Price And Income Elasticty - Analysis Of At&T Dsl Services.

Price and Income elasticty - Analysis of AT&T DSL services.

Introduction

Broadband Ð'- high-speed, always-on Internet connectivity Ð'- represents the next phase in the evolution of the Internet. Most experts predict broadband will enable applications and services that transform our economy, education, health-care, R&D, homeland security, military effectiveness, entertainment, government and the quality of life for citizens around the world. The deployment and usage of broadband will significantly impact the global competitiveness of nations and businesses in the future. This paper discusses how price elasticity and income elasticity impact the broadband Digital Subscriber Line (DSL) demand.

Broadband Internet and AT&T

Our learning team selected the Internet service provider industry and focused on DSL broadband service for price-elasticity analysis. This research is focused on AT&T Inc. (formerly SBC Communications). AT& T was established in 2005 when former Baby Bell SBC bought AT&T Corp. for some $16 billion creating the largest telecom outfit in the US. After the merger, SBC adopted the globally familiar AT&T moniker. Now, AT&T has agreed to acquire southern Baby Bell BellSouth in a deal valued at $67 billion. The new AT&T now has more than 49 million access lines in service. Cingular Wireless, the company's wireless joint venture with BellSouth, is the leading US wireless carrier with more than 54 million subscribers. The company is headquartered in San Antonio, Texas and employs approximately 189,000 people. For fiscal year 2005, the company reported revenues of $46.3 billion, an increase of 7.5% on fiscal 2004. Net income for the year decreased 18.7%, dropping to a 2005 total of $5.1 billion." (Datamonitor, 2006)

The internet-access market is growing at a rapid pace in the flat world and global economy. "The United States internet access market grew by 12% in 2005 to reach a value of $38.2 billion. In 2010, the market is forecast to have a value of $51.4 billion, an increase of 34.8% since 2005. In 2010, the market is forecast to have a volume of 246.6 million users, an increase of 24.7% since 2005." (Datamonitor, 2006)

Goals

This paper analyses the impact of price on demand for AT&T's DSL using the principles of price elasticity of demand. "The law of demand tells us that consumers will buy more of a product when its price declines and less when its price increases. But how much more or how much less will they buy? The amount varies from product to product and over different price ranges for the same product. And such variations matter. For example, a firm contemplating a price hike will want to know how consumers will respond. If they remain highly loyal and continue to buy, the firm's revenue will rise. But if consumers defect en masse to other sellers or other products, its revenue will tumble. The responsiveness (or sensitivity) of consumers to a price change is measured by a product's price elasticity of demand. (McConnell and Brue, 2005, p.356).

The larger goal of this paper is to determine how to increase the revenue of AT&T. This paper focuses analyses and applies the principle of price elasticity of demand which will enable AT&T to determine whether the price of DSL should be increased or decreased by 10%. Using income elasticity of demand, our learning team will determine if 10% increase in income will increase demand by more than, less than, or about 10%.

Price Elasticity of Demand and Revenue

Historical price data for a service as new as DSL is largely non-existent, several considerations and strategies must be examined to price DSL within the context of fundamental economic principles. Price elasticity, penetration pricing and price skimming are three principles that can help managers price DSL.

Price elasticity of demand is a measure used by economists and managers to determine how the demand for a good or service will respond to a given price. A service can be considered inelastic or elastic. An inelastic service is basically unresponsive to changes in price. Whether the price goes up - or down - demand remains basically unchanged. If a service is elastic, then a change in price will result in a change in demand for that service.

Price elasticity is typically represented by a numerical value derived from the following formula:

Price elasticity (Ep) = % change in quantity (sales) X % change in price

If the result is less than 1, demand is inelastic; if greater than one, demand is elastic. How much greater (or less) than 1 indicates the level of elasticity (inelasticity). Typically, determining price elasticity requires extensive pricing and demand data. Unlike T-1, there is insufficient historical data from which to evaluate the elasticity of demand for DSL services. Yet even when historical data is not available, price elasticity principles, if not necessarily the formula, still can be applied. If empirical information is not available, or too unreliable, then service providers can evaluate two key determinants of price elasticity to estimate a logical level of pricing. The primary determinant is the availability of substitute services; the secondary factor is degree of product versatility.

Services that have many substitutes tend to be more elastic. Customers have numerous acceptable alternatives to a currently used service; hence an increase in the price of DSL service will result in their moving to the alternative. Demand and revenues for the current service decrease, while the substitute service gains customers and an increased revenue stream. By corollary, the fewer substitutes available, the more flexibility the company has in setting a higher price. Evaluating substitutes obviously applies to pricing DSL service. The key is to accurately determine what constitutes a viable substitute product. For example, dial-up modems are not a substitute for DSL; the many advantages of DSL place it in an entirely different class of service. Nevertheless, there are numerous Internet access technologies available today, including fractional T-1, ISDN and 56 kb/s frame relay, which can be considered acceptable substitutes.

Another factor of price elasticity that is especially applicable to DSL is product versatility. That is, if a service can be used for two applications instead of one, it is more versatile. The more versatile a product is, the less sensitive