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Friday, March 31, 2006

Net Neutrality: The Small Consumers' Burden
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Among the oddities of the net neutrality debate is the Democratic House Commerce Committee members' embrace of a "hard" net neutrality mandate. This, of course, is in concert with self-styled left-leaning consumer groups like AARP, so maybe it is not that odd.

What is odd is the effect of the principle on the so-called little guy. It wouldn't be good. Net neutrality would decree that the only legitimate revenue model for broadband is for providers to recover all their costs from end-users. Thus, net neutrality would prohibit the emergence of a two-sided market business model. A two-sided market model would be like the one that supports "free" over-the-air TV with "preferential" payments by advertisers so those advertisers' bits are sent to consumers. A two-sided market also supports "free" search engines such as Google, Yahoo and MSN. Consumers don't pay, advertisers do. But under net neutrality applied to the applications or content layers, such a model would be anathema.

Net neutrality would also look suspiciously on price differentiation attempts. Indeed, in a "hard" form, a net neutrality mandate would ban all price differentiation. This means that the traditional means for a high-fixed, low marginal-cost business would be denied to broadband providers. This further means that the low-demand user -- the so-called inframarginal customer -- never subscribes to the network. From the consumer side, the lower demand users never trade up from dial-up to discover the value of broadband. From the provider side, these consumers never subscribe, thus making for less revenue to support the network. Less investment in broadband is the result.

Admittedly, some of the softer versions of net neutrality admit "bandwidth tiering" and other forms of price differentiation to consumers. That said, any net neutrality principle is going be suspicious of price differentiation, and will scrutinize it as a backdoor attempt to evade the mandate. This means increased regulatory costs to defend price differentiation strategies, and on the margin less willingness of providers to pursue such subcriber-gaining strategies.

So, we have a mandate that forbids two-sided markets from developing and either prohibits or looks askance at price differentiation. Both of these mandates increase the costs of broadband to end-use consumers. By saying end-use consumers must pay all of the costs, this inevitably means those consumers must pay more. The result is: less subscribership, less penetration among less well off customers, and less investment in networks.

If net neutrality then hurts the small consumer, what does it do to the "small entrepreneur," another party supposedly protected by such a mandate? By definition, a less subscribed, less invested in network is not good for the small web entrepreneur. Furthermore, the inability of two-sided markets to develop means that one of the technical problems of the net -- its insuitability, relatively speaking, to carry low latency applications like voice, video and online gaming -- is not solved through special quality of service arrangements between infrastructure and applications owners. Thus, if you are a small web entrepreneur developing a business that doesn't care about latency, your only problem is a less subscribed, less quality broadband platform. If you are developing low latency applications, though, your broadband platform will not be suitable for what you are trying to do -- and you are forbidden by the government from making any arrangements with the broadband carrier to change that.

This is not the first time that perverse consequences would flow from a benign-intentioned government regulation. The "little guy" who this is supposed to protect is burdened with higher costs, is less likely to subscribe and has a less robust network. Finally, this is not to deny some concerns about vertical foreclosure that Randy May's competition policy-based net neutrality is the suitable compromise.

PS: The paranoid in me still thinks that hard net neutrality advocates want less robust networks with fewer subscribers to justify massive public investment in broadband. With this public ownership and control, both taxation by regulation and social policy objective can presumably be accomplished. Never mind the law of unintended consequences. I am not a big devotee of conspiracy theories though, so I do not ultimately believe that these are really the long-term goals of NN advocates. Nonetheless, more calls for public investment is what results from less attractive private broadband offerings.

posted by Ray Gifford @ 10:50 AM | Net Neutrality

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