • Bad customer service

Prices are high in uncompetitive markets because they are constrained by your willingness to pay rather than by your ability to get a better deal from another provider. Because prices are driven by willingness to pay, sellers in uncompetitiveness markets try to charge different amounts to different people through complicated and non-transparent pricing schemes — this is economically efficient but annoying and violates people's sense of fair play.

Last but by no means least in an uncompetitive market there is little reason to invest in customer service. If you're calling to schedule an appointment with the cable guy, you by definition want cable so delivering it to you quickly and efficiently isn't a priority.

What options do policymakers have?

There are basically three ways to deal with high fixed cost infrastructure markets.

  • Public ownership
  • Price regulation
  • Cross your fingers

The problem is that none of them exactly solve the problem.

What's the public ownership model?

In the United States, public ownership is used for almost all roads, for many water and sewage systems, for some electrical utilities, and for broadband Internet in Chattanooga, Tennessee. The two big problems here are that both price and spending priorities end up being set by a political process rather than an economic one.

The tendency in the US, for example, is to drastically underprice access to in-demand roads. This leads to endemic traffic congestion at rush hour in many cities. It also denies the road network funding from drivers that could be used to pay for its upkeep, forcing heavy drivers to be financially subsidized from general tax revenues:

Sources_of_transportation_revenue On the spending side, the difficulty is that elected officials need to think about the next election. That encourages over-spending on personnel and contracting (so unions or contractors will like you) and under-spending on long-term upkeep of the system (the long-term is someone else's problem).

These pathologies of the public ownership model are how the United States manages to simultaneously have a massive sprawl-orientation transportation system and also tons of overstressed and under-maintained road infrastructure.

What's the regulated monopoly model?

This is a situation where a private companies provides the service on a monopoly basis but subject to intense regulatory oversight by a government agency. The regulated utility model is used for most people's electricity, for some water and sewage systems, and used to be the dominant approach to cable television and telephone provision.

The idea here is that the for-profit investor-owned nature of the monopoly will create incentives to bargain hard with workers and contractors and to think about the long-term, while the regulatory agency will protect consumer interests.

The problem is that rather than the best of both worlds, you can just as easily end up with the worst. The dominant business strategy for a regulated monopoly is to invest heavily in politics rather than infrastructure and get the most investor-friendly possible regulatory climate. Since nobody is going to care more about the regulatory commission than the regulated utility, the tendency is for special interests to win out.

What's the fingers-crossed approach?

The dominant approach to cable and telecommunication regulation in the United States since the mid-1990s has been to more or less hope for the best. Perhaps the economic fundamentals don't allow robust head-to-head communication, but these services aren't as crucial to human flourishing as electricity or water so ISPs and TV providers need to compete with non-consumption.

What's more, back during the regulated monopoly era most cities found themselves with two separate networks — one owned by a phone company, one owned by a cable company — that in the digital realm are capable of competing with one another. Last but by no means least, companies that own wires are threatened with competition from wireless providers, whether that's mobile phone companies or satellite television. The hope was that in practice this would look more-or-less like a competitive market even if there wasn't a ton of direct head-to-head competition.

The results, however, speak for themselves. Very few Americans are able to purchase to state of the art Fiber-to-the-Premises (FTTP) broadband internet connections. Prices for internet access are generally high. Cable companies are reducing their investments in new infrastructure. Instead of spending money on new infrastructure, the market leaders are spending money on acquiring other companies to consolidate control over existing infrastructure. And not coincidentally, these companies have extremely low levels of customer satisfaction.

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