Risk of 'Ignorance-Based' Pricing Schemes for Telecoms

Includes: IST, IXP, XTL
by: Dean Bubley

Almost exactly five years ago, I wrote a blog post cutting through the myth of "value-based pricing" in the telecoms industry. It followed on from the observation that people seemed happy to pay for SMS messages, and so therefore it must make sense for telcos to try and extract the maximum amount from all users, for all services at all times, rather than under-price and "leave cash on the table."

In principle, I agree that perfect markets (and perfect marketing) should indeed result in optimal yields and the "right" prices mapped on to realistic assessments of users' utility and perceived value. However, we live in a far from perfect world in telecoms, in which obfuscatory marketing, lock-in and sheer rip-offs prevail - and also, it must be said, sometimes too-low pricing as well.

Updating my definitions, it's worth a quick recap:

Bargain-based pricing - it's so cheap, it's unbelievable. You tell everyone about it. You use it for the sheer sake of it. You buy other stuff just as an excuse to use it more. Example: free WiFi in cafes, or 3G dongles that are cheaper than ADSL lines. Most free Internet services like Google (NASDAQ:GOOG) search and Facebook are also a "bargain" if you're prepared to suffer some advertising.

Value-based pricing - it's the right price. It seems reasonable given the probable underlying costs or its inherently fair market-based pricing mechanism. It does what it says on the tin. You can justify it easily. You mention it to friends or colleagues. Examples: Normal smartphones data plans, iTunes music, Google AdWords, eBay (NASDAQ:EBAY) pricing, Inflight WiFi.

Inertia-based pricing - it's a bit steep. You know you could find it a bit cheaper. But it works, it's convenient, and it's not worth the effort to shop around or switch. You don't complain, but you don't recommend it either. Example: SkypeOut calls, your current broadband provider, your current mobile voice tariff, airport food, iPhones

Ignorance-based pricing - it's a ripoff, but you don't realise it. You've got no real benchmarks, so it seems "reasonable." If it was cheaper, you'd probably use it more. You don't know it's available to other people (maybe in another country) at a much lower price. If you found out, you'd be quite annoyed, complain to friends, and probably feel a bit gullible and prone to switch suppliers when the opportunity arose. Example: SMS pricing, PSTN calls.

Resentment-based pricing - you know you're being ripped off hugely, but you "have" to pay as you have no immediate alternative. You grit your teeth, and (hopefully) expense it afterwards. You actively look for a way to avoid the cost, and minimise your usage. You complain to friends and colleagues. You develop "active customer disloyalty" and vow to switch suppliers, out of distaste for their show of customer disrespect, whenever you can. Examples: Hotel WiFi, most mobile data roaming.

You'll notice the assertion that mobile voice pricing is "inertia-based." But according to a new piece of research this morning, U.K. mobile subscribers appear to have sleepwalked more into the "ignorance-based" tier, spending on average 44% more than necessary on phone tariffs, or £195 a year (about $300), because they choose plans that are unsuitable.

That's enough to have pretty much every U.K. media outlet pointing out how much we're over-paying. Now to anyone in the cellular industry, this probably doesn't come as any massively-surprising news. Often, plans are specifically set to encourage upgrade to the next-higher tier. If average usage is 280 mins a month, then thresholds will likely be set at 250 and 500 mins, rather than the logical (but cheaper) 300 mins. Whether you view this as opportunist cynicism, or smart marketing, depends on your point of view. And whether you get called out on it.

The open question is whether this type of approach - while clearly generating revenues in the short term - is sustainable, and also whether it creates a damaging perception in customers' minds that operators are ripping them off. At a time when telcos are hoping to become trusted enough to be used for payments, digital lockers, identity management and so forth, they need to be careful to watch their reputation if they hope to gain true loyalty. Google and Facebook don't over-charge their users.

The other risk is that this type of egregious pricing strategy opens the door to "white knights" that can rescue customers-in-distress from the clutches of the evil, firebreathing pricing dragons. It is quite easy to imagine a GroupOn-type approach to buying mobile plans - collective groups of consumers that act with similar power to enterprises start to negotiate bulk deals, disintermediating the operators from identity while they are doing it. (I just realised I wrote a post about "consumer-oriented collective purchasing" three years ago, by the way).

Or alternatively, perhaps the U.K.'s price comparison site uSwitch gets recast by Apple (NASDAQ:AAPL) as iSwitch, exploiting their patented (and much-hated) notion of a remote-updateable SIM. What better way to perpetuate the $300 gross margins on iPhones than to offer users a way to monitor and optimise their phone plans? "We have calculated that you can save £10 a month by switching to Operator X from Operator Y. Click here to initiate number portability via iTunes and switch to your new provider."

One of the reasons for the mobile industry's historic profitability is that it has been able to derive huge profits from services which aren't really worth what people pay for them. SMS, roaming, too-large telephony plans. This is fine while people don't realise they're over-paying, and while there are no easy workarounds. But as the fixed-line voice providers have learned, once the process of discovering lower prices becomes more transparent, there can be a huge exodus of previously-loyal customers. By contrast, people buying an Apple product - or any other premium brand - knows that the supplier is making money, but they obtain value in other ways such as convenience or status.

There's no "cachet" safety-net in getting a too-large mobile minutes bundle, though.