By Joshua Gans, Professor of Strategic Management and holder of the Jeffrey S. Skoll Chair of Technical Innovation and Entrepreneurship at the Rotman School of Management, University of Toronto. Originally published at VoxEU.
Net neutrality has a simple goal – to ensure that consumers face an undistorted choice in choosing where to devote their attention on the Internet. The rationale for that goal is to ensure a ‘level playing field’ for those who provide content, applications, or anything else via the Internet.
It is in the US that this has become a hot political issue. (Indeed, why net neutrality isn’t as big an issue elsewhere is a genuine puzzle, but outside the scope of this column.) The Federal Communications Commission (FCC) is currently grappling with what, if anything, to do about net neutrality. The debate came to a head recently when Comcast – perhaps the largest internet service provider (ISP) – negotiated an arrangement with Netflix – perhaps the largest content provider in terms of bandwidth – to ensure a faster download speed to Comcast customers who use Netflix. Technically, Comcast were not offering Netflix anything that it would not offer others. However, the fact that content providers have to choose at all raises the spectre of distortions. Put simply, it appears that the entry toll for other entrepreneurs who might compete with Netflix for consumer attention has been raised.
Economic Perspectives on Net Neutrality
The recent economics literature on net neutrality has focused on a market structure that does not apply to the Comcast-Netflix issue. For instance, Choi and Kim (2010), Economides and Hermalin (2012), and Economides and Tag (2012) each examine situations in which content providers earn revenues from sources other than consumers (e.g. advertisers), and assess the impact of net neutrality regulations that prevent ISPs from charging content providers different prices to access consumers. They demonstrate that such regulations can facilitate a transfer of profits from ISPs to consumers, but that the investment impacts of that change are hard to predict.
For the current debate, the issue is that, in each of these models, consumers and content providers do not have a direct monetary relationship. But it was the very fact that Netflix has to convince consumers to part with a monthly subscription fee – above and beyond what they pay to Comcast – that makes this situation different. For if Comcast can charge Netflix for higher-quality access to their customers, then it is Netflix rather than Comcast that has to sell consumers on paying for higher-quality access.
Preventing Content-Based Price Discrimination
My recent paper (Gans 2014) closes the gap by providing a simple model that includes a direct pricing relationship between content providers and consumers. The paper confirms that, in the absence of net neutrality regulation, an ISP with market power can engage in content-based price discrimination (for instance, charging consumers more to access Netflix, or charging Netflix more to access consumers) to appropriate rents from content providers most valuable to consumers. Consequently, for entrepreneurs investing in content for consumers, there is a spectre of hold-up in the long-term.
The question then is whether net neutrality regulation can help prevent this situation. The paper provides two avenues by which content-based price discrimination may emerge (in ISP charges to consumers and content providers respectively). If, say, ISPs are prevented in discriminating on one of these (what I term weak net neutrality), I demonstrate that the effects of this can be undone by discrimination on the other. For instance, if the FCC were to prevent Comcast from charging Netflix more for quality or access than others, then Comcast could, by charging consumers more for Netflix (something that could be implicitly done with download caps), force Netflix to lower prices to consumers – appropriating any rents it generated through higher consumer charges. It is only by enacting strong net neutrality – that prevents all content-based price discrimination – that real effects emerge. Specifically, the mechanisms by which rents from content providers can pass through to ISPs are muted.
The conclusion here is that, if the goal of net neutrality regulation is to level the playing field for content providers and prevent their hold-up, regulators must work hard to close off all paths by which content-based price discrimination can emerge. Of course, it is also worth noting that this task is made easier where consumers and content providers do not have a direct monetary relationship. In this situation, weak net neutrality – preventing price discrimination to content providers – can have real effects. However, the missing price itself is no great benefit, as that price also plays a role in ensuring that consumers allocate their attention in a socially optimal way – and net neutrality regulation may harm that.
Addressing Concerns About Net Neutrality Regulation
This framework also speaks to two concerns with net neutrality that have been raised in the debate. The first is that ISPs will have insufficient incentives to invest in higher-quality networks. The paper demonstrates that regardless of whether there is net neutrality regulation (in any of its forms) or not, the incentives for ISPs to invest in quality are unchanged. Put simply, so long as ISPs can charge consumers for higher quality, they can obtain a return to that quality. Of course, if that quality matters for some content providers more than others (say, faster downloads for movies), then net neutrality regulation can alter the incentives to invest in quality networks – although in that case, it is by engaging in a targeted appropriation of rents from high-valued content providers.
The second concern is that net neutrality regulation is not of value if there is ISP competition. The argument is that policymakers should focus on ensuring that competition instead (Becker et al. 2010). The logic is that if consumers are displeased with how their current ISP is engaging in content-based price discrimination, they can switch to another. The difficulty with this argument is that it presumes that consumers will not want the ISP to engage in such discrimination. However, that is not entirely clear. This is because, in competition with one another for consumers, ISPs want to offer consumers the best deal. If engaging in content-based price discrimination allows ISPs to transfer rents from content providers to themselves, ISP competition will ensure those rents flow back to consumers. Hence, an ISP may become the consumer’s agent in exercising monopoly power, and so content providers may still be subject to hold-up. In this situation, strong net neutrality may short-circuit that flow of rents.
Concluding Remarks
What all this shows is that in a two-sided market in which ISPs bring content providers to consumers, regulation of pricing practices is a challenge and requires an extensive, whole-of-market approach. Moreover, in such markets, the forces of competition do not necessarily operate to ‘make all data equal’ in the manner net neutrality advocates are hoping for. Of course, as with any theoretical approach, it is difficult to say at this stage what the empirical relevance of the effects discussed here are. Nonetheless, it appears that, in the US at least, some experiments with content-based price discrimination are emerging that may very well yield those insights for the future and for other countries.
References
Becker, G S, D W Carlton, and H S Sider (2010), “Net Neutrality and Consumer Welfare”, Journal of Competition Law and Economics, 6(3): 497–519.
Choi, J P and B C Kim (2010), “Net Neutrality and Investment Incentives”, RAND Journal of Economics, 41(3): 446–471.
Economides, N and B Hermalin (2012), “The economics of network neutrality”, RAND Journal of Economics, 43(4): 602–629.
Economides, N and J Tag (2012), “Network Neutrality on the Internet: A Two-Sided Market Analysis”, Information Economics and Policy, 24(2): 91–104.
Gans, J S (2014), “Weak versus Strong Net Neutrality”, NBER Working Paper 20160.
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Net neutrality has a simple goal – to ensure that consumers face an undistorted choice in choosing where to devote their attention on the Internet.
That’s a point typically lost on right-libertarian trolls who assert that distortions only occur due to government interference. They remain ignorant that distortions can occur due to collusion, failure to fulfill contracts, lack of liquidity, monopoly, monopsony, and lack of symmetric information among many others. Furthermore in an institution where consumers have little to no choice in selecting services (as in the cable industry) there cannot be a market at all.
Once again, I’ve learned something new from Naked Capitalism: monopsony (and oligopsony). Thanks, Ben!
Glad I could help
Like all capitalism, it works until someone takes advantage. If all content providers send reasonably similar amounts of data, this is an easy argument. However, since Netflix provides such a disproportionate amount of data, it imposes costs on ISP’s that they would normally not have. Is this really fair? I’d imagine every business out there would love to ship their product basically free of charge. Yes, Netflix does pay its access carrier, but there is no equal and opposite match that the receiving carrier puts back on Netflix and its carrier to make it “neutral.”
Who pays buildout costs? Someone should. Problem is people don’t want data charges. They have them on phones, but even then providers are moving towards unlimited (though slower) data as T-Mobile offers.
In the end, Netflix is a special case and is taking advantage. There is no free lunch here. Someone pays. Maybe the cable portion of your bill goes up to cover expenses, but somewhere, somehow, the consumer pays. Now is it fair to raise a cable subscriber’s fee to cover the expansion of service caused by Netflix, if the subscriber doesn’t use Netflix? I don’t think so.
Netflix is taking advantage. It is a special case and needs a different solution. If Netflix had to charge its customers to pay realistic charges for data transfer, they’d be out of business!
Yes, the state should be building this out for their communities, and private enterprise should get out of the tollbooth business.
While communications remain in control of the for profit domain, the peoples voice will be muted.
The voices won’t be muted, but the message will be controlled. When news and entertainment were solely under the control of Big Media, the message was spun in the way they wanted it spun. Advertisers controlled content and decided what you did and didn’t need to know based on what they wanted to sell you.
The other thing about the old-fashioned Internet, the way it used to be, was that it removed the distinction between “consumers” and “providers”: when they say “other entrepreneurs who might compete with Netflix for consumer attention” they, at that time, were talking about everybody. The Non-Neutral Net fundamentally turns into cable TV where Big Businesses offer canned plans of canned content to mute consumers. When that gets done then the people who have no use for cable TV will have no use for the Internet either.
True enough, but things have changed with the Internet. Netflix and the great demand for bandwidth hungry films has arrived.
The necessary bandwidth to satisfy everybody (true net-neutrality) just is not there. Not without fiber-optic to the doorstep or perhaps universal Internet by satellite.
So, for as long as we must depend upon either cable or telephone wires to the home computer we have a Net-Neutrality problem that will not go away easily.
I figure the solution in urban communities is fiber-optic cable since the conduits exist, and satellite reception for sub-urban/super-urban communities.
Unless there is some other telecom means that can provide the heavy-hefting that commercial offerings like Netflix will necessitate, which I do not see presently.
America is moving slowly but ineluctably to a couch-potato existence. (And the rest of the world is not that far behind.)
‘Tis a shame, ’tis a real shame …
Funny thing. The bandwidth is there in Korea. It’s there in Japan. It’s not there here. Strange.
The relative lack of bandwidth in the US by comparison with the rest of the world is a symptom of the lack of competition and the lack of regulation.
korea has big bandwith because 50 percent of men under 40 play starcraft, an online strategy game. it’s one nerd nation!
Have you looked into how much dark fiber is in the ground and ready to go?
Still, the way we use the internet is defective. In particular, the streaming-rental model needs to die. The only reason streaming (instead of downloading) is the way we get our videos these days is because access control is easier to centralize, which works to the benefit only of the landlords, and certainly not of the network.
How is this different from telephone access? Seriously – there should be no difference at all.
Talent, Skills & Currency
The ignorant majority always proposes democracy, and upon failing chooses another prophet as scapegoat, to repeat the cycle. The beauty of peer pressure is that it is nearly always 180 degrees dead wrong, but never stops trying to confirm itself.
Artificial healthcare is now consuming Social Security. Taxation is about providing for a willfully ignorant majority, much like parenting, and most avoid responsibility, especially for others with the same embedded habits, preferring to compete for increasingly scarce resources. Government simply fills the void, as a collector.
You are at peak artificial scarcity bull-. That gal walking 10 miles a day recycling is more important than a CEO clear cutting, fracking and cashing in on green energy subsidies.
Don’t sell yourself short, by failing to put yourself to work. If you want to learn something about duration matching from critters in nature, and you do, set your distance from the human herd accordingly. Don’t expect to think clearly, to unfix the fix, while inside the something for nothing casino.
Doing something wrong, no mater how many times you repeat the mistake, doesn’t tell you how to do it correctly. You are a multi-dimensional printer. Why would you go backwards because some moron in an office, dependent upon extortion, projects a need, based on a biased perception of the past?
The debt algorithm is pretty simple: AB, ABC, ABCD, ABC, AB. B, C & D work for debt as income in the ponzi, on an interest gradient to provide A with asset control, until they all get flushed. In the very expression of your talent, you redefine assets, and the peer pressure hedge is overwhelmed at threshold. Labor recognizes labor, by discounting debt consistently.
Individual talent increases demand and supply. Forfeiting talent reduces it, which the majority artificially replaces until the planet responds. The planet has seen this show many times, turning over species after species. The distribution is not moved forward by confirming the ‘normalized’ distribution in a tax farm.
The old-timers know that they are caretakers, responsible for recognizing competent successors, not of their own. An economy cannot function without circulation. They are looking for a young couple that sees the world full of opportunities, building their skills together, to express their talents.
Optimally, you should be married, have a 24 hr/wk job supporting the majority at something like $15/hr, and be experimenting with a small business, but it’s never to late to start. The herd is always going the wrong way, increasing variability, booms and busts, with replication.
You are not going to learn anything useful in a positive feedback loop between the education complex and Homeland Security, fueled by debt. Start with one of the classic Ado compiler books, learn how to implement physics with V = IR, isolate switches with PV = T, and install quantum switches with nR compilation. Constants are relative to the system.
If you need office skills, examine everything that goes into and comes out of a FedEx/Kinkos. If you require legal skills, read the rules of court, hang out with appellate lawyers in a good law library, and watch the clerks manage caseloads for the judges. The court action is a derivative sh-show.
Productive cycling of natural resources for human use is shrinking toward zero, because the majority assumes that the world just needs better middlemen, building and consuming apps. Accordingly, the Internet has been twisted to breed extortion on a much larger scale, of, by and for a shrinking population, with declining skills and increasingly arbitrary behavior.
Facebook is a silly stupid company buying ideas with market debt, hoping that a blind squirrel will find a nut, cycling conspicuous consumption and advertising in the meantime. The best way to learn about circuits is to build them, minus the false assumptions at start up.
The Internet is being deployed to roll out global government, eliminating alpha, beta and portfolio tools. A bet on Uber is a bet on the path of taxi market extortion. RE is a bet on the value of variability created by extortion. Seems like just yesterday Twitter was a darling.
Return on investment is a function of time horizon, which favors singles in the short term, civil marriage in the medium term, and marriage in the long term. When the long term becomes the short term depends upon location cycle, which is why the global city prototype seeks to be forever young, short-sighted.
The idea that a person, much less a committee, can make investment decisions for others is certifiably insane, but that is central control. You are a natural resource, not the government middleman, and probability says that you as an individual are in a much better position to print. And you learn by doing.
You set your labor price with positioning, and the better you price duration over time, the more abundant your environment will be. Some people’s money is worth more than others. The cities practicing price and wage control are not concrete jungles of extortion strangling perimeters, with tourism branding as a substitute for life, by accident.
If you think about it, discounting debt is much more effective than issuing debt. Warren Buffet plays both sides, which is fine if you want to collect legacy industries on the margin like toys in a positive feedback loop, but not to build the future. He simply consolidates the middle.
Put your talent to work with skill development, and print your own future, for your children’s sake, in a positive feedback loop serving as the negative feedback loop to majority peer pressure. That J-O-B is a door, discounting your way to a home and a business. Don’t walk through doors that have inflation, something for nothing, on the other side.
Don’t assume that the old-timers didn’t see all this coming and didn’t leave the necessary parts. Recycle the Internet, bypassing all the digital extortion controllers feeding the middlemen, and you will see the labor market, for yourself.
Build your own clock, so you are not waiting in line, making gravity your friend instead of your enemy.
Why don’t you see yourself in a mirror?
Huh? I got lost somewhere near the first sentence of your post. How does your post address the topic of net neutrality? Sorry, I can usually follow and enjoy reading your comments but this one has me stumped.
If the pipe isn’t big enough to meet demand, don’t screw around with punitive schemes or bureaucratic or legislative band-aids, just make the pipe bigger. Internet infrastructure investments create a huge, almost unprecedented, economic public benefit. Private internet providers with near monopoly status have almost no incentives to improve service quality. In most places there are so few broadband options there is no real competitive dynamic–given the choice of investment or profit taking, the profit taking will win almost every time. Collusion whether consciously orchestrated or of the informal variety is all but guaranteed. Commercial for profit internet providers make as little sense as would have commercial roads or commercial water and sewage providers, real competition is impossible because having multiple infrastructures makes neither logical or economic sense and today internet is as necessary as water, roads or sewer. The only way private internet providers makes any sense at all is to put them under huge regulatory controls where they must apply for and justify rate increases and at that point public ownership makes far better sense. In fact billing small or non-commercial users fees at all makes no sense, as every dollar spent on accounting and billing bureaucracies is a dollar wasted on unnecessary and hugely expensive accounting, bureaucracy and paperwork. Billing and accounts require huge costly inefficiencies in that they contribute exactly nothing to actually providing the service–in fact they only exist to block access. Add in the other pure inefficiency, profit, and you are trying to fill a very leaky bucket. If private companies need be involved at all, better to do away with individual customer accounts entirely and have a single public payer that has real negotiating muscle–something the individual customer with no real choices never has.
This notion that private enterprise is magically more efficient than public enterprise needs to be killed and buried once and for all. The notion works at the small business scale where the consumer has a lot of choices, but it doesn’t scale up well and where the actual number of consumer choices is small, private enterprise is likely to be the least efficient way to fill a consumer demand.
What’s really working against net neutrality is mostly related to favoring private infrastructure in an area that logically wants to be public.
The focus on “content providers” is misguided. I am a content provider. So are you. The virtue of the internet is putting people in touch with people. That leads to both social and economic progress. Giving more power to current service providers and “content providers” will restrict both. Net neutrality is necessary to preserve the freedom of the internet.
Unfortunately, there’s a lot of bad infrastructure in place, and industry has absolutely no reason to encourage otherwise. Uplinks on the order of hundreds of kilobits per second are not great for serving things, and even worse for consuming things at the same time.
At least colocation services are commodified these days. $600/yr rents a space in a cabinet with power and a healthy amount of unrestricted Internet bandwidth, but that’s a bit steep for a private mail box equivalent unless you can claim some part of it as a business expense.
Generally, the post was a load of BS, typical of mainstream economists. Lots of jargon and high level words which hide the real, simple, fact. The Internet is like a highway connecting cities, towns, and villages, down to the driveways of individual homes. As such, “net neutrality” should be thought of as you saying “road neutrality”. Do you want the guy driving a Mercedes to get to drive on the interstate while you, in your VW Beetle, drive on the unmaintained country roads? That is the argument, pure and simple.
Now don’t start about how the telecoms deserve to set the rates according to bandwidth ‘cos they built the internet, or they “own” the pipe, or any other goof ball reason. The internet was built, directly and indirectly, by the taxpayer, usually in subsidies to the telecos. So no sympathy from me. They didn’t build it, they don’t fully run it, and they are really a utility, not something creative and special. So they don’t get to set the rules.