Why Broadband Is Still So Expensive

When PCs were becoming ubiquitous in the early 1990s, there was an adage to the effect that "the PC you really want always costs $2,500." It's been a long time since prices were anywhere close to that, and you could make a similar observation about cell phones, DVRs, and a host of digital devices we use for business and entertainment.

How did that happen? It's no mystery: innovation, economies of scale, and competition. Simply put, the market worked.

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Now compare those prices to those you pay for broadband service -- and behold the difference. While the cost of electronic devices has steadily declined in real terms, or relative to the amount of processing power you can buy, the big carriers are still charging more or less what they charged years ago. In this case, the market isn't working.

I've long suspected that the broadband industry is taking on the characteristics of a monopoly, and now there's evidence to back it up. Researchers at the Kellogg School of Management and the University of Rochester analyzed the contracts of 1,500 DSL and cable service providers from 2004 to 2009. They found evidence of only a very small price drop, between 3 and 10 percent, nothing like the decrease seen in the rest of the electronic world.

Low Costs for Them, High Prices for Us
Stagnant broadband prices are a fact, despite the steady retreat from regulation that has given the industry the untethered hand that free-market mavens claim would shower us with benefits. Indeed, as Shane Greenstein, co-author of the study, points out, consumers in most areas have just two wireline providers. Often that comes down to a choice of AT&T or Comcast -- neither of which is known for its customer-friendly ways. And since there are just two viable providers (as opposed to one) in many markets, duopoly is a more precise description than monopoly, says Greenstein.

He says that a 2003 decision to leave regulation up to the broadband companies themselves has caused much of the stagnation in broadband service prices. Revenue from homes makes up 70 to 80 percent of revenue in wireline Internet access market, while business demand makes up the rest. "So if you were in such a market as a supplier, why would you initiate a price war?" Greenstein said in an interview with Kellogg Insight, a university publication.

He also points out that unlike manufacturers, whose recurring costs keep margins low, telcos and cable companies enjoy a sharp drop in overhead once lines and switches are installed. Costs are then far below prices, and "at that point, it becomes pure profit," Greenstein says.

High prices may well have been justified early in the decade when companies were building out infrastructure and needed to recover costs. "However, we are approaching the end of the first build-out, so competitive pressures should have led to price drops by now, if there are any. Like many observers, I expected to see prices drop by now, and I am surprised they have not," he said.

There's another fact that should have -- but didn't -- force prices down: broadband's widespread adoption. Once infrastructure is in place, the marginal cost of adding a customer to the network isn't great. In 2004, just 20 percent of U.S. households had broadband service in 2004. Today, that number has increased to more than 65 percent.

Revenue has climbed even faster. The decade started out with broadband representing just 6 percent of the total revenue from Internet services; by 2006, that figure had grown to 72 percent, said Greenstein.

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