In 2006, the State of California deregulated its telephone rate market on the conclusion that local phone service had become sufficiently competitive (as demonstrated either by actual competition or by the contestability of the market). The result? Phone prices have gone up:
What is interesting here is we are also seeing something that I will -- for want of a better name -- call Reverse Ramsey Pricing. Ramsey Pricing is a theory I am running into a lot lately on why we should not impose network neutrality (which would prevent third parties from paying for differentiated delivery regardless of user preferences). Essentially, as explained to me by my opposite numbers, it holds that we should charge the highest prices to those who are most insensitive to price. This achieved by allowing providers to sell differentiated bundles of products or services, so that the cost of the basic service (on which the most price sensitive rely) will remain modest, with the largest profit margin on the bundle sustaining the modest basic service price. The example offered to me at one event was of a local gym, that sells a basic membership fee, but then sells to third parties the exclusive rights to sell additional services or equipment on the premises.
I shall leave aside the theoretic problems with this idea to observe that, as I explained to the Federal Trade Commission a year ago, we are not seeing this. We do not actually _know_ what the structure of the market is, how contestable, the genuine ability of consumers to switch, etc., etc. I call this the soda v. rain model. Let us consider the market for soda. Does bottled water compete in the same market? Probably. How about tap water? Well, tap water probably has impact, but we would really need a close examination of whether they compete, even though bot are are liquids you can drink when thirsty. What about mud puddles? I am fairly confident that despite the fact that mud puddles and soda both are liquid and can keep people from dying of thirst, they do not compete.
Betting on emerging competition is not even as good as soda v. mud puddles. It's like saying soda competes because it looks like rain, which may create mud puddles.
But in 2006, CA decided to bet on the incoming rain as competing with existing dominant providers. What happened? There is indeed a competitive response. But it does not work in the manner envisaged, because the market incentives are more complicated than the simplistic theory of competition advanced by the deregulation crowd suggest.
A fundamental of telecommunications networks is that plain vanilla common carriage/transport (be it voice, video, or data) is the least profitable function of the network, because nearly all the investment in building the network goes into developing transport. It is everything AFTER transport that has huge profit margins. As a result, carriers will not willingly compete for those customers that want only plain vanilla transport. Indeed, if they can can do so, carriers will avoid serving these customers. Carriers also favor bundles because they often increase the switching cost to consumers by making the bundle less substitutable with other products.
As a consequence, carriers jack up the price of the individual components of the bundle, including basic service, and then offer bundles that lower the individual price of each item in the bundle but increase the price to the consumer over all. Yes, if I get triple play, my basic phone service has dropped. But if I am very price sensitive (i.e., poor), I will have an unavoidable increase in cost to get basic service. In other words, I will get Reverse Ramseyed. Which is what we have seen in California.
It may be, of course, that we do not care or that we find this an acceptable trade off. This will result in a surplus for the highest end consumers who would always buy the largest bundle. That, in turn, will stimulate the development of additional high end services, because the profit margin on these services is relatively high. This is, to some degree, what we have seen as a consequence of cable competition. Prices rise, but the overall cost per channel has dropped.
From the perspective of public policy, this may be entirely acceptable depending on what you want to accomplish -- or if you believe as a matter of principle that the government should not "pick winners" and that the rise in the quality of the bundle will ultimately trickle down to added value for basic service customers. But we should not pretend, as so many state legislatures have, that deregulation will lead to lower prices for basic services in the way that people who subscribe to basic services understand, i.e., that they will actually pay less every month for phone service.