Should hotel Wi-Fi service be free?

How should a hotel price Wi-Fi access? It’s an interesting question because unlike, say, accessing the room’s minibar using a Wi-Fi network has externalities. Here is how Barbara DeLollis, a travel columnist for USA Today, explained the issue in an NPR interview (Limited Supply Of Hotel Rooms Forces Prices Higher, Jul 5).

WERTHEIMER: I wonder if hotels are going to begin to do something similar to what the airlines have done as a way to raise prices to maybe charge you for things that you have some expectation are going to be free.

DELOLLIS: Right now the biggest hot topic in the industry is Wi-Fi. The hotels they give Wi-Fi away for free, which are, you know, maybe the Courtyards, the Hilton Garden Inns, some of these hotels are starting to talk about, at least, should we start offering an optional upgraded Wi-Fi for a fee. You know, business drivers get into their hotels, at six o’clock everyone fires up your laptop in it’s sluggish. You know, and who can think of a worse thing than slow Wi-Fi when you have to get some stuff done or you want to talk to your family or check your Facebook page?

So hotels are starting to try and figure out a solution. Do we keep offering it for free and just try, as best we can, to address complaints? Or do we potentially offer a tiered system, where you can still have your free system for checking email, for example, but then maybe you can pay a certain amount of money? Maybe five or six or seven dollars where you can then, you know, watch your Hulu, your Netflix, you know, check your Twitter account, things of that nature. No one has really pulled the trigger on that yet on a brand-wide level, but, you know, we do know people are testing it quietly. So if you see that in your hotel, don’t be too surprised.

DeLollis had a column in USA Today that laid out some relevant data (Some hotels with free Wi-Fi consider charging for it, Jun 22).

• According to Dave Garrison, CEO of iBahn, one of the world’s top hotel Internet providers, 40% of travelers are carrying two Wi-Fi devices, and 25% are carrying three or more.
• Between March 2011 and December 2011, iBahn saw the amount of data per session in hotels jump 50%, which translates into higher costs.
• Free Internet access ranks toward the top of guests’ want lists from hotels, as travelers carry more devices on the road and more varied content is available through them.

Pricing Wi-Fi involves an interesting blend of extracting revenue and managing customer behavior. The quote from the NPR host (“a way to raise prices to maybe charge you for things that you have some expectation are going to be free”) suggests that this is all about separating consumers from their dollars. However, it doesn’t have to be that way. If the cost of providing Wi-Fi is largely fixed, then there is no economic reason not to bundles the provision of internet access in with the hotel room.

That statement, of course, requires a caveat. What I mean is that in a standard economic model with fully informed and rational customers, there is no efficiency lost in providing Wi-Fi access for free while upping the room rate. In reality, hotels may be playing games — hoping lower room rates appear higher in search listings, for example — to take advantage of irrational, naive customers. (For a model along those lines, see this paper.) However, that does not seem like a sustainable approach for hotels that have a common pricing policy across a large number of locations and serve many repeat guests (i.e., at hotel chains catering to business travelers).

The next question is whether the cost of providing access is largely fixed. Certainly, the hardware costs are largely sunk. Even if routers and such are leased, those costs don’t change when the guest in room 417 logs on. There is a question of how iBahn or other network providers charge hotels. If it is truly a metered rate, then each guest’s actions add to the hotel’s costs, but for many on-line activities (e.g., sending a few emails), these have to be small.

But that gets us back to congestion and negative externalities. When the guy in 417 logs on, he slows down everyone else’s service. When he is one of only a handful guests on line, this is trivial. But when everyone guest is trying to access the internet, that is a different story. Now it is very easy to write out a standard economics model in which the service is priced to reflect the delay imposed on other users. Said another way, a guest would have to internalize the externality he or she is imposing on everyone else.

What then of a tiered system? It is appealing since it allows the hotel to still claim free service while giving something better to those who truly value it. Further, it is an easy perk to give to frequent guests with sufficient status in the chain’s loyalty program.

But I see two challenges with this. First, tiering would allow the hotel to segment better and extract more revenue. Find as far as it goes, but usually in models such as this in which congestion is a real concern, this involves deterioration of the lower level offering. That is, the free service is going to suck. The network may be undersized and slow or may force users into short sessions so they have to log back in every 15 minutes. Note that since watching Netflix is a substitute for buying a pay-per-view movie from the hotel, there will be even more reason to cripple the free service.

The second challenge is operational for the hotel: How do you size the non-free system so that it provides service worth paying for? If you have a hotel full of traveling executives who are all willing to expense $20 worth of internet access, you need to have a network robust enough to provide all of them a good experience. But that effectively means that you have sunk the money on a network big enough to provide decent service to everyone and it would be efficient to offer it for free!