Tuesday, January 11, 2011

Unlimited Data Plans from Verizon

News reports indicate that Verizon may offer unlimited data plans as part of their service contracts for their version of the iPhone. Of course, AT&T moved away from unlimited data recently, shifting instead to tiered plans based on data usage. At the time, AT&T made this move because heavy users tended to be putting a strain on their network. Many now speculate that Verizon is quite confident that their network can handle heavy usage, and therefore, has decided to battle AT&T by offering these unlimited plans.

What's going on here? To me, this story begins and ends with a simple discussion of the cost structure of providing smartphone service. When we think about price rivalry among competitors, we should always try to understand the nature of the firms' cost structures. How high is the fixed to variable cost ratio? If fixed costs are very high, and variable costs are very low, then we tend to see vigorous price competition. Why? Well, firms are trying to cover their fixed costs. Put another away, if the marginal costs are very low, then any price above those marginal costs tends to add to the bottom line (adds to contribution margin, as accountants say). In the case of Verizon, if they believe the investments in their network are sufficient, then the marginal cost of having a consumer use more data on their smartphone amounts to almost nothing. Meanwhile, the fixed costs of developing that network are high. So, they have every incentive to try to spread those fixed costs among as many consumers as possible. In short, price will fall toward marginal cost in a highly competitive market.

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