by Berin Szoka & Adam Thierer
The latest call for "search neutrality" and "cloud neutrality" comes from Andrew Odlyzko of the University of Minnesota's School of Mathematics & Digital Technology Center--and probably among the top ten most influential academics in Internet policy. In his latest Review of Network Economics article "Network Neutrality, Search Neutrality, and the Never-ending Conflict between Efficiency and Fairness in Markets," Odlyzko shows (discussed by Ars) just how slippery the slippery slope of Net neutrality regulation will be--exactly as we predict in our recent paper Odlyzko concludes:
for pervasive infrastructure services that are crucial for the functioning of society, rules about allowable degrees of discrimination have traditionally applied, and are likely to be demanded for the Internet in the future. Those rules have often been set by governments, and are likely to be set by them in the future as well. For telecommunications, given current trends in demand and in rate and sources of innovation, it appears to be better for society not to tilt towards the operators, and instead to stimulate innovation on the network by others by enforcing net neutrality. But this would likely open the way for other players, such as Google, that emerge from that open and competitive arena as big winners, to become choke points. So it would be wise to prepare to monitor what happens, and be ready to intervene by imposing neutrality rules on them when necessary.
The net neutrality debate is often pictured as a contest between the two most prominent corporate champions of the opposing sides, AT&T and Google. But the underlying issue predates both companies by centuries. It was never resolved completely, since it arises from a conflict between society's drives for economic efficiency and for fairness. There is no reason to expect that this conflict will lessen, and instead there are arguments that suggest it will intensify. Should something like net neutrality prevail, the conflict would likely move to a different level. That level might become search neutrality. (And allegations about discriminatory behavior of a web search provider have surfaced recently in China, Tschang (2009).) Or, to take another currently popular concept, if "cloud computing" does become as significant as its enthusiasts claims, it could lead to dominance of a single service provider. The effective monopoly of that dominant player could then become perceived as far more insidious than any of the "walled gardens" or "intelligent network" that telcos would like to build.
Such an approach rests on a recognition that high-tech markets are driven by dynamic competition: Network effects often create markets with a limited number of players, so from a purely static perspective, such markets seem "monopolistic" or "oligopolistic," but over the perspective of just a few years, competition among technological titans tends to be highly rivalrous, with today's leaders often becoming tomorrow's laggards. Smaller entrepreneurial "furry mammals" quickly run circles around entrenched "dinosaurs" because established players necessarily struggle to keep pace with "disruptive innovation."
Many webmasters live in fear of the "Google Death Penalty"--relegation to the bottom of results for a "gray" search engine optimization tactic. The thin and ever-shifting line between "black hat" and "white hat" search engine optimization raises serious questions about arbitrariness. More ominously, search engines can openly profit from opacity here. If there is no clear route to the top of "organic results" for a given term, the only way to assure one's association with it is to buy "paid results" from search engines' themselves. Just as search engines worry that cable and telecommunications carriers may deliberately impair quality of service in order to force application providers to pay for a "fast lane," content providers may legitimately worry that dominant search engines "churn" organic results in order to make paid ads the only guaranteed method of reaching customers.
Serving up the standard online ads has turned out to be extremely profitable... And there are plenty more ads that can migrate online. But there are limits, since the advertising field is not all that large. (The total amount spent on advertising is lower than spending on voice telephony.) But if "behavioral targeting" can be exploited, extensive price discrimination would open up entirely new, and much larger, revenue sources. (Enterprises already spend on direct marketing and other promotions amounts comparable to what they spend on ads, and effective differential pricing could replace and augment that.) And the company in control of the process, the one with the information about customers, and in control of the delivery of the offers, could potentially end up in control of product pricing, essentially relegating the good and service providers to a commodity role. The profit potential of such a role is gigantic.
Odlyzko emphasizes that, "from the standard economic point of view, there is nothing nefarious about attempting to introduce differential charging," especially because it allows "service providers [to] obtain more funding, which may be used to build out networks." In other words, "differential charging" or "price discrimination" can certainly increase efficiency, ultimately benefiting the consumers who enjoy the improved products and services increased funding makes possible, but notes that "social acceptability of such practices is at wide variance with the recommendations of the conventional economic models." Translation: "gosh darn it, it's just not fair!" Odlyzko appears to be resigned to the conclusion that this essentially emotional reaction will ultimately drive the expansion of neutrality mandates, but doesn't clearly distinguish between this descriptive prediction and a normative judgment as to whether such an expansion would actually be good for consumers.
Odlyzko wouldn't be as widely respected if he weren't the sort of academic who takes such nuanced, if ambiguous (and perhaps even deliberately opaque), positions. But he could have followed in the footsteps of others who have mounted an unequivocal defense of "price discrimination." Among the best at explaining why we'd all be better off with less "fairness" is former FCC economist Rafi Mohammed, whose 2005 masterpiece The Art of Pricing: How to Find the Hidden Profits to Grow Your Business, never uses a single variant of the word "discriminate." Mohammed realizes that a rational conversation is hard enough when economic theory conflicts with what appears to be hard-wired emotional responses--but probably impossible when the words used for the economic theory is one as fraught with nasty historical connotations as "discrimination." So, to dispel any subconscious associations with racist thugs like Bull Connor, Mohammed simply--and brilliantly--introduces the term "the multi-price mindset" (id. at 86-91).
Mohammed isn't just read branding an impolitic term: The problem racial "discrimination" (what we usually think of when we hear the word "discrimination") is that it fails to discriminate among individuals of the same race, whereas Odlyzko's worries that pricing will be too finely focused on the individual consumer rather than the group. Moreover, Mohammed groups three related forms of "price discrimination" together under the term "multi-price mindset": differential pricing, versioning, and segment-based pricing. He explains brilliantly why this mindset is good for business:
A multi-price mindset is a series of strategies that enables you to profit from each customers unique product valuation. Remember those customers you thought would pay more? The multi-price mindset charges them higher prices, which they willingly pay. The multi-price mindset tips its hat to the law of demand by recognizing that lower prices will draw in new customers. Remember those shoppers who demurred because of price? The multi-price mindset discreetly offers them discounts. The multi-price mindset is the key to pricing for profits and growth for the following three reasons. First, price is aligned with value. If you aren't thinking about price in this manner, you are undoubtedly missing out on profits. Second, you'll make higher profits from the customers who value your product the most. Third, working in conjunction with the law of demand, the multi- price mindset increases your customer base through lower prices and offering new selling strategies. While you will earn fewer profits from these customers, you will nonetheless be earning additional, previously hidden, profits.
Of course, differential pricing means that many customers will pay less--or will buy products whose "one-size-fits-all" price simply would have exceeded their valuation of the product. Nowhere are benefits to consumers from multi-price mindset more apparent than in the realm of "Free." Wired editor Chris Anderson discusses three varieties of the "free" business model.
Yet another way that Google could justify its high valuation would be if the current hype about "cloud computing" becomes reality. If most of our data and computing migrate into a distributed network of processors and storage, entirely new opportunities would arise. Given the economics and the technology, with the "first mover advantage", "economies of scale," and similar factors, cloud computing could easily become dominated by one or a handful of players, who might then have huge power, and a corresponding profit potential. And Google is ideally positioned to grab such a role, since its core expertise is in deploying a distributed information technology infrastructure.
In either scenario, though, Google (or Yahoo! or Microsoft, or Facebook, or some other entity that might reach a position to exploit its position in the ways outlined here) would have to tread very carefully, since the public could easily decide its practices amounted to "being evil".
There are attractions to end-users in some levels of vertical integration. The concept of a do-it-yourself end-to-end network is attractive, but few users have the skills and patience to make it a reality. So we will likely see extensive vertical integration, the only question is where, and what dangers will it produce.
For Google (or some other entity) to fully exploit the potential of differential pricing or of cloud computing (and the latter would surely also involve extensive price discrimination), it is necessary to have a communications infrastructure that either that entity controls, or that is approximately net neutral. Otherwise, the communications network could grab the profits by charging differential fees to Google that would absorb most of the benefits, or could deploy its own competing "cloud" which might be less efficient, but could exclude competitors.
Unless we find a way to achieve "Digital DÃ©tente," the consequences of this increasing regulatory brinkmanship will be "mutually assured destruction" (MAD) for industry and consumers... "Digital DÃ©tente" would require that all parties concede something and work constructively toward a more "peaceful" (i.e., less regulatory) resolution. And yet, no Internet company wants to disarm unilaterally, foreswearing politics as a continuation of competition by other means. Only through multilateral disarmament could they break out of the current cycle of regulatory one-upmanship: If the companies in the Internet ecosystem could form a united front against increased government regulation and in favor of removing existing regulatory obstacles to competition, they could all return to their core competencies of creativity and innovation.