Month: December 2009

In the mid-1970s, U.S. telephone companies began adopting metered service pricing for telephone directory assistance.  Previously, unlimited free directory assistance calls were allowed under the flat rate for local telephone service.  The new pricing structure had a fixed allowance of free calls (typically three to five) and a per-call charge for calls above that allowance.

Concern about efficiency and excessive use motivated the pricing change.  Economists reified economic theory: “A principle of welfare economics is that each commodity should have associated with it a price or charge reflective of its marginal social cost.”  “What commodities?” and “How many commodities?” from this perspective are merely issues of number theory.  In practice, that means that a string of words (for example, “directory assistance”) defines a commodity.  If a market doesn’t exist for it, then reason is needed to explain the missing market.[1]  Such an approach utterly lacks appreciation for actual economic ecology.

Uncharged directory assistance service created business problems.  Directory assistance calls had significant marginal cost.  With uncharged directory assistance, high-volume directory-assistance callers created costs that greatly outbalanced the revenue that they provided.  For example,  in the early 1970s a major New York City newspaper used directory assistance as a costless credit check:

our ad takers would call directory assistance to confirm the telephone number provided by the individual placing the ad, and we assumed that if the person had a telephone listing they were paying their monthly bills. It was a quick and easy way to get credit approval on a relatively low-dollar sale amount at no cost to the newspaper.[2]

In fact, residential customers had a directory-assistance call distribution more skewed to high call volumes than did business customers.  Residential customers also were more likely to call directory assistance for numbers that could be found in their local telephone book.[3]  Loneliness, not shrewd business practices, was probably the most important driver of high directory-assistance use.  In any case, as an AT&T manager explained in 1976, “directory assistance cost had become a significant and escalating component of telephone service charges — approximately 50 cents per customer per month in 1974.”[4]

Metered pricing for directory assistance greatly cut service use.  Metered pricing reduced the total volume of directory service calls by about two-thirds in the mid-1970s. Much of this reduction came from among high-volume users.  Before metered pricing, about 89% of directory service calls were calls made above the threshold of three calls per customer per month. With metered pricing in Virginia in 2008, that share was only an estimated 33%.

A more subtle effect of metered pricing was to greatly increase the share of customers who did not use directory service.  In the early 1970s under flat-rate pricing, the share of customers who made no directory assistance calls was 30%. With metered pricing in Virginia in 2008, the share of customers who made no directory assistance calls was 82%.  Customers in Virginia at that time had a monthly allowance of three free directory assistance calls.  Creating a priced service apparently discouraged a large share of customers from using it, even though they could freely do so within their allowance of free calls.[5]

More imaginative consideration of the possible product space might have created a better information business.  Suppose two different directory assistance services were offered.  One would be unlimited directory assistance on a best-effort basis.  It would be included as a free service within flat-rated local telephone service.  By having a fixed number of salaried telephone operators employed for best-effort, free service, the marginal cost of additional free directory assistance calls would be zero to the service provider. The other directory assistance service would be a premium, directory assistance service with a guaranteed response window (service level agreement). It would have a per-call price corresponding to the expected marginal cost of additional operators needed to meet the service level agreement. Both the free service and the premium service would be available to all customers at all times.

The free service/premium service combination might easily have created a better business than the single-service metered pricing.  With single-service metered pricing, only about 5% of customers actually incurred directory assistance charges.[6]  The free service might have retained as directory assistance users the large share of directory assistance users that metered pricing alienated.  The free-service users might in some circumstances convert to premium service and create on average a higher share of charged customers. Moreover, the 5% of customers who actually paid for directory assistance did so only after exhausting their allowance of free calls.  Premium service allows charging a segment of customers for every directory assistance call.  The small share of customers willing to pay for directory assistance might also have been willing to pay for every directory assistance call.

Most importantly, a separate, free, directory assistance service could have served as a testbed for new technologies and new services.  It would have provided a natural space for early offering of non-live-operator services.  Similar, low-cost, free information services could have been offered.  Experiments with advertising could have been tried.  In short, much of what is now happening on the Internet could have grown out of a innovative restructuring of the directory assistance business.

Metered pricing to constrain high-volume users of a flat-rated service is textbook economics. Directory assistance has missed huge business opportunities.  Innovative business development requires thinking beyond what’s in textbooks.

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Data (for U.S.): effects of metered pricing on directory assistance use (Excel version); directory assistance business growth (Excel version).

Notes:

[1] See Daly, George, and Thomas Mayor, “Estimating the Value of a Missing Market: The Economics of Directory Assistance,” Journal of Law and Economics, v. 23 (1980). pp. 147-166.  The first quote in the above paragraph is the first sentence in id.  This line of thinking, which is particularly associated with Harold Demsetz’s work on property rights, has been highly influential among economists.

[2] Kuehn, Richard A., “A $1.5 Billion Niche” Business Communications Review, July 2003, p. 65.  Other evidence indicates that the value of the U.S. directory assistance business in 2003 was about $6 billion.

[3] For a graph of percent of directory assistance calls versus percent of lines (customers) for residences and businesses about 1973, see McDonald, J., “The Use of Management Science in Making a Corporate Policy Decision — Charging for Directory Assistance Service,” Interfaces, v. 7, n. 1, pt. 2, Nov. 1976, p. 9.  Residences had a higher percent of calls than businesses for every level of lines.  Among residential customers, 64% of directory assistance calls were to get telephone numbers listed in the customer’s telephone directory.  The corresponding figure for business customers was 52%.  Calculated from chart in id., p. 8

[4] Id. p. 6.

[5] The data and sources for the statistics in this and the previous paragraph are in the spreadsheet on metered pricing of directory assistance.  The spreadsheet includes additional data consistent with the points made above.

[6] See spreadsheet on metered pricing.

Telephone companies operated the first network-mediated, mass-market information search service.  It’s called directory assistance. Make a telephone call, voice a query, and get back relevant information.

By some narrow metrics, U.S. telephone companies have quite successfully developed this information search business.  Prior to 1974, directory assistance in the U.S. was a freely offered ancillary service to regular telephone service.  At that time, directory assistance had significant marginal cost:  additional human operators were required for additional information lookup and query response.  Telephone company representatives and economists argued that free directory assistance is economically inefficient and unfairly advantages heavy users of directory assistance.[1] Those arguments prevailed.  Directory assistance became a pay-per-use information search business.

The price per call for directory assistance has risen substantially since the mid-1970s and the monthly allowance of free directory-assistance calls has fallen.  Most jurisdictions that established charges for directory assistance in the mid-1970s set a five-call-per-month allowance for free directory-assistance calls. Subsequent calls cost 10 cents or 20 cents per call. Current allowances for free directory-assistance calls generally are lower than five calls per month.  Allowances continue to be reduced.  Recent telephone-company petitions to state regulators successfully reduced the allowance from three calls to two in Virginia, and from three to one in Tennessee.  In 2007, the average charge for a directory-assistance call from a landline phone was $1.28. Hence, adjusting for the rise in the consumer price index, real directory-assistance prices are two to three times higher in 2007 than they were in 1975.  That increase in price is particularly impressive given the shift from human operators to automated systems.  Automated systems undoubtedly provide significant cost savings.[2]

Telephone companies have also successfully removed directory-assistance wholesale service from federal telephone service price caps.  In 1992, regional Bell Operating Companies (RBOCs) reported $209 million in federal price cap revenue for offering directory assistance to other telephone companies at a wholesale price averaging 28 cents per call. Reported directory assistance calls and revenue subsequently fell, with reported directory assistance call volumes falling 5% per year from 1992 to 1996, and  48% per year from 1996 to 2000.  Other industry data indicate that total interlata directory assistance calls were growing about 8% per year from 1992 to 1999, and total directory assistance business revenue was growing about 10% per year in 1994.  By 2009, RBOCs reported almost no directory assistance calls or revenue, while the total value of the retail directory service business for all service providers had grown to roughly $9 billion.[3]  The reported fall in RBOC regulated directory assistance calls and revenue may have come from a shift to automated provision of wholesale directory assistance service.[4] In any case, RBOCs successfully removed in practice directory assistance wholesale service from federal price caps.

Despite telephone companies successes in establishing new charges, raising prices, and escaping regulation, telephone companies failed to develop vitally important business opportunities in information search.  Information search changed from high-marginal cost operator-provided services to low-marginal-cost automated services.[5]  With low-marginal-cost, network-based services, encouraging use of free services can be a valuable way to develop businesses.  Google and others, not telephone companies, have prospered from the development of the information search business.

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Data: U.S. directory assistance service statistics, 1974 to 2009 (Excel version).

Notes:

[1] See McDonald, J., “The Use of Management Science in Making a Corporate Policy Decision — Charging for Directory Assistance Service,” Interfaces, v. 7, n. 1, pt. 2, Nov. 1976; Daly, George and Thomas Mayor, “Estimating the Value of a Missing Market: The Economics of Directory Assistance,” Journal of Law and Economics, v. 23 (1980). pp. 147-166; Zachry, Charles C. Jr, “Usage-Sensitive Pricing for Directory Assistance,” Public Utilities Fortnightly, v. 100, n. 12 (Dec. 8, 1977) p. 23. These works emphasized the value of managerial science and economic analysis.  Introducing charges for directory service reduced the volume of directory assistance calls by about two-thirds.  See Daly and Mayor (1980) p. 155; Zachry (1977) p. 23.

[2] Here are data on the directory assistance prices and free-call allowances established in the mid-1970s and those about 2008.  On June 11, 2008, the Virginia Telecommunications Industry Association petitioned the Virginia State Corporation Commission to eliminate the directory-assistance free call allowance.  The Commission established a docket, issued an order for notice and comment, considered the 21 responding parties’ comments, and issued an order on Dec. 12, 2008.  That order reduced the free-call allowance from three to two per month.  On Jan. 8, 2009, the Tennessee Regulatory Authority (TRA) approved a traiff reducing Embarq’s directory-assistance free-call allowance from three to one (reconsideration denied in TRA order on Apr. 7, 2009). TRA approved a reduction in BellSouth’s free-call allowance from three to one on Apr. 17, 2007. See Exhibit 1 in relevant Citizens Telecommunications Co. filing. In the mid-1970s, unlimited free directory-assistance calls were typically allowed for handicapped persons, users of coin-operated phones, hospitals, and hotels.  They are now typically allowed only for handicapped persons.

[3] For data and sources, see the directory assistance business statistics. The RBOCs also collected considerable revenue ($84 million in 1992) through an ” information surcharge.”  The information surcharge is a separate, wholesale per-minute charge applied to all originating and terminating interlata switched access minutes of telephone companies’ interconnecting interlata telephone traffic. According to AT&T in 1998, the information surcharge had been applied since 1985 on the basis of an interim waiver for the recovery of  “costs relating to white pages and other undefined directory assistance costs.” The CALLS access reform, enacted in 2000, eliminated the information surcharge through targeting of price reductions required under price caps (see 47 CFR 61.45 (i)(2)(ii)).

[4] Directory advertising (Yellow Pages) historically has been a highly profitable, non-regulated business of telephone companies.  In recent years, the Yellow Pages business has been under acute competitive pressure.  In an order released on Jan. 23, 2001, the FCC ruled that local telephone exchange providers must offer nondiscriminatory access to their directory listings, at nondiscriminatory and reasonable rates, to competing directory service providers. See FCC Order, Provision of Directory Listing Information under the Telecommunications Act of 1934, 16 FCC Rcd 2736 (2001) [as MS Word document].  This order cannot account for trends in directory assistance calls prior to 2001.

[5] Based on Bell information, the marginal cost of directory assistance was estimated to be 19 cents per call in 1977.  See Daly and Mayor (1980) p. 157.  Currently many companies, such as Jingle, Bing, and Google, provide free directory-assistance services.