Wireless: Overstating Smartphone Data Hogs?

Thirty dollars for unlimited data: This is how Verizon Wireless beckoned AT&T (T) customers as it took orders for iPhone contracts on its network. Poor AT&T capped its data plans last year at $25 for two gigabytes; one gig is about the size of an episode of Glee in standard definition.

Verizon then said in a two-paragraph notice buried on its website that its network was a "shared resource" among its customers. It further sighed that it would have to slow data speeds for the top 5 percent of its users to save its customers from the "inordinate data consumption of just a few users."

In other words, the bandwidth hogs are ruining it for everyone. It's a curious phrase, "bandwidth hogs." Executives at Comcast (CMCSA) used it earlier this decade to justify limiting traffic on file-sharing sites. This week several newspapers, writing about Verizon's decision, used the phrase "data hogs" in headlines. The phrase suggests a moral failing: the sin of gluttony.

Wireless data is a finite resource. Data moves from a tower to a cell phone over electromagnetic spectrum, which carriers buy at auction from the federal government. Each carrier has a limited amount of spectrum, yet that limited amount renews itself, moment after moment. Think of electricity: The power plant runs all the time, but on hot days everyone turns on an air conditioner, straining the plant's capacity. Utilities are experimenting with smart meters that encourage customers to move their power use off-peak.

Wireless carriers, responding to a similar challenge, have chosen not to treat data like a commodity. Rather, they've carved off 5 percent of their heaviest users and stigmatized them. This is a business choice, not a natural economic consequence. Imagine that a power company, to prevent blackouts, has informed its customers that its heaviest users will be penalized with unpredictable brownouts two months running. Why do wireless customers tolerate this from carriers?

Some people do use a lot of data. This month, Cisco Systems (CSCO) reported that the top 1 percent of wireless data customers account for 20 percent of traffic. In any other industry, this market segment would be called "loyal customers." Casinos call them "whales" and give them free hotel rooms and special tables with high limits. Wireless carriers punish their whales.

Verizon has hinted that, like AT&T, it plans to move to tiered pricing later this year. Meanwhile, according to analyst Craig Moffett of AllianceBernstein (AB), AT&T is quietly letting some customers who used to have unlimited plans return to them. Carriers are playing two games of chicken simultaneously. First, among themselves: Each wants to earn more per customer by charging extra above a certain data limit, but none wants to be the first to do so. Second, with the rest of us: How low can they cap data without offending too many customers?

It's hard to tell how much carriers pay wholesale to provide bandwidth to customers. According to John Hodulik, an analyst for UBS (UBS), "It's just not something the telcos discuss." A paper last year by Merrill Lynch (BAC) calculated $3 per gig and falling. (Verizon and AT&T declined to provide figures.)

Assuming that estimate is correct, almost every customer is buying data at a painful markup. AT&T's basic plan is 0.2 gigs for $15 a month, which equals $75 per gig. That's a 2,500 percent markup over the cost of goods for, according to Cisco, almost three-quarters of all mobile users. For AT&T's next tier, the markup drops to about 400 percent. Ostensibly, AT&T is worried about running out of spectrum, but its tiered structure, which provides little incentive for minimizing data use, doesn't seem engineered to save bandwidth.

One time-honored way of allocating a scarce resource is to agree on a unit—a barrel of oil, a kilowatt-hour, a Glee of data—and let the price of that unit fluctuate according to demand. Some refer to this mechanism as a "free market." But if the wireless carriers were to charge by the gig, even if the market arrived at a generous 1,000 percent markup, they'd lose money over the tiered setup AT&T has in place now. No wonder wireless carriers prefer the language of tiers, caps, and hogs to a simple per-gig price.

Analysts and shareholders prefer the current pricing structure, too. Let's be clear, though: Tiered data prices are not in place to save bandwidth. Data hogs aren't the problem the carriers would have us believe (Cisco has 0.4 percent of customers using more than 5 gigs a month), and the other customers are very profitable. Dave Burstein, an analyst for DSL Prime, estimates that if capacity were the only factor, no carrier would need to introduce a limit under 10 gigabytes. The carriers are like sadistic Italian grandmothers: "Eat, eat," they say, but then, "You're too fat."

The era of unlimited plans does have to end. The best way to allocate finite goods is through transparent, efficient markets. As traffic increases on mobile networks—it nearly tripled this year, and Cisco expects it to grow twenty-sixfold by 2015—consumers will be forced to make smarter choices about how they use mobile data. Perhaps parents will be forced to download the toddler-pacifying Elmo videos at home rather than on-demand in the car. That's not a tragedy, it's what markets do. So the next time you hear a wireless executive complaining about data hogs, ask yourself: What's my reward for being a data piglet?

The bottom line: The heaviest mobile users get stigmatized as data gluttons, and yet carriers charge them the lowest markups.

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