The Price Sensitivity of Broadband

I recently ran across a solicitation from an ISP looking to hire a consultant to help them quantify the price sensitivity of ISP products. For those of you not familiar with economics, understanding price sensitivity would help to accurately predict the number of customers that would abandon a product if prices are increased. Understanding price sensitivity would also allow an ISP to create a demand curve which could predict the number of customers a business should attract at a given price.

It turns out that it’s incredibly difficult and mostly impossible to define the demand curve for most products in the world, including broadband. This is not to say that price sensitivity isn’t something that everybody in the industry would love to know, and I’ve been asked this question for my whole career. Early in my career I worked on rate cases, where a telephone company sought permission from a regulatory body to raise rates. Telcos didn’t raise rates very often back in the 70s and there was always a lot of gnashing of teeth by management who worried that a few-dollar rate increase would lose customers. It turns out at a time when telephone service was a monopoly that almost nobody dropped service, but telco management didn’t trust this to be true.

Perhaps the easiest way to understand a demand curve is to look at one of the few examples where it might be measurable. Consider Uber in a big market like New York City. The company raises rates any time there are more requests for drivers than there are drivers. This happens at busy times of the day such as during the morning commute and during for events like a snowstorm. People in a major city have alternatives to Uber. If Uber is too expensive people can hail a cab, walk, or try another ride service like Lyft. By now, Uber has gathered enough data in a market like New York City that they probably can closely approximate the demand curve for their service in the city. However, even here, the demand curve will be specific to New York and not Uber anywhere else.

However, broadband (and most consumer products) don’t work that way. There are a few other economic terms that are relevant to the topic. One is substitution. Customers are a lot likelier to be price-sensitive if they have a product alternative they view as equal. There are portions of the cities with Google Fiber where the telco also built fiber and where the cable company upgraded to gigabit speeds. In these rare little pockets a customer might find the broadband alternatives to be pure substitutes for each other. In most of the country, broadband products are not considered as substitutes. For years we’ve seen millions of customers annually ditch DSL for cable company broadband and a lot of those households are likely to never consider moving back to DSL.

One of the key characteristics of an economic substitute is the ease of customers to change between similar products. It’s easy to pick a choice other than Uber. It’s not easy to change ISPs and households agonize over making a change. Changing to a new ISP might mean sitting at home for an afternoon waiting for an installation technician. It also means suffering through the call with the existing ISP as they try to keep you as a customer. It likely means driving electronics back to the canceled ISP.

One of the components needed to estimate a demand curve is getting a lot of data points. This is what is so awesome about Uber for an economist – they can get piles of data to understand how customers react to various pricing offers. Broadband doesn’t generate a lot of data points – ISPs don’t change prices very often. Even when they do change prices, ISPs don’t get the same kind of instant feedback that Uber gets over a price change. If an ISP raises prices, they are not going to be able to correlate this with a customer who gets around to dropping them six months later because of the increase.

To further complicate things, my firm does surveys and we’ve found that the majority of homes have no idea about what they pay for broadband. This is not surprising since in most markets over 70% of households have bundles that disguise what they are paying for each product. Customers also tend to remember the advertised prices, which they may or may not have ever received, instead of the actual prices they are paying. Customers are also regularly duped by deceptive billing practices where ISPs hide parts of the cost of a product in hidden ‘fees’.

I can’t blame a new ISP for asking the price sensitivity question, and it’s not an unreasonable question to ask. But I would venture to say that even Comcast and AT&T have little grasp over the demand curve for broadband. If they start raising rates every year as Wall Street is expecting, then over time the giant ISPs might start to get an tiny inkling of the demand curve – but even then, broadband is such a complicated product that predicting price sensitivity will always be a guess.

Why People Cut the Cord

TiVo did a large market survey at the end of last year that, among many questions asked cord cutters why they cut the cord. Respondents were allowed to choose more than one response, with the responses as follows:

  • Too expensive                                     80%
  • Use an Internet streaming service   48%
  • Use antenna to get basic channels   27%
  • Like to binge watch entire seasons  19%
  • Dropped cable when moving            13%
  • Like the streaming original content 11%

Interesting to me personally was that my number one reason for cutting the cord was not even on this list. I’ve found that I can no longer tolerate watching linear TV. I generally am multi-tasking when watching video and I love the ability to pause, re-wind or watch video in a manner that suits my mood at the moment. I can absolutely not stand commercials any longer, and that means I can’t stand broadcast cable. I tolerate commercials when watching sports, but I will not otherwise willingly watch anything that includes ads. The same goes for me for any web site that wants me to watch an ad first – I just skip past the site regardless of how interesting I might have found the content. I know there are ways to skip ads on linear TV using DVRs to record shows, but it takes more work and doesn’t work for channel surfing. Netflix and other OTT providers have let me just forget about ads.

But I’d like to look deeper at the primary reason people list for dropping cable TV – the cost. Certainly there are households who feel like they are getting priced out from being able to afford cable TV after each large annual rate increase. Real household incomes have not grown much for many years while cable rates have risen 6% to 7% each year. And so there are some households that are forced to give up cable when the alternative is not paying for something more important like rent or a car.

But I don’t think that is what most people mean when they say that cable costs too much. Most cord cutters are not dropping cable because they can no longer afford to pay the monthly bill – rather, what they really don’t like is the perceived value of cable. And value is something very different than cost.

We conduct customer surveys at CCG and I think the big national surveys are not digging hard enough with the questions they ask. I don’t fault them for that because the TiVo survey was not just asking about cord cutting, but also about a whole other range of issues related to video. Our surveys are generally being conducted in small town or rural markets where one of our clients is considering building a new network. And in these surveys we can dig a little deeper because we are trying to answer a much smaller range of questions.

For instance, consider rural homes and farms in areas with little or no broadband. People without broadband in these areas generally watch cable TV using satellite service since that is their only option. We don’t see much discussion about cord-cutting in these markets, because that would means cutting your home off from almost all video. In rural areas you might be able to get a few channels through an antenna, but sometimes that’s even very limited.

But today the majority of people with broadband have tried one or more of the streaming services like Netflix or Amazon Prime. In doing so they are finding that they love the amount of unique content on these sites and they love the commercial-free streaming experience. And the more they like the streaming video experience, the less value they perceive in their linear cable TV subscription.

I think every cord cutter is happy to be saving money, and that is why they would pick that choice out of a list of reasons for why they cut the cord. But I really think that most of them really mean that they could no longer justify paying the high price for something that they no longer value as much as they did in the past.

In economic terms streaming video is now becoming a substitute for traditional TV. Since cable systems were built in the 70s the only real substitute for cable TV was rabbit ears and a big majority of homes opted to get more channels and more chose through a cable subscription. But as homes perceive streaming video as a substitute for a cable subscription they will do the side-by-side comparison and decide that cable TV costs more than what it’s worth to them. And I think this is what would prompt most cord-cutters to say that cable is ‘too expensive’ when given a survey.