For the phone companies , its free. It goes out over a sidelobe thats normally was used for something else, which is why the messages are limited to 140 characters. Because of the difference between European and North American Telcos, it was hardly used here in NorAm and the telcos had no idea how to price it.
Right now the cellphone market is going through somewhat of a renasaince, while data has come way down from three years ago, text messages have become value added products and risen in price, so it looks sorta lopsided at the moment. People like me have pots of data to use, but get whacked with text messaging costs, because its not worth the value package right now.
Text messaging rates only affect paygo users, most folks that have or are eligible for a contract have some sort of value pack that allows pot loads of text and MMS messaging. So its no longer an industry that I would expect some sort of government intervention.
Cellphone companies are in the business of making money and they have lawyers on one side telling them what they cant do , and accountants on the other telling them what they can get away with.
I don’t think you realize it but you’re agreeing with me in an argumentative way. reread the bit you quoted but put “gauged” in quotes. You don’t have to buy over priced txts was my whole point.
There are many, many products in highly competitive markets that are sold well above the marginal cost of manufacture. CD’s do not sell for 89 cents. A cup of coffee does not sell for a nickel. Almost no software is sold for the marginal cost of production. Solar power does not sell for a penny per kilowatt/hour.
There’s nothing special about the marginal cost that should make it dominate the pricing of products. In some industries it does. With commodities that are well established, capital costs are a small percentage of overall revenue, and the products are fungible, sure. But with most other products, other factors come into play. Anyone who has ever priced a product understands that you need to look at a whole host of factors other than the marginal cost of production - the lifespan of the product, the fixed costs of the infrastructure needed to sell it, the opportunity cost of the capital needed, projections of market demand over time and future pricing moves, R&D costs for creating it, the price of risk, marketing costs, etc. Sometimes, the marginal cost of manufacture is an almost-irrelevant consideration, as it is in the software business (and probably in the text messaging business as well).
There’s a difference between “signaling” and “collusion.” Signaling is what all the airlines did – that’s why you got to Orbitz or Travelocity and notice that many flights cost the same between American, Delta, United, etc. Even though they “signaled” each other, they still lost money.
Let’s say text message “marginal cost” is $0.0025 in your hypothetical example. But maybe AT&T engineers do the analysis and say that pricing it at $0.01 would be profitable but overwhelm the cell towers capacity with too much demand. Therefore, they work with the finance folks and determine that $0.15 would price enough customers out of the text message which would allow them to provide reliable service for text & voice with the network capacity they have. The $0.15 in a weird way acts as a “traffic” governor. Of course, the $0.15 is mathematically also “profitable”. A crazy way to “price” a service? Maybe, but companies don’t have to be logical – they just have to make money.
Let’s say Verizon’s marginal cost is actually $0.20 … but they notice AT&T pricing their text service at $0.15 …this is a price “signal” – it is not “collusion”. Verizon execs aren’t exactly sure why AT&T can offer their text service for just $0.15 – maybe they guess that AT&T users older equipment. Maybe that older equipment uses less electricity. Maybe they have less towers (less coverage) therefore they have less leasing costs. Maybe AT&T doesn’t include debt repayment into their “marginal cost” calculations but Verizon does. The Verizon execs don’t work at AT&T so all they can do is guess. In any case, Verizon takes the price “signal” from AT&T and also price theirs at $0.15 – a loss leader. Maybe the Verizon execs will make up for the revenue loss somewhere else… airplane wireless at $15 a minute or selling new Blackberry phones. Who knows?
To us on the outside, 2 companies both offering text messages at $0.15 looks like “collusion.” We tend to favor that explanation because we think we all pay too much.
I’m not saying this has happened but just trying to point out that prices often have no basis on marginal costs. Sometimes companies price their products intelligently, sometimes stupidly. It is hard to understand the logic unless you’re working inside the company.
I’m currently reading a book called “The Undercover Economist”, which talks about this issue. In a perfectly competitive free market, which also includes perfect dissemination of information, the price of something should be the same as the cost to produce it. Of course, a perfectly competitive market doesn’t exist yet, but a “normal” free market shouldn’t produce something as overpriced as text messaging, at least in the long term.
I think the possible reason why text messages are so expensive is because of gouging caused by what Scott Adams calls a “confusopoly”. It’s when the big players in the market try to confuse consumers by making clear information very hard to find.
Indeed. There are a billion examples like this. The less commoditized and more distinctive the product is, the less and less relevant marginal cost becomes.
Distribution of movies at the theatre or over the Internet
Perfume
Clothes (designer clothes have huge gross margins)
Lawsuits are an interesting case, because again, there is no ‘choice’ once the government decides to enforce a judgement by use of force. The defendant can’t say, "Naaa. I don’t want to pay $100 million. I’ll take my judgin’ business somewhere else.’
Pre-agreed arbitration clauses are a bit of a free-market fix to address this problem. Where before two parties enter into a contract, they agree to forgo traditional legal channels and submit to arbitration in case of a dispute.
All these points apply to voice calls and online plans as well. So the point remains why is it so much more expensive relative to bandwidth for customers to use SMS’s
compared to voice calls. It’s true that fixed costs have to be re-couped but why should SMS prices be a disproportionately important in doing this. Incidentally it is possible to re-coup fixed costs while still pricing at marginal cost through some kind of two-part tarriff which is quite feasible in the cellphone industry.
This sounds like a good example of the business model conflicting both with consumer welfare and economic efficiency. If prices reflected marginal costs better consumers would use far more SMS's and make less calls which would benefit them. And it would be a more efficient use of resources because SMS's consume far less bandwidth than voice calls. So the pricing strategy of the cellphone companies is distorting the use of scarce resources.
As for marginal cost, it may sound abstract but it is quite important to understanding the conditions under which markets are efficient. If prices reflect marginal costs then consumers are making decisions based on the opportunity cost of the good or service they are consuming. If the price is vastly larger than marginal cost they will consume less of a good than is efficient.
Now in the real world marginal cost pricing may not be seen because of high fixed costs or monopoly power but it is still a useful signal of whether the market is working or not. If a particular good is being priced vastly above marginal cost that may be an indication that regulation may be called for. Certainly a situation where marginal cost is falling rapidly and prices are rising is a warning sign. The biggest exception is probably intellectual property where the general policy is to give creators a temporary monopoly as an incentive and where marginal costs tend to be very low. So you may see large departures from marginal cost pricing.
The SMS service isn't really like that; it's more like a utility where the product is fairly standard and there isn't much innovation. So SMS prices look more like a case of companies using their monopoly power to harm customers and increase their profits. Therefore a regulatory response may be appropriate.
The key question is, “What is the cost to produce it?” We’re talking about the marginal cost of production here, not the overall lifetime cost of a product.
Let’s look at the high price of drugs. The marginal cost of making a pill is almost zero. So why do drugs cost so much money? Why can’t you buy the latest AIDS drug for the price of a bottle of Anacin? How would you price the cost of a pill?
First, you know that the lifespan of your profitability is fixed by patent law. So 17 years after you file your patent, it will expire, and then the generic makers can flood the market and you will be forced to sell closer to the marginal cost of production.
Then the drug costs $100 million to develop, and another $500 million to get through FDA trials. And the trials take 10-15 years, which means the $600 million spent upfront will have to earn two or three times that amount to cover the interest costs.
Then you have to make enough profit on that drug to cover the losses from all the drugs that were researched but never went anywhere.
Given all that, the end cost of the new drug is not even remotely influenced by the marginal cost of production. It could be a tenth of a penny per pill, or 500 times greater than that, and it would have almost no influence on the final price of the drug.
What is your definition of consumer welfare and economic efficiency? I would argue that business model perfectly reflects the proper tradeoffs between consumer welfare and economic efficiency.
The consumer is making a tradeoff between the value of the service
Value = Benefits - Price
and the next-best-alternative to creating value for himself (or his ‘surplus’) given the resources at his disposal: his time, money, etc.
The same argument holds for economic efficiency. The rest of your post supposes that the phone companies are incapable of understanding, or at least testing, the elasticity of demand and the effect on their own economics. Are you presuming they are too stupid to figure this out?
Well one definition of efficiency is maximization of the producer and consumer surplus. I am not sure what your argument even means. You seem to be saying that whatever price a consumer faces he will choose a consumption level based on his preferences. But question is whether the price in question is the optimal one in the first place.
Say the US government gave ATT the monopoly right to provide cellphone services in the US. Presumably they would react by ramping up their price since they face no competition. Now consumers still face a tradeoff between the value of the service and price but that doesn’t he mean he is not much worse off or that the economy isn’t less efficient.
Um no I am not assuming anything of the kind. You are really not making much sense here.
And why does this not apply to your typical person’s wages/salary? Why do people price their labor to the employment market in way that has no relationship to their marginal costs? Your analysis is inconsistent. It’s a false pretense to claim “consumer welfare” when people do not negotiate their salaries based on marginal costs.
Jane and Jill both work at company XYZ as filing clerks. Jane is single and lives with her parents rent free. Her salary is 50k a year. Jill is a divorced single mother with 3 kids and student debt. Her salary is also 50k. They both obviously have very different marginal costs. However, we do not pay people based on their “marginal cost” — it’s a meaningless concept except to Jane and Jill internally. You keep ignoring this.
You have a false notion that understanding marginal cost is some magic answer to fair pricing – it is not. Suppose that AT&T has ambitious plans to pipe 3-dimensional holographic movies into homes. How do they fund this very expensive idea which may or may not bring profits in the future? Maybe they have a 10-year plan to use some of SMS “profits” to fund this big research. Another way to fund this is to borrow billions from banks. But then they’d have to pay for the finance charges on that debt somehow… hmm… maybe by using the SMS revenue… so we circle back again. You seem so fixated on this “marginal cost” concept. Have you ever run a company?
Another reason “marginal cost” is nebulous … different managers will bake different component costs into the marginal cost. It’s not unusual for a new management team to step in and recalculate “marginal costs” and realize they’ve been losing money instead of making profits. This is often true of large complex businesses with many products sharing capital resources. The same Yamaha factory machines tubes for their motorcycles and also their music drumsets. Gee, what’s the marginal cost of the drumset… what’s the marginal cost of the motorcycle? If Yamaha themselves aren’t exactly sure, how could the government know better than Yamaha to dictate a price cap? Again, do we ask the government to dictate our salaries? Why not?
Just because the government doesn’t dictate Yamaha’s prices doesn’t mean Yamaha has free reign to charge whatever they want. If the motorcycle is too expensive, consumers simply choose not to buy it. Both consumers and the govt do not need to know Yamaha’s “marginal cost” (whatever that is) to make that buying choice.
If you think you “know” more about fairness when you know the “marginal cost”, you’re just fooling yourself.
Actually text messaging is not expensive at all, and that was the telco problem. You can meter it fairly easy, use little pay little or use a lot and pay alot. Telcos upped the cost of send and recieving text messages cause they can, its free money for them.
Ruminator,
I don’t think you understand the concept of marginal cost. It has nothing do with decisions about supplying labor and wage rates; the relevant concept in that situation would be “marginal disutulity of labor”
And marginal cost pricing is extremely relevant to understanding whether a market economy is efficiently utilizing scarce resources. This doesn’t mean that every departure from marginal cost pricing needs to be regulated. However very large distortions especially in industries with a large amount of monopoly power need to be carefully looked at.
If you think marginal costs are irrelevant to market efficiency what is your theory for why markets are efficient? Why should the price mechanism achieve an optimal allocation of resources? Suppose every cellphone company in the US were to merge into one company and ramp up prices would that benefit consumers and the economy?
The reason for that is because with perfect knowledge, each individual variation of a product or commodity becomes its own market, and each one gets stuck in a race to the bottom in terms of price, which leaves you with prices just above the marginal cost of producing it; i.e. the company doesn’t really make money on it.
In reality, price isn’t always the deciding factor in whether someone buys something where it’s cheapest. In my neighborhood, there’s a Fiesta (regional Hispanic-oriented discount grocery chain), a Wal-Mart, a Kroger and a Tom Thumb (Safeway). The Wal-Mart and Fiesta tend to be the price leaders on things like soap, flour, sodas, etc… closely followed by Kroger, and at some distance, Tom Thumb.
However, despite the higher prices on say… 32 oz of Tide Ultra vs. their competitors, Tom Thumb still sells Tide Ultra. Why?
Because people don’t want to make four grocery shopping trips to get everything at the very lowest price, that’s why. They’ll make an educated guess on which store will have the overall cheapest market basket of what they’re likely to buy, based on experience and/or advertised specials.
I suspect something similar may be playing into SMS messages; people are choosing their plans as an aggregated whole, and if their phone deal is good enough, people will suck it up on the text messages and deal with unusually high prices on them.
If you could get a text-only device (like a pager, I imagine), then I suspect you’d see more direct competition on text message prices, but as it is, there isn’t anything like that.
No. I’m not looking for a better academic terminology of wage rates. I’m talking about applying a consistency of principles and morality. Please do not confuse the analogy further by hiding it behind economics jargon. The point remains: if government reset everyone’s salary based on that person’s “marginal cost” you’d have a riot from the citizens. The analysis is the same. You still haven’t addressed this hypocrisy.
I believe marginal costs are relevant to market efficiency – but I don’t believe it is efficient for govt to 2nd-guess what is the proper profit in relation to that marginal cost.
In the short term, it may not give the low prices consumers desire. But in the longer term, it creates an incentive for another company to start up and offer another mode of communication that bypasses the monopoly phone company.
It’s funny, when Alexander Graham Bell first demonstrated the telephone, smart people were wondering what was the point of that invention when the existing telegraph worked fine. “Yes, but you can talk on a telephone!” That benefit didn’t seem to sink in. Later, we decide that the service costs too much and should be regulated. Strange how we need to regulate something that people used to consider unnecessary.
That would be a sidekick or the sidekick 2 from danger, at least one nokia and several other handsets that are more optimized for text messaging , but not limted to it.Direct competition would only be realistic if the network was homegenous to the GSM network, and the devices were sold in an unbranded and unlocked condition and your strictly paygo.
The only real times you get movement on pricing of packages , is if your a new customer getting an introductory price, or your coming up on the end of your contract and retentions has lattitude over what bennies it takes to keep you.
Just as an example, it took nine years and one company that had enough muscle to Push AT&T around, before Data prices became realistic. Im not sure how much people paid in the past for Data on other networks, but in Canada on Rogers, it was 25 dollars for one meg, now I have six gigs for 30 dollars.
It does not always have to be a solution made by govt that gets change happening.