IP Democracy: Free Market Economics 101 Courtesy of Verizon

Last week’s bit of nastiness for Verizon and BellSouth over their DSL “surcharges,” which are nothing more than relabeled USF fees, gets an airing at Business Week online. But given that BellSouth caved almost immediately in the face of FCC Chairman Kevin Martin’s anger, the piece focuses on Verizon, which, to date, hasn’t backed down on its surcharge.

To recap: the telcos formerly had to pay into a universal service fund (USF) to subsidize telecommunications in rural areas based on some portion of their voice and DSL revenues. The FCC eliminated the USF contribution for DSL, which the phone companies had passed on directly to consumers as a regulatory fee. But rather than cutting consumers’ bills, Verizon is continuing to charge all DSL customers an additional $2.70 or so per month, the amount of the former USF fee, in its newly reconstituted surcharge.

Here’s Verizon’s explanation about why it will continue to charge customers the additional amount — it’s a long explanation but read it carefully:

The company says it would have raised prices if it hadn’t gotten the regulatory relief, so the elimination of the USF fees lets it keep prices pretty much unchanged. Verizon prices DSL service competitively, hoping to recoup costs with other products, such as phone and TV services, says spokesman Eric Rabe. Verizon profits more from customers who subscribe to two or more of its services because each additional connection only adds marginally to the cost of supplying an original phone line.

SPREADING THE PAIN. The trouble is, many customers are opting for “naked” DSL, or standalone broadband. “The revenue from phone service helps pay for that DSL line,” says Rabe. “That revenue goes away when a DSL customer decides that they just want a cell phone (and disconnects their phone service). Now we have all of that cost for that line only offset by the DSL service.”

So Verizon opted to spread the added cost of the DSL-only subscribers over the entire Internet customer base by appending a monthly fee of up to $2.70 to all Internet customers’ bills, even those who also buy phone or television service through Verizon. “We didn’t want to make DSL service for those who don’t take phone lines prohibitively expensive,” Rabe explains. In other words, Verizon didn’t want to lose customers to cable services such as Time Warner’s RoadRunner (TWX ) by making it extra expensive to subscribe to only to its Internet service.

I read and re-read this explanation and it took me a while to figure out what’s wrong with it. Here’s why Verizon’s explanation is a bunch of ca-ca: By forcing all of its DSL customers to pay higher rates in order to keep the DSL-only customers on board, Verizon is making its best customers subsidize its worst customers.

In other words, Verizon is artificially keeping prices high for its triple-play customers and artificially keeping prices low for its DSL-only customers (by artificial I mean not these prices are not justified by the underlying cost structure). Under this scenario, Verizon may be keeping its DSL-only customers happier but it’s risking, to some degree, defection of its triple-play customers, or, at the minimum, isn’t offering its voice-video-data customers an additional reason to stick around.

So, Verizon contends that it must charge all DSL customers the USF equivalent fee so that it doesn’t lose some or all of its $25/month customers. (How many of those can there be, anyway?) Meanwhile, customers who buy bundles worth $125 or more per month are, well, screwed.

This makes no sense whatsoever — why would Verizon tilt pricing incentives toward its least lucrative service offering? My guess is that Verizon knows that its rationale is bunk.

The real reason Verizon is hanging onto the surcharge for everybody is because its DSL customers are already accustomed to paying it. At $2.70/month for 6.1 million high-speed subscribers (as of Q2 06), Verizon is gaining a windfall of $197.6 million per year.

The best part: the telco doesn’t have to do anything, nor does it risk anything, to get this money. Few, if any, customers will complain, particularly given that their bills won’t go up.

Posted by Cynthia Brumfield on August 29, 2006 3:24 PM to IP Democracy