Walking around U.S. cities, one is amazed at how many mobile phone stores occupy the most expensive retail space. How can Sprint, T-Mobile, AT&T, and Verizon afford to waste so much money on retail stores? Wouldn’t they be better off using the money to add some towers to provide more coverage, e.g., at the JFK airport?
The most thought-provoking economics book of recent times, A Farewell to Alms, has an answer to this on page 288:
The increasing returns to scale inherent in most modern production processes imply that for the typical transaction the price is much greater than the marginal cost … That means that modern markets for industrial products … are imperfectly competitive. … The difference between price and marginal cost means that producers have an incentive to spend resources in trying to sell more product at the current price, through trying to get customers to choose their products rather than the nearly identical products of their competitors. Selling is a huge part of modern economies…
Mobile phone service is the ultimate in discrepancy between marginal cost and price. The cost of serving one additional user on an existing network is just about zero; the price collected from that user is $50 per month.
This is the least interesting insight from the book, but it is one of the simplest to relate in a Weblog.
Hi Phil,
I am from Bangalore and now in London from last two months. I notice considerable mobile usage in both locations compared to India because of free incoming and low cost out going calls. The coverage is good even in rural areas of India. Ten years back, I have to call another village to pass information, now my family has four mobile and three land lines. I was in Holland Michigan and hardly people use mobile phones.
sam
“Mobile phone service is the ultimate in discrepancy between marginal cost and price. The cost of serving one additional user on an existing network is just about zero; the price collected from that user is $50 per month.”
The question which is hard to answer is: how much of that extra $50 in profits is the result of decreased quality and dropped calls for the initial users?
I see the same phenomenon in my fitness club, they spend much more resources selling new memberships, than they do keeping the club in good order.
This is what a service economy is. Use bodies instead of manufacturing to generate revenue and GDP. Yes. It scales very poorly and it makes you poor. What part of that did people not understand when everyone was OK with getting rid of manufacturing capacity in this country?
Phil,
Another industry that might match if not exceed the price to marginal cost is Big Cola.
Poor cell phone providers have been around for only a few decades now. They might have to put a cellphone into all the 6 odd billion people on earth, to make the kind of profits Coca-Cola and Pepsi have made all these decades.
It’s bordering on inhuman to let these corporate sharks set foot and operate in developing countries, selling their own water to them adding color and chemicals in a fancy bottle. Even the West laps it all up as if avoidance would lead to a coke deficiency.
With production costs bordering on a few cents per bottle, is selling cola at dollar fifty prices justified? Forget about looting developing countries. They have created so much plastic trash even in developed countries, and conveniently shirk the responsibility of recycling it. This would make a perfect case study on how to avoid corporate responsibility.
Everybody is all out against Big Tobacco and Big Oil.. no takers for Cola?
Swaroop, maybe if people have a hard time affording cola they should refrain from buying it.
Sometimes I look around and I say “Yikes! The people who love high school activities grow up and run the world. Everything is organizing and promotion and publicity.” Now we learn that some of the less-popular kids became economists and explain the high promotional effort by “low marginal cost.”
Maybe some of these things come and go. Cell phone service gets cheaper and for those who don’t chat too much there are prepaid plans in the range of about $100 per year (e. g., Virgin Mobile, T-Mobile). As basic service becomes a commodity, maybe some of the pricey sales effort will drain away. The economists will have a phrase for that, too.
In the 1950s, my working-class parents always preached a world-view of abundance. Making stuff was easy, the key person was the one who could sell things. It seems to me that the computer and high-tech world (and cheap Asian labor) has given us some relief from that. The products are amazing and prices fall. We want the stuff. I need a computer so I can read Phil’s blog! A few stores can move mountains of gadgets.
Cell phones are the exception that proves the rule. Billions are paid to buy bandwidth and build antennas. They need to be sure we buy! When we are saturated with mobile data, some of the stores will close.
Do you know, there used to be competing department stores that spent money every day to hawk ladies underwear in the daily papers? People joked about it. But the lingerie ads paid for freedom of the press. They were a pillar of democracy. Now all the stores are Macy’s. Maybe cell phone ads take up some of the slack. We hope.
Jim Worthey said: “As basic service becomes a commodity, maybe some of the pricey sales effort will drain away. ”
Interesting. How do you explain the recent letter I received from AT&T Mobility informing me that I will soon be paying about 15% more for my monthly service? Guess that they don’t know that they’ra a commodity.
Phil,
This is an interesting perspective with some truth to it. On the other hand, perhaps you have not noticed such branch offices packed at lunch time, evenings, and weekends with people seeking to solve technical problems, understand rate plans, switch providers, pick out phones with their kids, etc. All such business speaks to the good judgment of having stores in prime locations near where people live and work.
An interesting sidenote: the reference to “imperfect competition” ties back to Frank Knight, founder of the Chicago School of Economics and enthusiastic Christian philosopher. Knight started with a Platonic archetype for competition, i.e., a mental model that utterly evaded every facet of actual humans engaged in actual trade.
In his view, “’perfect’ competition had the following characteristics: Everyone is omniscient concerning all economic opportunities, all factors of production are infinitely mobile and infinitely divisible, every market contains an infinite number of buyers and sellers, no one has any ‘sentimental’ (i.e., non pecuniary) interest in anyone else, all the products of competing firms are identical and no innovation occurs in any field” (Ridpath, 1983).
In Knight’s ‘perfect’ world, no company would be able to make a profit beyond costs + interest return on capital. If one does, there is a flaw somewhere and the result is “pure profit” which is allegedly bad for society. Knight openly acknowledged his model does not correspond to reality: “All economic theory…is purely abstract and formal, without content.” But his models grew legs (the term ‘perfect’ had a moral attraction) and helped expand anti-trust laws: competition isn’t properly success and failure based on actions and consequences, risk and reward, but rather everything somehow coming out so no company is dominant in any field. His models laid the groundwork for the view that high profits are prima facie evidence of anti-competitive behavior that should be criminalized.