Tag Archives | price discrimination

Choosing channels à la carte

Would you be better off paying only for those channels that you watch?

The advent of digital set-top boxes and satellite televisions in India was extremely exciting at first. The ability to choose and pay for only those channels that individuals preferred was an appetising offer and held the promise of decreased cable bills for families. Many were under the impression that one could pick and choose exactly those channels that one regularly watches. However, the satellite television companies such as Dish TV and Tata Sky took the established American route and bundled the channels into certain packages. This actually resulted in increased costs for families for different reasons. The most obvious reason is that there is enough heterogeneity in preferences in a family and thus, multiple packages had to be selected. While, hypothetically speaking, one member would want a regional package (kannada movies+news package, for example), another member would want to have a sports package, while a third preferred English entertainment. This diversity leads to most families choosing all channels package, which would cost significantly higher.

The more prominent reason for increased costs, however, lies in economics. Providing such packages is called bundling, which is prevalent in imperfectly competitive markets. Bundling refers to the offering of several products for sale as one product. The reason for doing this is to capture all of the consumer surplus.

Take a hypothetical example: There are two customers and two channels. Amit prefers to pay Rs.75 for the Zee TV, but Rs.50 for Star World. Manjunath, however, prefers the opposite: Rs.50 for Zee TV and Rs.75 for Star World. If the cable company offered the channels individually, it can charge only Rs.50 for each channel and will receive Rs.200 as total revenues. If it charges anything more than Rs.50 per channel, say Rs.75, one of the customers will not buy it – Amit will not subscribe to Star World, while Manjunath will not subscribe to Zee TV. The cable company ends up loosing revenue (Rs.75*2 = Rs.150). So, by charging at Rs.50 per channel, the cable company maximises profits and total consumer surplus is Rs.50 (Each customer gets the channel at Rs.50 when they were willing to pay Rs.75 for one of the channel and thus, enjoys a consumer surplus of Rs.25)

Imagine now that the cable company offers a package for Rs.125, a pure bundling strategy, where individuals cannot choose the channels separately. Now, both consumers pay exactly according to their willingness to pay (thus, eroding their consumer surplus) and the cable provider increases its profits to Rs.250. This extraction of consumer surplus by the cable company is known as price discrimination.

Bundling channels into packages might not be as harmful to the consumer as economic theory suggests.

Bundling channels into packages might not be as harmful to the consumer as economic theory suggests.

Given this scenario, it would be tempting to clamour for a regulation where cable companies should provide à la carte option to the consumer where he gets to choose only the channels that he prefers. While economic theory suggests that the consumer would be better off doing so, it is not evidently clear that this might be the case in practice.Content providers, like Star and Zee, also have high degree of market power and would then renegotiate the price with cable companies. Imagine that, under the bundling offer, Star and Zee, received Rs.120 each as revenue from the cable company (who retains Rs.10 profit). Now, if the cable company offers each channel individually, chances are that Star and Zee will increase the rates of their respective channels to Rs.75 to capture all of the consumer surplus, since they are loosing one of the customers. Thus, both Amit and Manjunath will end up paying a price equal to their maximum willingness to pay for one of the channels and they might be worse off as they are loosing the choice of the other channel. Microeconomic Insights has some interesting research on this and found that “consumers bought and watched fewer channels, and their average spending was estimated to rise by 2.2%.”

Anupam Manur is a Policy Analyst at Takshashila Institution and tweets @anupammanur

 

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Outrageous Outages

The economic cost of power cuts to India is as high as 1% of GDP. It is time to reclaim that through proper pricing, privatisation and better management of supply.

Karnataka is experiencing dark days. Many parts of Karnataka are experiencing disruptions in power supply, or outages, for 8 to 10 hours in a day. Bangalore, the capital of Karnataka and IT capital ofIndia, has been experiencing three hours of scheduled power cuts and a few more hours of bonus unscheduled ones. Starting from today, Bangalore Electricity Supply Company (BESCOM) officially extended the scheduled power cuts from three hours to four.

Night time satellite image  of power cuts in Karnataka

A slightly modified night time satellite image showing Karnataka in darkness due to the power cuts.

Power cuts of this nature in a major metropolitan area are nearly unheard of and Bangalore’s aspiration to become a global hub for business and innovation is under serious threat. Power disruptions are exactly that – they disrupt the everyday lives of citizens and businesses. There are plenty of news reports and stories of ordinary lives getting disrupted due to the power cuts. Inconvenience to citizens aside, power cuts have huge economic costs to businesses.

A study by Federation of Indian Chambers of Commerce conducted a survey on the cost of power cuts to businesses in India and the numbers are staggering. The study revealed that Indian companies are losing up to 40,000 rupees ($733) a day each because of power shortages, which are taking a toll on production. The survey, which covers 650 industries of various sizes across India, said that as many as 61% of the companies surveyed suffered more than 10% loss in production due to power cuts.

This 2009 report in India Today surveys the extent of economic costs to Indian companies. It quotes a study by Manufacturers’ Association for Information Technology (MAIT) and Emerson Network Power estimates that the cost of power disruptions to India Inc is to the tune of Rs. 43,205 crores (nearly 1% of GDP) per year. Manufacturing is, quite understandably, the worst hit sector, followed by financial services, Telecom, real estate and infrastructure. The estimate loss for firms in these sectors is a whopping Rs 54,434 per hour, as the report states.

Where is the light at the end of the Tunnel?

Every summer and sometimes during the post-monsoon period, the government has a pre prepared statement for the reasons for power cuts: shortage of rainfall, technical glitches in the power plants, thermal plants being shut for maintenance, etc.  However, the real reason for the constant power problems is the mispricing of electricity.

Comparison of average national cost of electricity. Source: http://www.theenergycollective.com/lindsay-wilson/279126/average-electricity-prices-around-world-kwh

Comparison of average national cost of electricity. Source: http://www.theenergycollective.com/lindsay-wilson/279126/average-electricity-prices-around-world-kwh

Electricity is cheap in India. A bit too cheap. The recently revised tariff for domestic consumers in urban areas in Karnataka will be Rs 2.70 per unit for 30 units, Rs 4 per unit for consumption between 31 and 100 units, Rs 5.25 per unit for consumption between 101 and 200 units and Rs 6.25 per unit beyond 200 units per month.

Further, there are two types of price discrimination that takes place in India. One is based on the type of consumers. Higher rates for industries and low rates/free electricity for farmers, etc. The second discrimination is based on the quantity consumed – per unit cost increases with higher number of units consumed.

The first type of price discrimination is done in order to enforce cross-subsidization of electricity. It ensures that industries pay for the farmer’s electricity. This has got to be stopped, just as diesel and cooking gas subsidies are being dismantled. All ESCOMs (Electricity Supply Companies) in India are under severe losses, which reduces their ability to ensure continuous supply of electricity by maintaining the plants, having a regulatory and enforcing structure to reduce theft of electricity and finally to reduce leakages in the distribution channels.

Price discrimination based on quantity consumed will ensure proper pricing of electricity. The higher number of units consumed, the more one pays. Big industries will naturally pay more than common households, but not as much as the present system. Small to medium enterprises may also end up paying more, but it would be significantly lesser than the opportunity cost of losing business due to power cuts plus the cost to arrange alternate modes of electricity production (diesel generators, etc).

Privatisation: It is time that the government realizes that more than half of India’s future power generation and supply should and will be done by the private sector. Incentivize the private sector to invest in power generation capacity.

Scientific management of power supply: ESCOMs in India should operate the way a private firm does: project production quantities, possibilities for production disruption, alternatives for mitigating the disruptions, predicting hike in demand, etc. It is surprising that the State Electricity Companies quote hike in demand as the reason for power shortages every summer. The meteorological department had announced well in advance that the monsoon this year will be below average and yet, it managed to catch the Power ministry and BESCOM by surprise.

Predicting increased demand and forecasting supply shortages will help the companies to prepare alternatives in advance. BESCOM can introduce special seasonal tariffs for summer or prepare for a weak monsoon by making arrangements to buy power in advance.

Reforms in the power sector have been in the public sphere for far too long without any concrete action. Smart cities, Make in India and any such ambitious projects will remain a dream until continuous supply of electricity is sorted out. It is time to reclaim the lost 1% of GDP due to power cuts.

Anupam Manur is a Policy Analyst at Takshashila Institution and tweets @anupammanur

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Using Price Discrimination to ensure Net Neutrality

The main reason that telecom companies are unable to ensure higher profits is essentially a pricing problem and the answer would lie in using price discrimination and charging higher for data.

Airtel claims that its revenues are falling due to free internet based services like Skype and Viber. It feels that it is missing out on its share of the pie as people can call each other for no charge using their data packages. To grab their ‘fair’ share, they want to charge the internet companies for allowing their service through their networks. This is a critical blow to net neutrality. However, if they are truly worried about their profits, they can instead resort to pricing their data services higher by using price discrimination.

The new plan proposed by the TRAI backed by Airtel and co. is trying to create a scenario where producers are given preferential treatment. The plan proposes that sellers can pay the internet service providers to ensure that their products get priority over other products. In essence, the data packets that come from their servers should be given precedence over the data packets coming from their competitors. It is this that has been driving the internet activists over the wall, as it breaks the quintessential property of the internet: that of being neutral. Lots of other writers have spoken about how the absence of net-neutrality will throttle small start ups. Others have addressed this issue in terms of the detrimental effects on our national interest. Most of them, though, take issue with the impingement on their personal liberty. If my service provider makes a deal with a company, agreeing to prioritize its data compared to its competitors, I am being robbed of my choice. The prioritization by the service provider is making a choice on my behalf.

The main reason that is given for pushing discriminatory internet services is that the revenues of the telcos are falling: they have previously invested a lot in buying spectrum, investing in infrastructure, etc, but are finding that their main voice and messaging services are being replaced by internet companies who offer the same services for free through the telcos’ infrastructure.

The numbers on the balance sheets of the telcos suggest that the revenues are far from falling. It has seen steady growth in the past few years and what’s more, there is ample scope for them to tap into the ever growing market of mobile internet users. Then, we can assume that they are normal companies wanting more profits through vertical collusion and cartelization. The reason they have not been able to profit as much as they want from the data services that they provide is essentially a pricing problem. If they felt that the internet services like Skype or Whatsapp were free riding on their data, they can easily increase the amount they charge for data. The reason that the telcos are not increasing their prices is perhaps because of the competition between themselves. Despite the market having few sellers, they face an elastic demand curve, where the slightest increase in prices will drive users to other competitors. This is basic market mechanics based on the Bertrand model of competition.

SECOND DEGREE PRICE DISCRIMINATION

The telcos can practice a form of reverse second degree price discrimination. Price discrimination is a concept in economics which refers to the act of charging different prices for similar or same goods to different consumers. There are various types of price discrimination that is followed in the market – based on geographical location, based on income elasticity of demand, based on the quantity bought and so on. When the price charged is based on the quantity bought, it is known as second degree price discrimination. It basically refers to the discount one gets with bulk purchases. However, the telcos can practice reverse second-degree price discrimination, where they charge lower prices for lesser usage and a progressively higher price for large data consumption.

This will ensure that VoIP services, which uses a lot more data is charged higher, as against text only messaging services. This scheme is still neutral in the sense that differential rates are being applied based on quantity and not on type of service. However, the solution of a blanket ban on prioritizing certain services might reduce economic freedom of the consumer. If service based discrimination has to be made, the choice has to be with the consumer. If a person runs his business solely based on international VoIP calls and doesn’t mind paying extra for ensuring reliability and speed, he should be able to access that privilege. Or, for that matter, a Facebook or Twitter addict who wants these apps to be quick such that they can post real time selfies, should be able to choose these apps over say, apps which give real time updates on political happening in Nicaragua. Thus, people can be given a choice as to which data packets have to be prioritized within their limited bandwidth. This will ensure that there is a high degree of net-neutrality, while ensuring economic freedom to the individual consumer.

Anupam Manur is a Policy Analyst at Takshashila Institution and can be reached on Twitter @anupammanur

 

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