How ISPs Cost Average Their Plans

I’m a “Regular” over at the Whirlpool discussion forums.  That particular Whirlpool site has nothing to do with washing machines, instead devoted to broadband, the Internet and related technologies.  All areas that I share an interest in with the other ne’er-do-wells you’ll find there.  So I thought I’d devote this, my very first blog entry, to talking about how Internet Service Providers (ISPs) in Australia structure their plans using a cost average model.

I don’t work for an Internet company, but below is what I understand to be the basic methodology.  Imagine an ISP of 10 subscribers with the following typical downloading habits:

A 0.5 GB
B 1 GB
C 2 GB
D 0.5 GB
E 2 GB
F 3 GB
G 1 GB
H 15 GB
I 17 GB
J 20 GB
total 62 GB
average 6.2 GB

An ISP incurs many monthly costs, not the least of which is bandwidth.  Note that ISPs don’t buy blocks of data in the same sense that you or I might.  ISPs buy (or more accurately rent) bandwidth.  That is, they own the stream but sell you the bucket.  62GB total per month from the table above equates to roughly (62x8x1000000/(30x24x60x60)=191kbps.  So let’s say, in this example, that the imaginary ISP rents a 200kbps stream from a bandwidth wholesaler at a rate of \$250 per month.  Break that \$250 down between 10 customers, using an average of 6.2GB a month, and you can see that it works out to approximately 250/(10*6.2)=\$4.03 per GB per customer per month.

Of course the ISP has other expenses associated with running a business such as tax, salaries, commercial rent and so on.  Not to mention the desire to incorporate some sort of profit margin at the end of the day.  For the purposes of this example we will say that it costs the ISP \$4.50 per GB per customer per month to retail data and make an honest living.

We now have enough data to develop a cost averaged plan.  Since \$4.50×6.2GB=\$27.90, and the ISP’s heaviest user requires 20GB per month, all of the subscribers will comfortably fit into a theoretical “20:30” Plan… 20GB allocation per month (beyond which their ADSL speed is “shaped” down to dial-up speed) for \$30 per month.  The first thing you’ll notice is how this distorts the figures.  On paper it looks like the ISP’s subscribers are only paying \$30/20GB=\$1.50 per GB of data, even though in reality it is costing three times as much.  The second thing you’ll notice is that this is only made possible by a large proportion of customers utilising only a small proportion of their quota.

All the prices and usage quoted above were completely made up for illustrative purposes.  And I’m sure things are much more complicated in the real world.  But I hope you now get the basic idea behind cost averaged plan structures.

By definition, a cost averaged plan always results in winners and losers.

In my example it is clear the extent to which the relatively light users (i.e. Customers A to G) are disadvantaged by such a plan.  They are disproportionally subsidising the minority of heavy users (Customers H, I & J).  Had the imaginary ISP charged everyone the flat \$4.50 per GB fee calculated above, the most a light user would have to pay (Customer F) is 3GBx\$4.50=\$13.50 per month.  Less than half the amount being charged under the cost averaged model.  The heavy users of course would be significantly worse off.  However, in fairness they would only be paying for what they used.  The ISP would still make the same profit.

Cost averaged plans are inequitable.  I believe it is unfair that a majority of light users are being asked to subsidise the heavy downloading habits of a minority.  I also believe that in the long term cost averaged plans are unsustainable.  As more people utilise more data rich elements of the Internet (such as streaming video) more of the time the cost averaging model has to eventually break down.

So why do ISPs do it?

The only explanation offered to date for operating under such a model is that people don’t want to be faced with massive bills that could ensue from a fixed rate unlimited plan.  Fair enough too.  Especially when you’re talking about ADSL2+ speeds at \$3-\$5 per GB.  With this in mind a possible solution would be to offer a flat fixed rate per GB plan with an optional “maximum monthly spend” limit.  Under this option you could elect to be shaped beyond a dollar limit (\$100 in a month for example) rather than a data limit.  Such a system would be fair, equitable, transparent, flexible and safe for all customers.  And still profitable for the ISP.

And then everybody is a winner.