Message: 44
Date: 2.1.97
From: <nicholas@media.mit.edu>
To: <lr@wired.com>

Pay Whom Per What When, Part I

When you fly your dog across the Atlantic, you pay a fixed fee. By contrast, inter-European airfare is determined by your dog's weight. Now, imagine that you couldn't buy an individual airline ticket for yourself or your dog. Instead, suppose airlines offered an annual pass that covered an unlimited number of flights. Or, imagine that you could buy individual tickets and the price was determined by your weight.

Americans can't seem to comprehend the British National Health Service, yet they pine for the simplicity of Steve Forbes's flat tax. We hold strong if seldom consistent views on how we should pay for things.

The digital world has created an opportunity to totally rethink billing methods. In turn, we will be forced to revisit the fundamental concepts supporting service cost and customer value. Most debates today on whether and how the Internet should be tariffed are mere reruns of debates that already have been played out in the world of atoms. Tomorrow's debates will be different. They will focus on issues unique to the world of bits. Unlike atoms, bits aren't consumed by consumers. They can regenerate - infinitely.

Subscribing to subscription
During the next few years, we will witness an explosion of payment methods. Yet, unlike the 40-odd calling plans offered by your cellular telephone provider today, payment plans will combine two principal ideas: flat fee and pay-for-use. Neither of these is superior to the other, but we'll see innovation in both.

The mind-set of most netizens, both consumers and service providers, supports a flat fee - a fact the European telcos still don't understand. But the digerati are at fault as well for not recognizing the rush toward pay-for-use. Both can, and will, benefit the consumer.

From the consumer's point of view, there are two apparently contradictory arguments in support of flat fees: certainty and serendipity. People like to know in advance what something will cost, even if the flat fee results in a cost that may be higher than they would have paid "by the meter." Also, people want to browse, window shop, or find some unexpected treasure without the sound of a meter ticking.

From the seller's point of view, flat rates offer even greater advantages. First, cost savings. Fifty percent of the price of a phone call covers billing - the cost of a call is cut in half right away by changing billing rates to a flat fee. Second, the relative certainty of income. The cost of a magazine subscription - typically much less than the price of a year's worth of newsstand issues - serves as an excellent example. The information provider is guaranteed a certain amount in sales and, further, gets paid in advance - both of which help cash flow. The more the provider has to invest in advance of sales, the better this appears.

Marginal marginal costs
The flat-fee concept is particularly desirable when marginal costs to the supplier remain, well, marginal. Europeans are astonished by the American practice of refilling the customer's coffee cup for free - try that on the Piazza San Marco or Champs-Élysées. Yet the marginal cost of an extra cup of coffee is low, making the practice well worth the price, given the possibility of attracting new customers - even those who don't drink the extra coffee. In the world of bits, marginal costs are often indistinguishable from no cost. Once a user consumes a few bits, why not let him or her have a few more for free? What if the marginal cost to a supplier, who offers increased use, was actually negative? The increasing incidence of advertising on the Net makes this a growing possibility, so much so that I predict within three years few people will pay their local ISP for Internet access, and potential high-value customers will be paid to surf.

Digital dumping
Japan consistently has been accused of dumping, whether it's supercomputers or semiconductors. The complaint results from the allegedly predatory practice of taking huge losses until the competition is obliterated, at which point a completely monopolistic position can be taken resulting in exorbitant fees. American trade associations cry foul. Congress is never far behind.

Yet Netscape emerged and gave its browser away for free. Now, with 70 percent of the world's market share, the company charges US$49 and up per copy. Not a peep from anyone. Is this because Americans whine about dumping only until we do it successfully? No. It's because there is an unspoken acknowledgment that the rules of trade have changed. Bits aren't sold the same way atoms are sold.

Netscape introduced an entire new class of payment. Instead of a one-off payment for a given capability (x) or a usage-independent subscription (x/t), Netscape pioneered the idea that what you pay for is effectively the rate of change in functionality (dx/dt, for the left-brained).

All forms of usage-independent pricing, however, have their downside. If you use something rarely, why pay a monthly overhead? As someone who drives little, I find the Swiss and Greek systems of annual road fees far less attractive than the French and Italian toll systems where you pay as you go.

Alas, the cost-savings argument of a fixed fee is rapidly disappearing for suppliers. This is due to the falling price of computer cycles and the introduction of new forms of electronic payment, both of which help reduce the cost of transactions to virtually zero. Today it costs a dollar to process a check and 25 cents to handle a credit card transaction. When payment systems cost a penny, the case for fixed-fee quickly erodes.

However, the real driver for pay-for-use is more subtle: it is the opportunity to tie payments more closely to customer value, as discussed in the next issue.

This article results from conversations at CSC Index Vanguard meetings with Richard Pawson (rpawson@csc.com). Pawson, who coauthored much of the text, is director of research for the CSC Index Foundation.

Next Issue: Pay Whom Per What When, Part II

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[Copyright 1997, WIRED Ventures Ltd. All Rights Reserved. Issue 5.02 February 1997.]