Estimating the Price of Internet Services.

The Internet Market:-

The Internet Market Players
The key players in the internet market includes the Suppliers (Operators), the Consumers (Users) and
the Regulators. The suppliers are mainly Telco Operators with infrastructure to uy and resale
international andwidth and redistriute it to the local consumers ! the internet users. The Regulator is
mandated to ensure that there is a le"el playing field etween the competing suppliers and that the
users# interests are not compromised.
($alrand %&&') gi"es a diagram that shows how these three players inter(relate across the Operators
)etwork as shown elow*
(+ig. ,)
The users purchase (-emand) internet ser"ices from the internet Ser"ice .ro"iders at gi"en .rices.
The Re"enue accrued is then used to in"est in the Operators network y way of e/pansion. This is
ecause the more users a particular network has, the more congestion that network is likely to suffer (
resulting in degraded 0uality of ser"ice (1oS). 2 ser"ice pro"ider who fails to address the capacity or
0uality of ser"ice issues is likely to lose the users to competition.
($alrand %&&')clearly captures these closed looped interactions and goes further to identify their
respecti"e knowledge domains as 3conomic, Regulatory and Technological. She argues that the
performance of communication networks (1oS) has een studied e/tensi"ely ut with little regard to
how this is links into the 3conomic and the Regulatory layers.
(Courcouetis 4 $eer %&&5) had earlier made a similar oser"ation when they said that traditional
engineers often de"elop communication ser"ices without reference to how they should e priced. They
howe"er argued that .ricing and Competition issues are worthy of study, ecause*
( pricing affects how service is provided, and how resource is consumed
( pricing mechanism pro"ides incentives to control performance and increase staility
( pricing mechanism allows more flexible ser"ice and efficient resource usage
( Competition and regulation issues are important especially for control of bottleneck resource
The ackground and fundamental principles necessary to model the pricing of communication ser"ices
is largely orrowed from these two sources and is summari6ed elow. This knowledge scope will
pro"ide the 7ustification for the e"entual group of "ariales ! conceptual framework ( that will then e
adopted and simulated using the System -ynamics framework.
The Market Player Objectives.
Typically, the Operators aim to increase or ma/imi6e their 8Supplier Surplus9 that is their .rofit !
su7ect to their )etwork Capacities.
Supplier Surplus = Revenue Cost of Supply, where
Re"enue : Unit .rice / 1uantity of (/) amount of Ser"ices Consumed
Cost of Supply : Cost of Supplying (/) amount of Ser"ices.
The Users aim to increase or ma/imi6e their 8Consumer Surplus9 that is their )et ;enefit ! su7ect to
their udgetory constraints.
Consumer Surplus = Utility Market rice where
Utility : the unit price users is willing to pay for the ser"ice
<arket .rice : the actual price of the ser"ice offered in the market.
The Regulator aims to increase or ma/imi6e the 8Social Surplus9 that is the total enefit for oth the
consumers and suppliers in the market.
Social Surplus = Supplier Surplus ! Consumer Surplus"
The Internet Market Structure.
The main commodity in the internet market is =nternet ;andwidth. Typcially, a supplier would
purchase the andwidth in ulk from international markets (in 3urope>US) and resale in the local
market ! under the traditional Wholesaler->Retailer->Consumer market structure. The wholesale
andwidth supplier is known as the =nternet ?ateway .ro"ider (=?.), while the retail andwidth
pro"ider is known as the =nternet Ser"ice .ro"ider (=S.), who interconnects with the consumer or users
to the internet.
=n the early, %&&&s this market structure was strictly demarcated along the $holesale>Retail>Consumer
paradigm and the wholesale =?. were not allowed to play in the retail =S. markets and "ice("ersa.
Currently howe"er, the international and local practice y regulators is to pro"ide the so called
8con"erged9 license regime that allows an Operator to e oth a wholesaler and retailer of internet
andwidth
Market Tyes
Costas Courcouetis, Richard $eer(%&&5) says that the final internet price offered in the market
depends on two things ! the market type and the o7ecti"e of the price setter. The three market types
are <onopoly, .erfect Competition and Oligopoly.
.rior to the turn of the century, most operators were go"ernment monopolies ( wherey only one
operator was allowed to operate within a gi"en national economy. The current and international trend is
towards perfect competition en"ironments where many operators are encouraged to play in the internet
market and none is dominant enough to control prices. @owe"er, due to the high capital in"estment
nature of the telecommunication markets, most national economies e/hiit oligopoly types of
telecommunication markets ! wherey only two to three players are operating or ecome dominant in
the market.
Rationale !or Settin" the Internet Price
The <arket, Supplier and the Regulator are the three entities that can set prices of the internet ser"ice !
with the Consumer eing ale to only respond to the same. The tale elow summari6es the price
o7ecti"es of these entities within different market conditions.
The Market settin" the Price
The tale elow shows the o7ecti"e of price setting within a free, open and competiti"e market
en"ironment.
Price
Setter#
-Per!ect
Market
Market Tye Price Objectives Constraint
.erfect
Competition
.rice gra"itates towards an
e0uilirium "alue, where
the supply meets demand
Su7ect to User uptake or
.rice elasticity (Supply 4
-emand dynamcs)
Su7ect to <arket +ailure*(
)etwork 3/ternalities
Su7ect to )etwork
Capacities 4 <arginal Costs
=n situations where there are many suppliers and many users (.erfect Competition), the price of goods
and ser"ices will tend towards a "alue that is the most efficient in terms of cost of production and user
uptake or utility. ;asically, each supplier will offer a price to the user and await the user#s response in
terms of uptake of the internet ser"ice.
The price the supplier offers takes into consideration the cost of producing that ser"ice as well as the
profit margin anticipated.
Supplier rofit#Surplus= $x% &C$x% where
.(/) is the unit price offered for the ser"ice of 0uantity /
C(/) the unit costs for producing the ser"ice amounting to / 0uantities
The .rice, . offered must e/ceed the Cost, C of production for the Supplier to remain profitale and
stay in usiness. The amount of 0uantities, / taken up y the users depends on the user#s "alue or
utility for the ser"ice and the price offered.
$hereas the supplier aims to ma/imi6e profits, the user aims to ma/imi6e his net enefit or surplus.
User Surplus = U$x% $x% where
U(/) is the user#s utility or the unit price he is willing to pay for / amount of the ser"ice.
.(/) is the unit price offered for the ser"ice of 0uantity /
The supplierAs o7ecti"e is to ma/imi6e the profit and the userAs o7ecti"e to ma/imi6e his surplus is in
constant conflict such that an initial price offered y a supplier will generate a demand response (ased
on price elasticity) that informs or signals the supplier to either increase or decrease the price offer. =f
the initial price was too high, the users will refuse to participate in the market since the price will
e/ceed their utility. The supplier will therefore e left with goods or supplies that no one is consuming
and he will immediately try to entice or stimulate usage y way of reducing prices. This eha"iour
e"entually leads to a stale price "alue known as the e0uilirium price where the supply is e0ual to the
demand ! a market clearance situation.
=n a perfectly competiti"e market, the price arri"ed at is therefore determined y the laws of supply and
demand ( with competing suppliers aiming at ma/imi6ing their profits y dri"ing down their cost of
production rather than y attempting to increase their prices. Recalling
Supplier rofit#Surplus= $x% &C$x%
=t is e"ident that that if .rice, . is constant and the lowest possile since no supplier wants to lose the
market to the competitor through a higher price, then the only way profit can e ma/imi6ed is y
reducing the costs of production, C. =nno"ation, efficiency, high producti"ity, 6ero tolerance to wastage
thus ecomes the hallmark of a supplier operating in a free, open and competiti"e market. Similarly,
the user also enefits since recalling that*
User Surplus : U(/) ! .(/)
?i"en a fi/ed utility, U, the continued dropping of .rice, . results in the increase of the user enefit or
surplus.
Rationale !or mo$elin" Per!ectly Cometitive Market
2 perfectly competiti"e market is therefore a Regulator#s dream come true since it is the answer to the
regulatory o7ecti"e of ma/imi6ing the Social Surplus ( namely ma/imi6ing oth the Suppliers profit
and the Users Surplus.
Social Surplus = Supplier Surplus ! Consumer Surplus
2 perfectly competiti"e market automatically arri"es at this regulatory solution without any
inter"ention and purely under market dynamics of supply and demand. $hereas a perfect market is
theoretical and rarely e/ists in practice, the initial simulated system dynamics model will assume the
internet market in Benya is perfectly competiti"e in order to map out the ideal situation. Suse0uently,
the initial model will e tweaked to pro"ide e/temded models that reflect and match the realities of the
market.
The Sulier%Oerator Settin" the Price
The tale elow shows the o7ecti"es and market conditions that influence the pricing decisions of a an
Operator in the market.
Price
Setter#
-Sulier
Market Tye Price
Objectives
Constraint
<onopoly <a/imise
.rofit>Surplus
Su7ect to Regulatory pressure and
)etwork Capacities
Oligopoly <a/imise
.rofit>Surplus
Su7ect to Regulatory pressure and
)etwork Capacities
.erfect <arket>
Competition
<a/imise
.rofit>Surplus
Supply 4 -emand dynamics
<arginal Costs
Tale ,
2 supplier en7oying the enefit of a monopoly may select prices that ma/imi6e profits without due
regard to the user enefits. 2 monopolistic supplier does not face the risk of losing customers who
would otherwise go for the ser"ice to another supplier. 2 monopolistic supplier will therefore tend to
e/ploit consumers y setting a 8take(it9 or 8lea"e(it9 high price that leads to fewer ut high paying
customers participating in the consumption of the ser"ice. 2 monopoly therefore re0uires the
inter"ention of a regulator to moderate the price offered with a "iew to ensuring a fair price that allows
more users to participate in the ser"ice ! hence increasing oth the user and the supplier surplus.
2n oligopoly market is one ha"ing limited suppliers and limited regulatory inter"entions. The supplier
o7ecti"es remain the same ! that of ma/imi6ing profit. @owe"er, gi"en the limited competition, the
risk e/ists that the suppliers may collude and defeat competiti"e pressures y setting negotiated prices
designed to ser"e only supplier ut not user interests. This form of situation creates cartels in the
market that the regulator should e aware of. Typically, the Regulator would identify cartel pricing and
often inter"enes y setting .rice(caps for the market. 2 .rice(cap is a ceiling price calculated y the
regulator and enforced in the market such that suppliers may not charge ser"ices eyond it.
Mo$el to estimate Internet Price.
@ow can Regulators estalish the fair price for charging internet ser"icesC @ow can regulators deal
with the issue of Users claiming on one hand that they are o"er charged and the Operators on the other
hand claiming that their prices are competiti"e and fairC 1ian 4 Rouskas (%&,&) attempt to answer this
0uestion y using oth the economic and the game theories.
Using the economic theory of supply and demand, 1ian 4 Rouskas (%&,&) estimated the Cost, C of
producing and distriuting andwidth. They also estimate the Utility or willingness of Users to pay for
the andwidth using the .areto -istriution function. This proaility distriution function has
estimates for the Utility function ased on different types of andwidth Usage.
Utility, U(/) : D E /F G
where oth Hamda 4 ?amma are selected to match =nternet Usage eha"iour of some 2merican
market.
Hamda D : I
?amma G: &.J
/ : the andwidth under use
The "alues for Benya will re0uire an analysis of the =nternet User eha"iour of the Benyan internet
market in terms of what amount of minimum and ma/imum andwidth Benyans are demanding and
their corresponding fre0uencies.
Cost, C(/) : KE/
where
.ico K : &.&J
/ : the andwidth under use.
@a"ing known the Utility and the Cost functions, the Regulator can then estimate the Social Surplus for
each category of andwidth used.
The e/pected functions would follow the pattern elow.
Social surplus, User Surplus and Operator Surplus as from 1ian 4 Rouskas (%&,&) ao"e.
&ar"ain Po'er.
Once the Social Surplus is estimated,the Regulator can then use game(theory which is that ranch of
decision theory that descries mathematically how decisions are made in situation of conflicting
o7ecti"es etween two or more players.
$here
L, : the User Surplus
L% : Operator Surplus
U:User Utility>"alue for M andwidth
C:Cost of proding M andwidth of =nternet ser"ice
., :.rice User pays for Ser"ices
.% : .rice Operator recei"es for Ser"ice
.(high) : @ighest .rice user willing to pay for M andwidth of ser"ice
.(low) : Howest .rice Operator is willing to accept to pro"ide the ser"ice.
?: ?ap etween what User .ays (.,) and what Operator Recei"es (.%)(the transaction cost.
=n a simplified case where the the transaction cost, ? is 6ero, then the .rice, ., paid y the User the the
same as .rice, .% recei"ed y the Operator. ;oth players, User and Operator will eande"our to
ma/imi6e their surplus ased on their argaining power, ;. The argaining power is the relati"e aility
of each player to influence the setting of prices.
Het the User argaining power e ;, where &N;N:,, and the Operator argaining power will e (,(;)
=n other words, when User argaining power is ,, (ma/imi6ed) then the Operator argaining power will
e minimi6ed i.e. (,(;:&) and "ice "ersa. This ;argain situation will mathematically define the market
situations of <onopoly, Oligopoly and in .erfect Competition =.e
<onopoly, ;:&, User has no argaining power. Operator ma/imi6es his Surplus
Oligopoly, ;: &.J, oth User and Operator share argaining power, oth share the Social Surplus
.erfect Competition, ;:,, User has full argaining power, and ma/imi6e his Surplus.
Since oth players (User and Operator) are trying to ma/imi6e their surplus, the prolem ecomes one
of optimi6ation i.e. how to estalish a price that increases or lea"es oth of them happy ! gi"en certain
conditions such as the cost of pro"iding ser"ices (Cost C)and the capacity or willingness of the users to
pay for these ser"ices (Utility, U)
This prolem was sol"ed y the mathematician O+ )ash (,IJ&) who formulated the prolem as
<a/imi6e the )ash .roduct, ): L,F(;) E L% F(,(;) su7ect to the constraints

L, PL% N: U(C(?
L, Q:U(.(high)
L%Q:.(low)( C
$ith the optimum price eing descried elow.
3ssentially, the .rice .,, paid y the User is gi"en y the e0uation
.,:(,(;)U P ;(CP?)
and .rice .%, recei"ed y the Operator is gi"en y the e0uation
.%:(,(;)(U(?) P ;C
=n cases where the transaction cost, ?, is put to Rero (for simplicity) then the Optimal price charged
would e*
.: .,:.% : (,(;)UP;C.
$here
; is the ;argaining .ower of the User,
U is the Utility of the User for M amount of ;andwidth
C is the Cost of .ro"iding the M amount of ;andwidth
Results#
2pplying data from an 2merican market (San -iego =nternet 3/change point, %&,&), the following
Optimal .rice "alues were calculated as eing the Optimi6ed .rices for =nternet Ser"ices.
?raphically
Same data interpolated for the Benyan <arket.
Estimated Price per Bundle/Tier
x(GB) 5.00 6.00 7.00 8.00 9.00 10.00
Utility(Ksh) 1195.65 1458.15 1710.48 1954.06 2189.99 2419.14
Cost(Ksh) 21.25 25.50 29.75 34.00 38.25 42.50
Social Su!lus(Ksh) 1174.40 1432.65 1680.73 1920.06 2151.74 2376.64
"ic#$ " (%o&o!oly) 1195.65 1458.15 1710.48 1954.06 2189.99 2419.14
"ic#$" (Co'!#titio&) 21.25 25.50 29.75 34.00 38.25 42.50
"ic#$ "((li)o!oly) 608.45 741.82 870.11 994.03 1114.12 1230.82
4.00 5.00 6.00 7.00 8.00 9.00 10.00 11.00
0.00
500.00
1000.00
1500.00
2000.00
2500.00
3000.00
*sti'at#+ "ic# !# Bu&+l#,-i# o. GB
Utility(Ksh)
Cost(Ksh)
"ic#$ " (%o&o!oly)
"ic#$" (Co'!#titio&)
"ic#$ "((li)o!oly)
Ba&+/i+th (GB)
K
s
h
Conclusion.
This presentation, introduces regulators to mechanisms of calculating the optimi6ed prices that are
e/pected to e at play in a the "arious market en"ironments (<onopoly, Oligopoly or .erfect
Competition). The work is still in progress with the aim of using actual Benyan data within the
mathematical formulations and e/tending the solution to cater for simulated impact of the "arious
prices on multiple market "ariales such as ;andwidth Capacities, Operator Re"enues and =nternet
.enetration.
Estimated Price per Bundle/Tier
x(GB) 1.00 2.00 3.00 4.00 5.00 6.00
Utility(Ksh) 0.00 325.68 632.19 921.15 1195.65 1458.15
Cost(Ksh) 4.25 8.50 12.75 17.00 21.25 25.50
Social Surplus(Ksh) 04.25 317.18 619.44 904.15 1174.40 1432.65
Price, P (onopoly) 0.00 325.68 632.19 921.15 1195.65 1458.15
Price,P (Competition) 4.25 8.50 12.75 17.00 21.25 25.50
Price, P(!li"opoly) 2.13 167.09 322.47 469.08 608.45 741.82
0.00 1.00 2.00 3.00 4.00 5.00 6.00 7.00
0.00
200.00
400.00
600.00
800.00
1000.00
1200.00
1400.00
1600.00
*sti'at#+ "ic# !# Bu&+l#,-i# o. GB
sub-title
Utility(Ksh)
Cost(Ksh)
"ic#$ " (%o&o!oly)
"ic#$" (Co'!#titio&)
"ic#$ "((li)o!oly)
Ba&+/i+th (GB)
K
s
h