2009/05/16

Telco pricing and market 'price elasticity'

There's a counter-intuitive effect with marginal cost of Production Factors, like energy (and Teleco services) - using the factor more efficiently, consumes more of the resource. Because you make more profit, lower prices, produce more and demand for the resource increases. The Khazzoom-Brookes Postulate/Jevons Paradox:
"energy efficiency improvements that, on the broadest considerations, are economically justified at the microlevel, lead to higher levels of energy consumption at the macrolevel."
The structural reason is simple: the market is highly price elastic, so decreasing prices a little lifts total sales considerably. In economics, this is a well solved problem for non-monopoly markets, "Profit Maximisation" occurs when MR = MR (Marginal Revenue equals Marginal Costs). [For monopolies, MR = 2*MC, IIRC.]

In the 70's & 80's at O.T.C., we made record profits each and every year - by exceptional marketing and sales strategy, which included dropping prices every year. [The TV adverts series, like the 'Memories' campaign, won many awards.]

This was driven by the technology: Moore's Law drove the per unit cost of services in both cable and satellite down exponentially.

Profits margins increased because full cost reductions weren't passed on. By the mid-80's it was cheaper from the East Coast to call London or New York than use Telstra to call Perth ($1/min).

This is a lesson Telstra Management never learnt and was obviously lost when O.T.C. was subsumed into 'the Borg' in 1992: passing on part of the Moore's Law savings, Revenue and Profits both increase.

Economic theory is very clear on this point:
Traditional (Premium) Telco Pricing isn't just 'bastardry', it kills your profits which will eventually kill your company.

People love to talk/communicate, it is one of the defining characteristics of Homo Sapien.
This underpins the profitability and constantly growing demand for Telco services... This, the consumer demand, is the real 'crown jewels' (or 'birth-right') of Telco's, not their networks and technology.

Nobody has yet plumbed the limits of the price elasticity curve for human communications.
Setting the marginal cost of phone calls to zero doesn't kill your profits as shown by the US 'free call' areas.
It does lead to changed behaviours - more calls, many shorter.

Conclusion:
The incumbent Australian phone companies, Telstra, Optus & friends, don't understand the fundamentals of their business:
  • Moore's Law has been driving down their input costs exponentially for 4-5 decades, yet they haven't passed on those savings. The differential is now 100-10,000 (guesstimate).
  • The demand for human communication is close to infinite.
  • The Comms market has close to infinite price elasticity.
  • Profit Maximisation is simple and 'Premium Pricing' (what-the-market-will-bear) is exactly wrong.
The challenge for the Telcos now, especially Telstra, is unwinding from their 'Premium Pricing' to a rational 'Profit Maximisation' model. How do they explain price reduction of 10-100 times?

The consumer backlash, if not managed, will be savage and punitative. The original 1990's duopoly Telco's, Telstra and Optus, will suffer greatly - to the point of being endangered.

"You can fool some of the people all of the time" - but woe betide you when those you've fooled understand they've been gouged/conned and have alternatives.

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