Wednesday, January 2, 2008

Why phone and internet plans are meant to be difficult to understand

Have you ever spent the morning on the phone trying to find the best deal on a new phone line and internet plan? It seems that every company has something new and different to offer; specials package deals, bonus calls, free modem, or free installation if you sign up for the two-year contract. The options are endless. 

If we measured the competitiveness of a market by the amount of customer choice, the telecommunications market would certainly have to be regarded as highly competitive. Mobile phones are perhaps even worse. With loyalty programs, free phone upgrade and phone insurance, and any number of other nifty deals to persuade customers into believing they have the best deal. In the end, it was the toss of a coin that made the decision for me. Not one of the plans, after strict comparison and scrutiny, seemed any better or worse than the others. In fact, it seemed that all the companies were offering the same product, for the same price, but packaged with any number of confusing ‘bonuses’ and ‘specials’. And there is a logical reason for this situation, which doesn’t quite fit with the Howard Governments belief that privatisation provides more efficiency through more competition.

It must first be stated that the benefits of a perfectly competitive market cannot be ignored. When there are low barriers to entry, new firms can easily enter the market to compete, and since the products are so comparable and customers have complete information, they can make the simple choice of purchasing the cheapest product offered. In this model, the cheapest, and therefore the most efficient producers become profitable, while the least efficient producers are forced out of the market. And if those who remain in the market begin to raise prices, it is easy for competing firms to enter and profit by undercutting the competition until the prices fall. 

Unfortunately, this theoretical market model does not actually exist in the real world. Like in physics, where a theory requires a frictionless environment, there can be no application of this theory until the limitations of the model have been addressed. And the most serious of these limitations for the perfect market are the product comparability and the complete information available to the customer.

By consciously manipulating these two criteria of a free market, all firms in the market are able to avoid a state of true competition that would produce the most efficient allocation of services and are able to artificially inflate the value of the commodity, hence producing more profit for each firm in the market. This is not meant to sound like a conspiracy because indeed each firm does not need to meet in back rooms with the other firms in the market and all agree to limit customer information and the comparability of their products. They each simply need to aspire to the great marketing ideal of product differentiation, a concept that is fundamentally designed to artificially eliminate direct competition by removing direct comparability.

The power of product differentiation, through its ability to remove comparability and create an information gap to distort what could be a perfectly competitive market, can be demonstrated by the case of the term life insurance market in the US in the late 1990s. There was a mysterious and dramatic drop in prices across all firms that did not correlate to price drops in other forms of insurance, which themselves were steadily rising. 

According to economist Steven D. Levitt, this can be attributed to the realisation of a perfect market through the power of the internet. Although term life insurance policies had been quite homogeneous before this period of time, the process of shopping around for the cheapest price had been convoluted and time-consuming, whereas websites such as suddenly made the process almost instantaneous. In just a few years, the value of the term life insurance market in the US had dropped by USD$1bilion because of the new-found ease of comparability. What insurance firm would want this to happen? Even if you were a small player in the market, say a 1% market share, your turnover had just dropped by $10million. It is perhaps one of the great recent examples of the power of perfect competition in allocating resources efficiently, yet possibly one of the greatest blunders by the insurance industry.

Let us now return to the Australian telecommunications market. It is quite possible at the moment, that no two companies offer an identical phone or internet plan. The process of comparing the plans to find the best deal is currently convoluted and time-consuming (much like in the previous insurance example), and the products have been differentiated in seemingly all possible ways. Recent websites are attempting to remove this information lag and do the comparison with a double click, but may only be adding to the confusion as telecommunications providers further differentiate their products through packages and bonuses, and modify their plans more frequently in the name of incomplete information.

Imagine now if all firms in this market offered the same three identical plans - a low use package, a mid use, and a high use, all with identical call rates, fees, contracts and download quotas. What would happen to the market? Would, as in the case of term life insurance, prices plummet and leave the market with a dramatically decreased total value? If we are to believe in the ideas of Adam Smith and other advocates for more competitive markets, the answer must be an astounding yes. The real catch to this whole affair is that more competitiveness would only benefit the customers, and not the powerful and influential telecommunications firms, and not the federal government.

For the ideals of the Howard government of revenue raising through privatisation of public assets to make any sense, you must believe that in private hands, the markets will work competitively and hence benefit the customers, also know as the Australian people. But evidently, it will not.

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