New Zealand Institute for the study of competition and regulation inc.

Abstract

In most OECD countries, dial up internet accounts have typically been offered under two-part tariffs, where connection and usage are charged separately. By contrast, broadband accounts are typically offered under flat-rate tariffs. As consumers purchase internet accounts based upon their combined valuations of each of the connection and usage components, it would be expected that different broadband tariff structures would result in different rates of broadband diffusion. As broadband is the successor to dial-up internet technology, the diffusion rate will also depend upon the dial-up tariff structure.

Using theories of two-part tariffs, bundling and price discrimination, this paper examines the effect of both dial-up and broadband tariff structures on broadband diffusion. Specifically, flat-rate broadband tariffs slow the rate of diffusion, relative to an optimal two-part tariff. Flat-rate tariffs prevail as a strategic means of extracting rents from early adopters with high connection values, but low usage valuations. Flat-rate dial-up tariffs slow the rate of substitution to broadband via two mechanisms: a larger ‘connection gift’ from bundling with voice telephony and a larger ‘usage gift’ from usage beyond the point of marginal cost. Relative to an optimal two-part dial-up tariff, the marginal substituter from flat-rate dial-up to broadband has both a higher connection valuation and a larger usage volume. Conversely, two-part dial-up tariffs where usage subsidises connection result in earlier substitution to broadband, as both the connection valuation and usage volumes are lower.