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Thursday, October 27, 2005

The Real Net Neutrality Debate: Pricing Flexibility Versus Pricing Regulation
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As Ray noted in his essay last week on Clearwire and VoIP blocking, I have long argued that broadband service providers (BSPs) will eventually will end up price differentiating based on bandwidth usage, in part because of the futility of differentiating based on service bundling or technological applications / usage.

What I mean by this is that most attempts to discriminate against specific websites or applications are likely doomed to fail or end miserably for the carriers. First, with Net surfers getting more sophisticated with each passing day, it will be very difficult to block most activities without them finding ways around the restrictions. Second, attempting to discriminate against certain types of bits is complicated for the carriers and will likely require more effort than it's worth. Third, even if carriers were able to discriminate against certain bits, if they went overboard it would spark an intense consumer backlash and a likely exodus to an alternative broadband provider. (And if a serious alternative backbone provider was not yet available in that region, excessive blocking / meddling by the incumbent BSP would likely serve as the best incentive for new entrants to enter the market and offer a less-restricted surfing experience.)

But critics claim that I'm full of it and some of them pointed to last week's front-page story in the Wall Street Journal as evidence. In their article, "Phone, Cable Firms Rein in Consumers' Internet Use," reporters Peter Grant and Jesse Drucker claim that, "Several large telephone and cable companies are starting to make it harder for consumers to use the Internet for phone calls or swapping video files." The story goes on to note that some BSPs "have begun to closely monitor the uses of their network with an eye toward controlling activity by users who are swapping movies, TV programs, pornography and other video files. Operators say file sharing is growing so quickly, it threatens to sharply slow down other uses."

What are we to make of this? Are BSPs hell-bent on controlling our web-surfing experiences and even resorting to "discrimination" against certain types of uses or activities? Should that be illegal? Are there other ways of handling this problem?

Let's begin by acknowledging that there is a potential problem here. While some intensive corporate and individual Net users may not realize it (or just don't care to admit it), excessive web-surfing by a small handful of users can have negative externalities. Other, more casual users of broadband networks could be impacted by a handful of bandwidth hogs who eat up the bulk of system capacity. Just as lanes on a highway can get clogged up from too much traffic, the same goes for broadband networks.

In the case of broadband networks, however, a small handful of people can be responsible for putting more cars on the road than others and causing the online traffic jams. As the WSJ story reports, according to Mike Lajoie, chief technology officer of Time Warner (TW), fewer than 10 percent of TW subscribers consumer more than 75 percent of the bandwidth. And I've actually heard even more extreme numbers reported by other BSPs, with the ratio being more along the line of 5-10 percent of users eating up closer to 90 percent of bandwidth.

Of course, these numbers shouldn't really be surprising. At least at this point in time, the vast majority of web surfers are basically looking to do a few routine things online in any one sitting and then getting offline and back to the real world. These casual users jump online to check e-mails, monitor a few eBay auctions or a favorite newsgroup, and perhaps look at the news on a few websites. And then there's the other users who might best be labeled "Netizens," since they almost literally live in cyberspace on a full-time basis. These are avid online gamers, the file-sharers, and the online video watchers, and yes, the porn-surfers. They spend endless hours uploading, downloading, sharing, and playing online. And they consume massive chunks of bits in each sitting. (I want to make it clear here that I do not have a problem with any of these activities, rather, I am merely trying to point out that a small handful of websurfers impose the largest burden on broadband networks. In fact, I am probably in this group myself!)

So, here's the key question in this debate: How should BSP deal with these bandwidth hogs? If a small handful of Netizens really are imposing more of a burden on the system, what can and should be done about it (if anything at all)?

Currently, some BSPs deal with the problem by basically sending the most intense users a dirty letter essentially saying "Please cut it out, or else" but it is somewhat unclear what the "or else" is. Under many of the Terms of Service agreements I have read, BSPs say they will cut of your service for certain "violations" of the agreement, including excessively burdening the system with traffic. But it is my understanding that such provisions are rarely enforced. (Seriously, if anyone knows of a bandwidth hog being cut off, please send me info because I try to keep track of these things).

As the WSJ article suggests, the other strategy that some BSPs are currently considering involves tinkering with networks to potentially restrict or slow access to certain sites or activities. In other words, the BSPs start to act like more of a full-time traffic cop and try to direct flows during times of peak usage.

In my opinion, both of these strategies represent a silly way to deal with the problem of excessive bandwidth use by a small minority of users. The second strategy presents a major enforcement nightmare for the BSPs and would create much ill-will with a core part of their customer base. Moreover, if BSPs really did start cutting off service to large groups of users or, worse yet, slowing down or blocking access to certain sites or services, it would open them up to intense scrutiny from the regulatory community. Because even though we are moving away from common carrier notions in the world of communications, many still want to regulate high-speed network providers as if they were common carriers. Indeed, Net Neutrality regulation is really nothing more than common carriage law for the Information Age. It seeks to enshrine those old principles into law for the next generation of networks and services.

But if lawmakers went that route--and recent drafts telecom policy reform on Cap Hill all include some sort of Net Neutrality provision--it is important to understand that this means the continuation of price controls for communications. This is because, in practice, common carriage law is toothless without price regulation. You can have all the common carriage / non-discrimination principles on the books that you want, but unless regulators have the ability to also control prices those principles are meaningless. After all, a BSP faced with merely a behavior constraint could simply price access to the protected service or application at a different rate to discriminate against it.

This raises the most interesting issue in this entire debate: Why is it that BSPs are not currently attempting to meter broadband usage and price it to account for demand and "excessive" usage by some users? In my opinion, this would be the most efficient and least meddlesome why of dealing with this problem. Per-minute or per-bit pricing schemes could help conserve pipe space, avoid congestion, recover costs and enable BSPs to plow the savings into new capacity / innovation. Despite this, no BSP seems willing to engage in any sort of metering of the pipe. Why is that?

I think there are two reasons that BSPs have so far been unwilling to price discriminate. First, broadband operators are probably concerned that such a move would bring about unwanted regulatory attention. Second, and more importantly, cable and telco firms are keenly aware of the fact that the web-surfing public has come to view "all you can eat" buffet-style, flat-rate pricing as a virtual inalienable right. Internet guru Andrew Odlyzko, has corretly argued that "People react extremely negatively to price discrimination. They also dislike the bother of fine-grained pricing, and are willing to pay extra for simple prices, especially flat-rate ones." And George Gilder, another famous Net guru, noted in his book Telecosm that, "Everyone wants to charge different customers differentially for different services. Everyone wants guarantees. Everyone wants to escape simple and flat pricing. Forget it." Gilder bascially argues that simple and flat pricing is almost always preferable from a consumer perspective and, therefore, network providers should avoid more complicated pricing schemes.

For these and other reasons, BSPs probably don't want to rock the boat too soon with more creative price discrimination schemes, but someday they may have to as bandwidth-intensive web sites start to eat up more and more pipe capacity. While simple and flat pricing seems like the sensible approach, it remains likely that some BSPs will eventually attempt to craft tiered or metered pricing schemes. While some consumers will cry foul, a number of bandwidth-intensive Internet vendors and website operators will likely be absolutely apoplectic over such a move, and some may even run to regulators seeking redress.

This raises the important question of whether or not broadband operators should have the right to price network access in this manner. And, would Net Neutrality regulations prohibit such innovative pricing schemes from being employed in the first place?

The answer remains uncertain, but clearly, if some form of network "non-discrimination" rule is on the books, some website operators and content providers may push to invoke it against a BSP that suddenly announces a new metered pricing scheme for bandwidth-intensive web offerings. It would be very unfortunate if this scenario came to pass, since such creative pricing schemes may be part of the long-run solution to relieving Internet congestion and allowing carriers to accurately assess user charges for Web activities. Supply and demand could be better calibrated under such pricing schemes and broadband operators may be better able to recoup sunk costs and make new investments in future infrastructure capacity or network services. As Odlyzko argues:

Thus even if it is not optimal from a global point of view, it might be necessary to introduce complexity in order to be able to construct and operate the telecom infrastructure, especially the residential broadband networks that are so eagerly awaited by government and industry leaders. That might mean allowing carriers to charge differently for movie downloads than for Web surfing. That, in turn, might require a new network architecture. Such a move would not be unprecedented. The key (although seldom mentioned) factor behind the push for new network architectures appears to be the incentive to price discriminate. It is an incentive that has been operating since the beginnings of commerce.

The bottom line is that it should be left to markets, not regulators, to determine what pricing schemes are utilized in the future to allocate scarce space on broadband pipes. The broadband marketplace is still in an early developmental stage, having only existed for a few years. What business model will prevail or make network activities profitable in the future? Pay-per-view? Advertising? Metered pricing schemes? Some hybrid of these and other systems? No one knows for sure, but policymakers need to allow network operators the freedom to innovate and employ creative pricing and service schemes so that market experimentation can answer that question.

This what the fight over Net Neutrality is really all about: Pricing freedom versus pricing regulation.

posted by Adam Thierer @ 11:11 AM | Communications , Mass Media , Net Neutrality , Wireline

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