Hidden Monopolies

I wrote a post last year about Maxis offering the iPhone on an exclusive basis, tied to long term contracts. I haven’t changed my mind about the potential problems this brings to consumer choice and what it means long term for competition in the telecommunications industry in Malaysia, even as the local asking price of the iPhone has dropped and with DiGi coming in as a second provider.

My thoughts on the matter bear repeating:

My opposition to this is that the way this is structured constitutes monopoly behaviour and restricts consumer choice. All the telcos have shifted to this model for wireless broadband modems, so the business model itself is nothing new. But putting it into practice with handphones is in my view a dangerous precedent, because that takes the business model mass-market. Here's my take:

1. Lock-in contracts means customers can't leave a telco without paying a hefty penalty.
2. Subsidised hardware distorts the price signals for handsets. Check out the difference between the new customer prices and old customer prices.
3. Exclusivity is market distortionary as well - want the iPhone? You have to be a Maxis customer, and never mind their service level. I can't confirm the exclusivity aspect, but I suspect it's there as that has been Apple's standard practice in every market they've tried to enter.
4. As a result of all the above, both Maxis and Apple will gain monopoly profits.
5. The incentive for maintaining after-sales customer service is substantially reduced.
6. The pressure to compete on price and service as far as voice and data are concerned, is also substantially reduced.

My biggest fear is that the iPhone deal will force other handset makers to follow suit - want a Samsung Omnia? Go to this telco. Want a HTC Touch Pro 2? Go to this telco. Want the latest, greatest Nokia? Go to this telco. The market becomes defined not by who has the best or cheapest service, but rather who has the best subsidy and hardware. If consumers were fully rational in the economic sense and take into account the total cost of a contract, this business model would never get off the ground. But the lower upfront costs relative to unsubsidised hardware seriously colours consumer perceptions, and we contribute to reducing competitive pressures in the market.

The point of this post is that what I thought would happen is slowly coming true – take this post for example, of the kind of results the exclusivity model creates (market selection based on non-price competition; lower standards of customer service). Worse yet, Samsung is now in the same game with Maxis.

I was shopping for a new smartphone as a birthday present for my wife, and settled on the Samsung Galaxy S. It’s a fantastic device with great hardware and running version 2.1 of Google’s Android OS. But the problem is that it’s exclusive to Maxis – even Samsung showrooms don’t have it.

Maxis is offering the Galaxy S at RM900 off its RRP, which sounds like a good deal. When Maxis first introduced the iPhone, customers had to pay near retail price levels. But obviously Maxis aren’t doing this from the goodness of their hearts – they’re in business to make money (full disclosure: I own stock in Maxis and have been a long term customer). Taking up this offer means committing to a 1 year contract which at minimum will cost you RM98 a month (including a one year RM120 rebate on data charges). If you want out, you’ll have to pay a fine.

You have to question why Maxis is offering such a deep discount on a premium phone, since Samsung aren’t obviously giving it for free. To be fair, I don’t think Maxis is subsidising these phones to any great degree, as you can find the Galaxy S for under RM2k online (including overseas shipping) – that RM900 difference is illusory.

But even given that we’re only probably talking about a couple of hundred Ringgit, Maxis has to make up that difference somehow, and still make a profit. I suspect that the cost of their investment in bandwidth is relatively fixed, which means that any traffic they can capture over and above what covers their fixed costs is pure profit.  That’s one potential source.

Another way to do this is to segment the market and set prices based on the individual marginal cost/marginal revenue intersections in each market segment, thus achieving profit levels higher you can get with a single pricing structure across the whole market.

If this sounds familiar, it’s undergraduate microeconomics, and refers to monopoly rents and appropriation of consumer surplus via price discrimination. If it doesn’t, don’t worry – the example I’m going to show should (hopefully) make it clear.

In this case, let’s look at Maxis’ pricing structure for data:

1. RM58 for 500MB per month
2. RM78 for 1.5GB per month
3. RM88 for 3GB per month

This compares pretty well against what Maxis used to charge: about RM120 per month for unlimited data (with a soft limit of 3GB which was hardly ever enforced) a few years back. That looks good for the consumer, as the lower pricing means more consumers get access to affordable mobile data consumption.

But consider this – marginal cost per kB/MB/GB should be the same for each customer (what’s the marginal cost for receiving a packet?) yet the “cheapest” data plan charges 11.6 sen per MB, and the “expensive” plan charges 2.9 sen per MB. That’s a 4x difference in pricing. This would only make sense (maybe) if fixed costs were high per customer, and maybe they are. But the increase in prices relative to the increase in bandwidth is non-linear – which suggests that the low-bandwidth customers are being discriminated against, and Maxis is earning monopoly profits off of them.

In theory, monopolies earn abnormal profits by charging lower prices to markets with a higher elasticity of demand (the rate of change of quantity demanded relative to price; i.e. this market is highly sensitive to prices), and higher prices to markets with a lower elasticity of demand (low sensitivity to price). The difficulty in the physical goods market has always been segregating buyers in each market, so that those charged lower prices can’t sell on their goods to those paying higher prices, which would arbitrage away the price differences and the monopoly supplier’s abnormal profits. In this case, the markets are self selecting (low bandwidth users will always opt for the low rate plan, and vice versa), and there is no possibility of trading unused bandwidth between the different categories of customers.

As consumers, we’re used to the idea of discounts on bulk purchases. But the digital world doesn’t have the frictions that make bulk discounts sensible in the physical world – inventory costs, transportation costs, carrying costs and the like. In short, non-linear tiered pricing structures like Maxis is charging for data access are an example of monopoly pricing power, in a supposedly competitive environment. We’re lucky in the sense that we have an open relatively unregulated grey market for handsets – but that doesn’t excuse the creeping reduction in competitive pressure the subsidised, exclusivity pricing model is bringing to the Malaysian market.