An old adage of marketing is that people do not buy drills – they buy holes. Cliché it may be, but the statement embodies real wisdom, in that businesses that focus on value as the customer sees it are more likely to prosper than those that do not.

The cliché leads to other thoughts, such as:

It is good to sell something that creates multiple kinds of value, and especially one that appeals to a wide variety of customers who want different things from it. (My electric drill also sands, buffs, grinds, and wire-brushes.)

It is good to discriminate on price so as to serve customers with both high-value and low-value uses.

In the modern era, almost everything is produced via long and complex supply chains, and how to divide the customers’ payments’ among all the intermediaries is a vexing question.

These truths apply to the Internet as well as to drills and holes. No one buys pure connectivity. They buy email, and voice connections, and websites, and social media, and other ultimate desiderata. What customers are willing to pay is a complex function of the values they place on the different possible ultimate benefits, and these benefits and values are highly idiosyncratic.  As the capabilities of the system increase, more and more combinations of ultimate outcomes are enabled, and customers up the amounts they are willing to pay for the connectivity system as a whole.

The Shift, issued recently by Alcatel-Lucent (ACU), makes the point that telecom service providers are now able to collect in real time extensive data on “presence, availability, location, and profile” and that this enables the creation of new services limited only by our imaginations. It adds:

Multiple markets are willing and able to pay for these kinds of features, according to the many studies, both original and compiled, that you’ll find in these pages.

That’s key. Consumers and developers want and will pay for the kinds of features that can be built on top of presence and availability data, for security and diagnostics. What does that money then help pay for? More pipes!

Everyone wants more and faster bandwidth and consumers would like to get it for less money than they pay today. How on earth will providers build out additional capacity, while lowering the cost of basic service? [The authors] argue that the types of features that could be upsold to developers and consumers could be the source of revenue that pays for the much-needed build-out of more network capacity.

The last point is the key — that the money available to build capacity of all kinds depends on the value consumers place on the final outcome (the holes) rather than the cost of the pipes or devices that enable the outcome (the drills).

It is difficult to square this vision with the Internet as described in the FCC’s Open Internet Order.

The Shift contemplates a diverse industrial ecosystem in which producers of all kinds share in the payments that customers are willing to make for value. This is indeed the only system that makes economic sense – one in which high value uses pay more for the underlying platform(s) than do lower-value uses.  It is not rocket science; it is elementary network economics as worked out, however imperfectly, over the past 150 years. There are no perfect answers, because the problems are difficult and dynamic, but there are degrees of imperfection.

The FCC Order occupies a much more primitive universe, one in which there are abstract ISP providers, and applications, and perhaps devices, but the complexities of supply chains and revenue sharing and differential incentives are undiscovered.  The term Ramsey Pricing (pricing according to value attached to the service), which is a most important concept in the regulatory trade, is unknown, as indeed are crucial considerations of fixed costs and variable costs. The whole thing reads as if it were written by a bunch of lawyers, and recent graduates at that.

The Republicans from House Energy & Commerce have noted the lack of any regulatory analysis in a letter to the FCC Chairman. One awaits the reply. But the problem is not the lack of sophisticated economic analysis, it is the lack of any grasp of the elementary principles of industrial organization and consumer psychology. At best, the FCC is relying on the analytic equivalent of my grandfather’s old manual drill when it could use a modern cordless electric.

The REAL real problem is that if the agency got more sophisticated it could not issue its rule, and we certainly could not have that, could we?

[Cross-posted at Digital Society]