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Rethinking Flat Rate Pricing for Broadband
How Service Providers Can Monetize
Internet Traffic Growth via Value-Based Pricing
Cisco Internet Business Solutions Group (IBSG)
Cisco IBSG © 2012 Cisco and/or its affiliates. All rights reserved. 07/12
Rethinking Flat Rate Pricing for Broadband Services How Service Providers Can Monetize Internet Traffic Growth Via Value-Based Pricing Introduction The telecommunications industry is facing a fundamental issue: on the one hand, increasing requirements for new investments in broadband Internet access and transport infrastructures that support continuous growth in broadband traffic; and on the other hand, reduced ability to exercise pricing power with customers and, thus, increase revenues.
At the same time, broadband is approaching maturity. In 2011, broadband services became mainstream in developed countries, with fixed-broadband penetration exceeding 60 percent of households and mobile broadband penetration reaching more than 40 percent of the population in two-thirds of Organisation for Economic Co-operation and Development (OECD) countries.1 Meanwhile, traditional voice and messaging revenues have strongly declined due to commoditization, and this trend is expected to continue. Therefore, operators are now relegated to connectivity products. The value that operators once derived from providing value-added services is migrating to players that deliver services, applications, and content over their network pipes.
As if this were not enough, Internet access prices are dropping, sales volumes are declining, and markets are shrinking. The culprit: flat rate “all-you-can-eat” pricing. Such a model lacks stability—sending service provider pricing into a downward spiral—because it ignores growth potential and shifts the competition’s focus from quality and service differentiation to price.
This overall outlook does not indicate that the telecom industry has reached a standstill. New access products are emerging, creating immense potential for innovation: bandwidthhungry applications such as video that require advanced access products and efficient networks, combined with the emergence of the digital connected home, present new opportunities to monetize networks, services, and operations.
Now is the time for the telecom industry to consider innovative pricing models for broadband services to enable a better match between the price customers pay and the value they derive from services. Successful pricing strategies will be essential to directly managing profitability for both fixed and mobile broadband operators.
Cisco Internet Business Solutions Group (IBSG) analysis of OECD broadband statistics (June 2011) and Economist Intelligence Unit data.
Unsustainable Internet Traffic Growth: Fact or Myth?
According to the Cisco® Visual Networking Index, global fixed Internet traffic is expected to more than double between 2012 and 2016, while global mobile Internet traffic is expected to grow more than eight times during the same time period (see Figure 1).
Source: Cisco Visual Networking Index, May 2012.
At the same time, advances in technology have enabled telecom operators to manage 33 percent more traffic each year at investment parity..
Between 2006 and 2010, the telecom industry sustained even higher traffic growth rates— without impacting profitability—by implementing efficiency and productivity measures.
Looking at integrated players (those serving both fixed and mobile markets), profitability was stable even though total Internet traffic grew 48 percent per year during this period (see Figure 2).
Telecom Operators’ Profitability Versus Internet Traffic Growth, 2006–2010.
Source: Cisco IBSG analysis of S&P Capital IQ. Data is based on figures from 124 publicly traded integrated telecom operators (fixed and mobile) from around the world, and on the Cisco Visual Networking Index, 2006-2010.
Fixed-broadband operators should be able to sustain forecasted traffic growth over the next few years with no negative impact on margins, as the incremental capital expenses required to support it are under control. Mobile operators, however, will have a more difficult situation to manage, as forecasted traffic growth is well above what technological evolution can absorb. Moreover, mobile telecom costs not only are linked to technological advances and productivity improvements, but also to spectrum scarcity. According to Rysavy Research, “[Mobile] operators cannot simply double their use of spectrum and double the number of cell sites in their network each successive year. If no changes are made, demand could exceed capacity within three to four years.”2 For these reasons, many mobile operators are looking to offload parts of their mobile broadband traffic onto fixed networks (for example, via Wi-Fi). Fixed networks offer better performance than mobile networks when users are in high-traffic areas and/or spatially limited locations (such as homes, offices, shopping malls, and stadiums), while simultaneously limiting scarce mobile spectrum usage. About 80 percent of time spent accessing the Internet from a mobile device occurs from “fixed locations.”3 “Optimizing the Mobile Application Ecosystem,” 4G Americas, April 2011, with research from Rysavy Research, April 2011.
Cisco IBSG Connected Life Market Watch, 2011. Fixed locations are defined as home, office, or other indoor location.
The “myth” in the industry is that Internet traffic growth is unsustainable from a cost perspective. This is both true and false: true for mobile broadband operators and false for fixed-broadband operators. Nonetheless, operators must fight the increasing commoditization of connectivity services and related price pressures that lead to decreasing revenues by developing new and appropriate pricing strategies.
Understand Pricing Evolution Pricing for Internet access has undergone significant transformation since the early days of dial-up service. The Cisco Internet Business Solutions Group (IBSG) has defined four waves of Internet access pricing. Figure 3 summarizes these waves.
Source: Cisco IBSG, 2012 Metered. Before the advent of broadband, most Internet service providers offered Internet access as a dial-up service. Customers’ monthly Internet access spending had two components: 1) Internet service subscription fee, and 2) metered fee related to the amount of time a customer was connected to the Internet. Competitive differentiation was based on price and availability of dial-up points of presence (PoPs).
Flat Rate. In the early 2000s, broadband Internet access services were introduced. In most countries, fixed telecom operators and Internet service providers adopted a flat rate all-youcan-eat pricing mechanism to encourage service adoption. Flat rate pricing was also extremely simple to implement and market. Competitive differentiation was based on price and access speed.
Cisco IBSG © 2012 Cisco and/or its affiliates. All rights reserved. Page 5 White Paper Usage-Based. Broadband became mainstream in the more advanced economies beginning in 2010. Competitive differentiation was, and still is, based on price and speed, but operators are now experimenting with different forms of usage-based pricing, adding traffic tiers (or traffic caps) to the mix. The introduction of traffic tiers and caps—especially for fixed broadband services—is not welcomed by the majority of customers, as they have learned to “love” flat rate all-you-can-eat pricing. Most customers consider usage-based pricing for broadband services “unfair,” according to the 2011 Cisco IBSG Connected Life Market Watch study (see Figure 4).
Customers’ Perception of Usage-Based Pricing by Country and Service Type, 2011.
Source: “Moving Toward Usage-Based Pricing: A Connected Life Market Watch Perspective,” Cisco IBSG,
2012. Mobile data was not available for Canada and the United States at the time this paper was published.
Operators must carefully manage the introduction of usage-based pricing mechanisms.
They should employ tiers that sound reasonable and are properly priced to their customers, thus minimizing the risk of potential negative reaction. Ideally, in the midterm, newly introduced tiers should not impact what customers currently pay for most products/services. It is important, however, that operators start informing their customers that “traffic is not free”; otherwise, they may find themselves in the position of having to introduce usage-based pricing much later, with the potential for negative customer reaction.
Value-Based. Customers are starting to select broadband Internet access services (either fixed or mobile) based on access speeds and traffic tiers; customers will migrate from one tier to the next based on increased usage (see Figure 5).
Illustrative Example of Potential Usage Tiers.
Source: Cisco IBSG, 2012 In the midterm, it will be important for broadband providers to start defining tier levels that fit costumer profiles and usage needs without impacting customer spending. Marketing departments should develop and deliver new communications plans to clearly establish, in customers’ minds, the benefits of new pricing. Any changes to pricing models should not occur without communicating to customers the benefits of those changes. Operators must also develop tools that enable customers to easily monitor their consumption levels and alert them when those levels are nearing tier limits—thus alleviating possible “bill shock.” Competitive differentiation will be based on multiple value dimensions: prices, access speeds, traffic tiers, and service options.
Today’s all-inclusive flat rate pricing model must evolve toward differentiated pricing.
Network-driven service industries with a large share of fixed costs—airline, logistics, and railway, for instance—typically adopt differentiated pricing models once their businesses have matured.
Monetization Strategies for Fixed and Mobile Broadband Monetization strategies for fixed and mobile broadband will differ greatly, reflecting that the cost to deliver mobile traffic is 10 to 100 times higher than the cost to deliver fixed traffic.4 Penetration Pricing The norm5 in fixed broadband is penetration pricing: monetizing Internet access services via flat rate all-you-can-eat monthly fees. Some fixed-broadband operators are experimenting with monthly traffic caps to limit excessive traffic consumption by a small, but growing, proportion of their customers. For example, in 2011, AT&T and Comcast introduced a monthly cap of 250 GB per fixed-broadband access line. The cap signals to customers that “Internet traffic is not free,” and addresses the issue of heavy service users (“bandwidth See Appendix A for further discussion on fixed and mobile broadband cost structure.
In 21 of the 34 OECD member countries, fixed broadband Internet access is provided as a “flat fee” service with no caps for consumption. (Source: OECD Broadband Statistics, September 2010)
hogs”) without impacting the average customer who consumes 22 GB per month6 (see Figure 6).
Fixed-Broadband Service-Usage Tiers (Real Example).
Source: Cisco IBSG, 2012 AT&T and Comcast are two examples of best practices in the introduction of usage-based pricing. Based on Cisco IBSG’s preliminary follow-up, the introduction of such a high, fixed cap did not generate any substantial negative reaction from these operators’ customers.
The norm in mobile broadband is volume-based pricing: “…89 percent of mobile broadband operators employ volume-charging models, sometimes in conjunction with capped pricing plans.”7 Those few operators who still market unlimited flat rate pricing for mobile broadband usually have caps in the fine print of their offers. Caps in mobile broadband are set at low levels (for example, 1 GB, 3 GB, or 10 GB per month) compared with fixed broadband. The average mobile broadband Internet line consumption is well below 300 MB per month, with only 5 percent of mobile broadband customers using more than 2 GB of traffic per month.8 How these norms might evolve depends largely on competitive dynamics driven by market structure. Where all players experienced both low traffic and penetration, penetration pricing clearly ruled. The U.S. telecom industry is one example. As this market matures—with all players having reasonable market share and well-utilized networks—it will continue to evolve toward tiers and/or volume-based caps (such as AT&T and Comcast).
New entrants, however, may complicate matters. As demonstrated by the recent arrival of the mobile service from Free Mobile, a subsidiary of the Iliad group in France, new entrants might naturally adopt penetration pricing to win market share, putting pressure on competitors’ volume-based schemes. This proves that tariffs alone are an insufficient strategy: value-based pricing should be based on improved network capabilities that can support value-added services for maximum differentiation and impact.
Cisco Visual Networking Index, June 2011.
“Global Mobile Broadband Traffic Report, H1/2011,” Allot Mobile Trends, Allot Communications, 2011.
Cisco Visual Networking Index, February 2011.
Value-Based Pricing Research from British regulator Ofcom shows that consumers are becoming “addicted” to broadband services, and heavy broadband users are willing to pay more for improved broadband service options.9 These findings may encourage broadband telecom operators to explore value-based pricing. Additionally, research from Wharton School professors Jagmohan Raju and John Zhang shows that price is the single most important lever to drive profitability.10 Simon-Kucher & Partners illustrates how premium pricing is possible even for a commodity product like water (see Figure 7). This is an example of what excellent marketing can achieve.