The Two Faces of the Internet: Untangling Net Neutrality

There are two faces to the internet, a dichotomy exposed by the net neutrality debate. One is the internet content market - which as a general matter is highly competitive with low barriers to entry and numerous, diffuse participants. The other is the market for high-speed internet service - which some characterise as highly concentrated with considerable barriers to entry. The difference between these two interrelated markets motivates the movement for net neutrality regulation. Its advocates worry that unless prevented by law, the internet service providers (ISPs) will project their market power into the internet content market, stifling broad-based competition and with it innovation valuable to society at large. Emerging technology has given access providers the means to ban or discriminate against content moving along their networks, although the same technology also has the possibility of improving the quality of internet service to consumers. This article describes the net neutrality debate, providing the necessary background and then addressing the most convincing arguments on either side, with special attention to the economic incentives of the actors and the effects on competition.

Technological background

In transmitting internet content the network breaks the data into small pieces called packets. These packets are then sent through various intermediate computers, routers, before eventually arriving at the destination machine. Each of these routers has limited bandwidth, ie, they can only transmit a fixed number of packets at a time to downstream routers, creating the possibility of congestion.
The problem of congestion is further complicated by the growth of real-time applications - those that involve constant interaction with end-users. A momentary delay in content transmission, a matter of seconds, goes unnoticed when reading e-mail, but will ruin the user's experience with a real-time application like streaming video or online gaming. In short, real-time internet applications are much less forgiving of network congestion.
A possible means to manage internet congestion is to privilege some applications. This concept is often discussed using highway metaphors, eg, real-time applications will have priority access like emergency vehicles or through a special 'lane' of internet access so they will not be hindered by normal traffic congestion on the network. The less delay-sensitive applications, in turn, would yield right of way. This more discriminating system would represent a departure from the present routing practice of first-in first-out (FIFO), which sends packets out in the order received regardless of their content or the type of application. The 'priority lane' arrangement can be used to deliver what the industry calls increased Quality of Service (QoS) in order to improve the overall consumer experience. This strategy is now possible via deep packet inspection (DPI) technology, which extracts information from the packets moving along the network. Prior to the advent of DPI net neutrality was not much of an issue - the ISPs could not have efficiently discriminated between internet content even if permitted to. Now, however, the technology exists, and with increased network traffic and the ever-rising prevalence of real-time applications, so does consumer demand for increased QoS. This is a particularly attractive strategy for managing internet traffic because increasing the internet infrastructure takes so much time and capital. New routing protocols, though they require research and development, are considered a cheaper solution to just adding capacity.

Defining net neutrality

Network neutrality means different things to different people, so defining the policy proposal can be challenging. Internet pioneer Vinton Cerf's has proposed a wide-ranging net neutralty regime,1 which would make it unlawful for ISPs to ban or discriminate against content based on its source, creator, destination, or content. Most net neutrality advocates add that ISPs should also be barred from dictating what devices customers can connect to the internet, eg, an access provider would not be able to forbid customers from attaching telephones to the internet in order to take advantage of voice-over-internet-protocol (VoIP) technology. The reasoning is analogous - forbidding customers from attaching the devices necessary to use the application is the same as banning that content from the network.

Assessing the merits of net neutrality

The impetus behind net neutrality

Net neutrality advocates argue that regulation is justified by ISPs' market power and their incentives to project that market power into the internet content market. VoIP is commonly cited to illustrate this point, and was the subject of one of the first enforcement actions relating to net neutrality.2
VoIP is a substitute for traditional telephone services, which are a major source of revenue for the Incumbent Local Exchange Carriers (ILECs) that are among the most significant ISPs due to their ownership of both last-mile and backbone infrastructure. Because VoIP providers who are not also ISPs typically do not need to invest in traditional telephone infrastructure, VoIP services are able to be priced below the competing telephone services. Some argue that ILECs, therefore, have a clear incentive to discriminate against non-affiliated VoIP providers, and they can do so by banning it from their networks, or, more subtly, by discriminating against it by reducing VoIP content's speed or ease of transmission along their network. Since VoIP is a real-time application, even a relatively small reduction in speed can ruin the end-user's experience through garbled messages or unacceptable delays in communication. Either banning or discrimination will protect the ISPs' revenues from telephone services by eliminating this competitor.
Advocates of net neutrality regulation also argue that the same is true for any service the ISPs themselves provide to their customers. If, for example, the ISP offers its own e-mail application or search engine, it may have a similar incentive to ban or discriminate against rival services. In addition, the ISP may also extract seek payments from independent content providers by threatening to discriminate against them. This can alternatively be framed as offering to provide better QoS to those who pay a fee. Timothy Wu puts it more colourfully as a 'Tony Soprano model of networking [...] If you are offering some companies better service and degrading others, you are saying pay us or we will ruin your business. That's simply a protection scheme and not a market strategy.'3 Thus, the content offered by the access providers themselves or their affiliates who have paid for the privilege will enjoy a competitive advantage - in the extreme case their rivals will not have access to the network at all.
The advocates of net neutrality regulation argue that these outcomes are undesirable to consumers - the ISPs will be able to extract supracompetitive profits from their own internet content and those content providers who deal with them, stifling innovation and market entry in the internet content market, and depriving consumers of the benefits from that highly competitive market.
Because it is clear that this outcome, if plausible, would harm consumer welfare, much of the substance of the net neutrality debate focuses on whether or not it is plausible.

ISPs' market power and incentives

Consumers value a variety of different internet content, so if the ISPs restricted their internet access as previously described they would eventually switch to another ISP. Opponents of net neutrality explain that this threat prevents the ISPs from discriminating.
Observers disagree on the competitiveness of the internet access market. Advocates of net neutrality regulation describe the internet access market as a monopoly for many businesses, and a duopoly of cable and telephone companies for homes,4 while opponents of net neutrality regulation see the internet access market as much more competitive, especially in light of emerging technologies.5
To see the importance of competition in the internet access market, consider the VoIP example. If an ISP excludes or degrades VoIP from its network, then consumers who desire that service will want to switch to a competing ISP who offers a superior VoIP product. Furthermore, assuming that there are two ISPs in a given geographic market and both simultaneously degrade VoIP on their network, then all this may do is drive consumer demand for emerging broadband competitors (if available) who offer a superior VoIP product.

The one monopoly rent theory

Opponents of net neutrality regulation also cite the one monopoly rent theory to demonstrate that even with monopoly power ISPs will lack incentive to discriminate among content . The theory holds that a monopolist has no incentive to monopolise a complementary product if it is competitively supplied and used in a fixed proportion with the monopolist's good. Under these conditions, the complementary good can be thought of as an input to the primary good. The monopolist will be charging the profit-maximising price for the final product, so if it monopolises the complementary market it will have no incentive to raise price - that would push the price of the final good away from the profit-maximising point. The monopolist has no incentive to raise the price of one of its inputs, and is content with the lower, competitive price. The application of this theory to the internet markets is straightforward: the ISPs will already be extracting the maximum profit from their product, so acquiring market power over internet content serves no purpose.
The proponents of net neutrality regulation claim that regulation would still be justified where content providers themselves present a competitive threat to the ISPs. Returning to the example of VoIP, while ISPs may not be able to increase their profits from internet access by discriminating against non-affiliated VoIP providers, they still might have incentive to discriminate against VoIP providers order to protect its profits generated from offering telephone service.

Sufficiency, or lack thereof of antitrust law

Net neutrality advocates worry that, freed from legal constraints, ISPs will engage in anticompetitive conduct. Antitrust law, of course, already forbids such conduct, and, moreover, carries stiff penalties. So, the question arises: why do we need net neutrality at all, why not leave the matter to antitrust? Indeed, framing the debate in the rubric of antitrust law counsels against net neutrality's blanket prohibitions. In antitrust, courts use two basic standards to evaluate business practices. Those practices deemed to never, or at least very rarely, have legitimate pro-competitive purposes are categorically banned under the per se rule. Those that under some circumstances could be pro-competitive are accorded rule of reason analysis which weights the effects. Despite the fears of net neutrality supporters, a non-neutral net offers some pro-competitive benefits, and so would enjoy the rule of reason. But, net neutrality policy amounts to a pre-emptive per se ban, and its opponents ask how this could be justified.

The costs of net neutrality

As preceding sections suggest, there exist compelling arguments on either side, so we cannot determine whether a non-neutral internet would lead to ISPs dominating the content market. Given the risk, though, we might be tempted to adopt net neutrality as a prophylactic measure. Net neutrality does, however, carry with it significant costs.
There are the costs attending any regulation, such as monitoring and administration. More importantly, regulation frequently has unintended consequences because it substitutes the views of regulations adopted at a specific point in time for the ever evolving views of consumers and market participants. In this context, it should be noted that the internet has largely developed free of regulation, and many would argue the absence of regulation is responsible for the internet's unprecedented growth and innovation.
For example, one cost of net neutrality regulation is that it might bar much of the QoS improvements described at the start of this article. Without the permission to discriminate network traffic on the basis of content the ISP could not, for instance, treat real-time applications differently so as to maximise consumer utility given the limits of the present infrastructure. This cost could be mitigated by adopting a more modest, perhaps more realistic, net neutrality policy that would allow ISPs to discriminate content based on the type of application while still forbidding them from discriminating based on the content's source or author. The greatest concern is that ISPs will exclude internet content that competes with their own, and this more limited form of net neutrality still addresses that (although there will still be some exceptions, such as when the independent internet content competes with a non-internet product sold by the ISP, as is the case with VoIP).
Even a scaled-back net neutrality leaves the deeper problem, though. Net neutrality fixes a kind of business arrangement and closes off at least some avenues of network innovation. Even the modest formulation of network neutrality could, for example, adversely impact the nascent content delivery system industry. These companies contract with content providers like CNN.com to provide additional servers that deliver their content faster. These firms thus privilege internet content based on the source. Opponents of net neutrality regulation claim that it might stifle an important form of innovation with certainty only to avoid harms that are, at best, speculative.

Conclusion

This article has canvassed the economic arguments on either side of the net neutrality debate. As even this brief survey reveals, there are no straightforward conclusions. Any choice of net neutrality policy will involve an uncertain trade off, such as the risk of ISPs dominating the internet content market against the loss of potential innovation in business arrangements like content delivery systems.

Notes

1 See, eg, Net Neutrality Before the Senate Committee on Commerce, Science, and Transportation, 109th Cong. 12 (2006) (statement of Vinton Cerf, vice president/chief internet evangelist, Google Inc.).
2 See In re Madison River Communications, LLC, Order 20 FCCR 4295 (3 March 2005). The case ended in a consent decree with the Federal Communications Commission.
3 Network Neutrality: Competition, Discrimination, and Nondiscriminatory Access Hearing Before the Task Force on Telecom and Antitrust of the House Committee on the Judiciary (2006) (testimony of Timothy Wu).
4 Eg, Tim Wu and Chrisopher Yoo, 'Keeping the Internet Neutral? Tim Wu and Christopher Yoo Debate', 59 Fed. Comm. L.J. 575, 586 (2007).
5 Eg, Christopher Yoo, 'Network Neutrality and the Economics of Congestion', 94 Geo. LJ 1847, 1891-95 (2006).

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