An Analysis of Incentives for Network Infrastructure Investment Under Different Pricing Strategies

In this paper we present an analysis of investment incentives for network infrastructure owners under two different pricing strategies: congestion based negative externality pricing and the prevalent flat rate pricing. The challenge in a networked environment is to increase capacity of the different components of the network appropriately based on demand for these different components. We develop a theoretical approach to guide the capacity appropriation through the network when the dynamic congestion pricing strategy presented in Gupta et al. (1996) is used. The theoretical model is used to construct a heuristic for capacity appropriation when flat-rate pricing is used. We then use a simulation model to compare the impact of dynamic congestion based pricing with flat rate pricing on the choice of capacity level by the infrastructure provider. We investigate the impact of variety of factors including the per unit cost of capacity of a network resource, average value of the users’ requests, average level of users' tolerance for delay, and the level of exogenous demand for services on the network. Our results indicate that relationships between these factors are crucial in determining which of the two pricing schemes results in a higher level of socially optimal network capacity. The results also indicate that regardless of how these factors are related to each other, the average stream of the net benefits realized under congestion based pricing is always higher than the average net benefits realized under the flat-rate pricing. We also investigate the impact of profit maximization and value flow maximization on the optimal capacity levels.