The History of Communications and Its Implications for the Internet
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The history of communications and its implications for the Internet Andrew Odlyzko AT&T Labs - Research [email protected] http://www.research.att.com/ amo Preliminary version, June 16, 2000. Abstract The Internet is the latest in a long succession of communication technologies. The goal of this work is to draw lessons from the evolution of all these services. Little attention is paid to technology as such, since that has changed radically many times. Instead, the stress is on the steady growth in volume of communication, the evolution in the type of traffic sent, the qualitative change this growth produces in how people treat communication, and the evolution of pricing. The focus is on the user, and in particular on how quality and price differentiation have been used by service providers to influence consumer behavior, and how consumers have reacted. There are repeating patterns in the histories of communication technologies, including ordinary mail, the telegraph, the telephone, and the Internet. In particular, the typical story for each service is that quality rises, prices decrease, and usage increases to produce increased total revenues. At the same time, prices become simpler. The historical analogies of this paper suggest that the Internet will evolve in a similar way, towards simplicity. The schemes that aim to provide differentiated service levels and sophisticated pricing schemes are unlikely to be widely adopted. Price and quality differentiation are valuable tools that can provide higher revenues and increase utilization efficiency of a network, and thus in general increase social welfare. Such measures, most noticeable in airline pricing, are spreading to many services and products, especially high-tech ones. However, it appears that as communication services become less expensive and are used more fre- quently, those arguments lose out to customers’ desire for simplicity. In practice, user preferences express themselves through willingness to pay more for simple pricing plans. In addition, there is a strong “threshhold” effect to usage-sensitive billing. Even tiny charges based on utilization decrease usage substantially. In a rapidly growing market, it is in the service providers’ interest to encourage usage, and that argues for simple, preferably flat rate, pricing. Histori- cal evidence suggests that when service costs decrease, such arguments prevail over the need to operate a network at high utilization levels and to extract the highest possible revenues. Communication services have long exhibited many characteristics of modern high-tech industries, namely high fixed costs, network effects, and difficulty in allocating costs among many products and services. Therefore the historical lessons of this paper are likely to be applicable to many pricing situ- ations in the future. When prices are high, and purchases infrequent, airline-style “yield management” is likely to dominate. On the other hand, when prices are low, and a service is used many times a day, simple pricing and uniformly high quality are likely to be more common. Historical analogies as well as current expenditure data also suggest that in the “digital conver- gence” of broadcasting and point-to-point communications, it is the latter that will dominate in shaping the evolution of the Internet. The current preoccupation with professionally produced “content” is probably more a distraction than help in planning for the future. Content has never been king, it is not king now, and most likely will not be king in the future. The development of the Internet is likely to be determined by the same growth of the myriad unpredictable commercial and social interactions that have fueled other communication services. Contents 1 Introduction 3 2 Communications: grit and glamor, or why content is not king 12 3 Growth in communications: quantity and quality 31 4 The Internet and other communication services 45 5 The effectiveness and utility of pricing 56 6 The role of distance dependence in pricing 63 7 The conventional economic argument for flat rate pricing 67 8 The strong public preference for flat rate pricing 70 9 The dramatic effect of usage sensitive prices 72 10 Dynamic effects of flat rates 77 11 Miscellaneous examples of pricing trends 79 12 Mail 85 13 Telegraph 93 14 Wired voice phone 105 15 Cell phones 112 16 Minitel 116 17 Residential access to the Internet 118 18 Non-Internet data networks 120 19 Dedicated business connections to the Internet 121 20 Software agents and other technological palliatives 125 21 The role of distance distribution of traffic 127 22 The tragedy of the commons 131 23 Data transmission prices 133 24 Conclusions 137 2 The history of communications and its implications for the Internet Andrew Odlyzko AT&T Labs - Research [email protected] http://www.research.att.com/ amo 1. Introduction The goal of this work is to draw lessons from the history of communications. The view is broad, covering many technologies, and many decades or even centuries of data, and thus is of necessity not very detailed. However, it does produce some clear patterns. This is remarkable in that the history considered here covers many services, including regular mail, the telegraph, and the telephone. This history also covers many types of economic environments, including government monopoly, private untrammelled monopoly, government regulated monopoly, and competitive markets. The only constant factors have been relentless technical progress and growth in volume of communications. The historical record carries lessons for pricing, quality-differentiated services, the valuations of the dot-coms, as well as for the question of whether indeed “content is king” on the Internet. Many of these lessons carry over to general ecommerce. The Internet has historically treated all packets equally, and pricing has been predominantly through flat monthly rates depending only on the size of access links, not on usage. Today, there is a strong momentum towards changing both of these principles. Influential figures in the data networking com- munity make statements such as the following: Although flat-rate continues to be the predominant form in which Internet access is sold, that form of pricing is unviable. Flat-rate pricing encourages waste and requires 20 percent of users who account for 80 percent of the traffic to be subsidized by other users and other forms of revenue. Furthermore, flat-rate pricing is incompatible with quality-differentiated services. Pravin Varaiya, abstract of INFOCOM’99 keynote lecture There is extensive work on development of multiple service levels, typically with some implied guar- antee of performance, usually referred to as Quality of Service (QoS). If those are deployed, they will necessarily require pricing schemes more complicated than the standard flat rate ones. The driving 3 force behind these developments is economic, based on the view that it is not feasible to provide satis- factory levels of quality for all transmissions at a reasonable cost. There is also concern (expressed in the quote above) about fairness of light users subsidizing heavy ones under the current scheme. While the momentum is towards introduction of QoS and more complicated pricing systems, there have always been voices arguing in favor of preserving the simplicity of both operations and pricing of the current Internet. Their counterarguments can be substantiated through evaluations of the costs of multiple service levels to end users, and on considerations of what utility users derive from data networks [Odlyzko7, Odlyzko8]. Shortage of bandwidth is less of a problem than is often thought, and the general complexity of the system is a large barrier. An important observation behind many of the arguments in those papers is that what users really care about are fast transactions. As a result, whenever they can afford it, they run their links at low utilizations, since the main benefit they derive comes from the ability to burst at high speeds for short periods. In such an environment, flat rate pricing is most appropriate, and QoS does not help much. The historical approach of this paper also leads to a skeptical view of most of the ongoing work on QoS. There have been many calls for usage-sensitive pricing similar to that of Pravin Varaiya quoted above. For example, an investigation of phone service in New York City in 1905 concluded that, so far as large cities are concerned, unlimited service is unjust to small users, fa- vors large users unduly, impedes expansion of the telephone business, tends to inefficient service, and that, as a financial proposition, is unsound. p. 246 of [Stehman] As will be shown in Section 14, the case for usage sensitive pricing in local phone calling in 1905 was much stronger than it is on the Internet today. However unsound it may have seemed, unlimited local calling for a flat monthly fee for residential users has persisted in most of the United States for all of the 20th century. It seems worth exploring why it did, what effects that has had in comparison with other countries that adopted usage-sensitive pricing, why it is being re-introduced in many of those countries, and what conclusions we can draw from this about the likely future of the Internet. If we compare the telecommunications industries in different countries, we find few signs of harm from the “unsound” practice of flat rates for local calls. Table 1.1 shows that U.S. citizens use their phones considerably more than inhabitants of other affluent industrialized countries at only a slightly higher cost. Thus at least from this high level view, both consumers and service providers benefit from flat rate pricing. 4 Table 1.1. International comparison of telephone industry revenues and usage in 1997 country revenues as minutes of phone fraction of GDP calls per person per day Finland 2.52% 16.6 France 1.93 10.6 Japan 2.06 10.6 Sweden 2.05 20.7 Switzerland 2.66 13.0 U.K.