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Thursday, February 22, 2007

Additional Concerns with the Skype-Wu Proposal
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Two days ago, I posted a short essay expressing my strong reservations about the new Skype petition requesting that the FCC impose Carterfone-like regulations on wireless operators. Over on the the TLF, James Gattuso followed up yesterday with a piece of his own. And this followed last week's series of essays about Tim Wu's "Wireless Net Neutrality" paper by Jerry Brito, Hance Haney, James Gattuso, Tim Lee, Scott Wallsten, and Randy May. (The Skype petition essentially asks the FCC to implement Prof. Wu's ideas into law, so for purposes of this essay I will treat them as the same proposal.) I wanted to elaborate a bit more on this proposal because I think this issue is profoundly important to the future of innovation and competition in the wireless sector.

Burning the Village to Save It?
The fundamental question raised by the Skype-Wu proposal is whether America will continue to allow competition in wireless network architectures and business models to see which systems and plans (a) consumers truly prefer and that also (b) allow carriers to recoup fixed capital costs while (c) expanding and innovating to meet future needs. The Skype-Wu proposal would foreclose such marketplace experimentation by essentially converting cellular networks into a sort of quasi-commons and forcing private network operators to provide network access or services on someone else's terms. That someone else, of course, is the Federal Communications Commission (FCC), which will be tasked with devising rules and price regulations to ensure "fair and non-discriminatory" access / interconnection pricing.

In my opinion, when you get right down to it, this proposal is a declaration of surrender. That is, Skype and Prof. Wu almost seem to be saying that while it's nice we've seen innovation at the core of the wireless sector over the past two decades, we now need to get on with the important business of establishing rules to ensure the maximum amount of output or innovation at the edge of networks while largely ignoring what happens at the core, or even prohibiting certain things from happening at the core. In other words, to maximize the freedom to innovate at the edge of networks, we must now restrict the freedom to innovate at the core in some ways.

In essence, therefore, this proposal represents a call for the forced commoditization of cellular networks and would necessitate at return to the rate-of-return regulatory methods of the past. It would freeze network innovation in place and stop of the clock on one of the great American success stories of the past quarter century. For these reasons, I will argue that it is essential it be rejected.

Assume-a-Platform Thinking
The core of the problem here is that the Skype-Wu proposal--like other Net neutrality / open access regulatory proposals that have come before it--falls into what might most appropriately be called the "assume-a-platform" school of thinking. That is, proponents of forced access regulation seem to ignore market evolution and discount the potential for sudden technological change. They instead adopt a static mindset preoccupied with micro-managing an existing platform regardless of the implications for innovation on the existing networks or the development of future networks.

This static, zero-sum mentality dominates much of the thinking over Net neutrality regulation and explains why commons proponents are preoccupied with demand side concerns (i.e., who gets access and at what price) while they blithely assume away supply side considerations (i.e., how networks get funded, built, expand and innovate).

It's clear that Net neutrality proponents feel quite passionately about the question of innovation at the edge of the network. But where is their concern for innovation at the core of the network, or the innovation and investment needed to bring about entirely new network infrastructures and architectures? Apparently content with the networks of the present, Wu and Skype seeming feel comfortable imposing regulations on existing network operators to ensure that innovation is maximized at the edge of those existing systems.

But what about other platforms? Is it completely unreasonable to expect that other platforms might be developed? Should regulators merely regulate existing platforms to ensure consumers get as much out of them as possible? But what will that mean for those existing networks and the ability of those providers to innovate?

Consider what would have happened if policymakers would have adopted this mindset a decade ago. Clearly, almost none of the "edge" applications and technologies that are on the market today--including, most notably, Skype itself--would have functioned on the cellular networks or handsets of the past. How is it that we got where we are at today? Was it magic? Did these sophisticated networks fall to Earth like manna from heaven?

No, it was the result of innovation at the core of networks to enable a robust and sophisticated new infrastructure that could support the new edge applications. The clunky phones and rudimentary networks of the past were ill-suited for the business and consumer applications that were coming, and wireless operators knew it. And so they invested. Billions. As a result, the networks grew -- both in scale and sophistication. But they only grew because the legal / marketplace conditions and incentives were properly aligned. The necessary prerequisites for innovation were present. By contrast, the Skype-Wu proposal would upend those incentives and undermine the foundations of future network investment, innovation and expansion.

Calling the Game Too Early
Like other Net neutrality proponents, Skype and Prof. Wu largely choose to just ignore these questions about dynamic innovation at the core of networks and the incentives that make it possible. About the closest Prof. Wu gets to a serious discussion of these issues comes toward the end of his is paper when he notes:

The future of the industry, of course, is hard to predict. There is a chance that ongoing spectrum auctions may lead to greater market entry. Smaller firms, like Clearwire Communications, which offers wireless broadband services in some markets, may attempt to provide services that compete with the major carriers. Yet the current trend is in the opposite direction. The industry is a textbook oligopoly--premised on a bottleneck resource--with four major players. While no one should discount the possibility of new entrants, we must also look at the facts as they are, not as how we might imagine them to be.

Oh, I get it, Tim. You've called the game! Even though you admit that "the future of the industry.. is hard to predict," you're saying that there's no need to wait around to see what happens next. Let's just get on with the business of slicing up the fixed pie of networks and services that we have now.

Well, not so fast.

Prof. Wu is way off-base about both the current and future state of affairs in this market. As Hance Haney, Tim Lee, and Scott Wallsten, made clear in their earlier posts, there's a lot more competition at work in this market than he's giving it credit for. And even if it was just a 4-firm "oligopoly," that doesn't mean the market can't be vibrantly competitive under such a state of affairs. There are all sorts of 4-firm markets in this world and the sky in not falling there or here.

And, looking toward the future, the pessimism about future technological development is similarly unwarranted. Ours is an innovative culture, and few sectors have been more innovative over the past decade than the wireless sector. New technologies and services have been developed in the past, and will continue to be developed in the future, but, again, only if the innovators: (1) believe they can reap the fruits of the significant investments they will need to make and, (2) are not directly or indirectly prohibited by government from entering new markets, providing new services or experimenting with different business models and even network architectures.

This is why it is absolutely essential that we allow competition in network architectures and business models to see what consumers truly prefer. If we instead convert networks into giant commons and forbid such marketplace experimentation, then not only will we be unable to determine which systems or models are most efficient, but we will create pernicious investment / innovation disincentives, for both existing and potential infrastructure operators.

Against Infrastructure Socialism
In sum, the Skype-Wu proposal would essentially tell infrastructure operators and potential future operators of wireless networks: your networks are yours in name only and the larger community of wireless users--through the FCC or other regulatory bodies--will be free to set the parameters of how your infrastructure will be used in the future. Hearing that message, it is fair to ask why a network operator (or potential operator) would ever want to invest another penny of risk capital in a sector that was essentially governed as a monolithic commons or public good.

If we want innovation and investment to take place at the core of wireless networks, operators must have the right to make determinations about how to configure, package and price their goods and services. By contrast, if we leave it the regulators to do it on behalf of other users or interests (like Skype) who are more interested in maximizing benefits at the edge of the network at the expense of core innovation, the results will be disastrous. As Stanford University economists Bruce Owen and Gregory Rosston have argued in the context of Net neutrality for wireline networks (but it's equally applicable here):

The difficulty is that if we assign property rights in access to users rather than suppliers, resulting in an efficient price of access (zero), there will be no long run supply of Internet services. A zero price yields zero revenues--a lesson many dotcoms learned too late. While the benefits of the Internet can be made available to a particular user at zero cost, they cannot be made available to all users at zero cost.

And the same could be said of wireless networks and services as well. Of course, Skype and Prof. Wu have not suggested that wireless networks be given away free-of-charge, but they have not answered the difficult questions about how network access and services would be priced under their model to ensure future investment and innovation is not retarded. Applications or software providers that ride on top of existing networks will obviously want access prices to be as low, or close to zero, as is possible. But what if the carriers want to impose a small charge to help offset the burden on the network or to pay down their initial fixed cost of capital investment?

That's where price controls come into the picture. Every forced access regime necessitates the creation of pricing regulations. But as soon as you start playing that game, you run the risk of commoditizing the network since you deprive network operators of the ability to pay down costs and invest in upgrades. And so rate-of-return regulation must be brought into the picture as well to ensure prices are "fair and non-discriminatory" while also ensuring that carriers have at least some revenues to plow back into network investment / upgrades.

This is the dreadful regulatory model of the past that we have spent the last quarter century trying to dig ourselves out of. It became abundantly clear to everyone what a disaster this regime was for consumers and companies alike since it left little room for infrastructure innovation or competition.

But instead of relegating this nightmare of regulatory model to the ash heap of history, we're now witnessing an effort to roll back the clock and put it all back on the books. If the sophisticated networks of the future that we will need are going to get funded, developed and deployed, then infrastructure socialism in all its forms must be rejected.

posted by Adam Thierer @ 11:38 AM | Net Neutrality , Wireless

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You continue to have outstanding clarity of thought about all the disastrous implications of the "infrastructure socialism" approach.

You are dead on in your "assume the platform" characterization and in exposing their logic that if they value the network inputs at zero, prices are zero and their is no Internet and none of the freedoms and democracy they say they want to preserve and protect.

You do a great job at exposing the intellectual bankruptcy of their thinking.

Kudos, I always love reading your work.

Scott Cleland

Posted by: Scott Cleland at February 22, 2007 2:58 PM

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