Six years ago, the Phoenix Center released (and later published) a paper entitled Network Neutrality and Foreclosing Market Exchange: A Transaction Cost Analysis. In that paper, we analyzed the effects of network neutrality proposals that foreclose or severely limit market transactions between content providers and broadband service providers. Our model revealed that under plausible conditions, rules that prohibit efficient commercial transactions between content and broadband service providers could, in fact, be bad for all participants: consumers would pay higher prices, the profits of the broadband service provider would decline, and the sales of Internet content providers would also decline. As a result, such proposals would eliminate the potential for efficient, voluntary, welfare-improving market transactions.
Notwithstanding our warning, such proposals were eventually formalized in the FCC’s Open Internet Order. Significantly, while the FCC’s Open Internet Order prohibits such transactions for wireline networks, the Open Internet Order does not block voluntary deals in the mobile broadband sector. Given this opening in the rules, a real-world attempt to exploit this exception was inevitable.
As fate may have it, we now have anecdotal evidence of such an attempt. To wit, the Wall Street Journal just reported that ESPN is discussing with at least one mobile wireless carrier a deal that allows the cable sports channel to subsidize consumers’ wireless data plans. Video content is bandwidth intensive, and the usage charges incurred for mobile data properly incent consumers to consume bandwidth rationally. Consequently, to the consumer, ESPN’s content—which is largely streaming video of sporting events and news—is more costly to consume at the margin. Demand slopes downward, so the higher cost leads to lower consumption. Since ESPN is partly in the business of selling eyeballs to advertisers, the reduction in the use of its service cuts into profits. Likewise, since consuming ESPN’s video is desired by consumers, the reduction in demand for ESPN over mobile networks also reduces the demand for mobile data plans, reducing the profits of the mobile data provider. With both ESPN and the data networks hurt by the opportunity cost of bandwidth, there’s a win-win possibility for a voluntary market exchange.
In the ESPN deal, it appears that the arrangement may remove ESPN’s bandwidth from inclusion in the monthly data cap, a move that frees up the bandwidth allotment for other forms of content. Since the ESPN deal takes its content off the meter, in effect we have ESPN paying for a higher data cap for subscribers of its content. Of course, consumers are permitted to increase their limit or buy data above their limits, and this approach may arguably serve the same purpose as the transaction between ESPN and the carrier. For example, AT&T charges $10 per GB over the customers subscribed data cap. It appears that streaming a football game on a mobile connection could consume 0.6 to 1.2 GB (about $10 per game).
However, a consumer buying more data is unlikely to be the same deal as a direct content-to-carrier arrangement. First, the consumer is unlikely to know how much bandwidth is being consumed, and in my opinion, most consumers would prefer a service that says “ESPN is unlimited.” Second, while I have no insight into the negotiations, I suspect that the ESPN-carrier deal will have a price below $10 per game (i.e., about 1 GB), in large part because of the relative efficiency of an arrangement between two large and well-informed parties instead of between millions of mostly uninformed parties. Thus, by allowing the deal to occur between the content provider and the broadband service provider (rather than consumer and provider), the total cost of the arrangement is reduced, creating additional surplus. The ESPN deal will be an eco-system-wide price reduction; a result consistent with our theoretical model from 2007.
In the press release of a later work—Non-Discrimination or Just Nonsense—I was quoted as saying, “… the FCC’s proposed rule will likely block efficient voluntary transactions and block quality improvements. When that happens, consumers and content providers lose. Eventually, it will be the content sector pleading for the elimination of this rule.” The ESPN deal shows why this is true. Everyone stands to gain from the better management of capacity and congestion, so there are opportunities for surplus-creating exchange. Voluntary transactions in the less regulated mobile sector can increase consumer welfare, but such potential unfortunately remains bottled-up in the wireline sector as a direct consequence of the Open Internet Order.
Certainly, it is the job of regulators and antitrust officials to monitor markets for anticompetitive activity, and at a high level the concept of “openness” of the Internet is sensible. But one cannot regulate or mandate “openness”—it is an idea, not a policy. Policies are legally-defensible and written rules that direct specific action. Policies are also not limited to the actions involving the purported target activity, but produce evasive responses and alter the incentives across the entire ecosystem (e.g., the Open Internet Order will likely, at the margin, shift investment to wireless from wireline networks). Regulators of the ever-evolving Internet, perhaps the most important general purpose technology of our day, should not be enticed to act for the sake of claiming action on a sexy topic. Outright and ex ante prohibitions on voluntary transactions between the content and network layers is, in my opinion, exactly that.
The Internet, and the concept of network neutrality, deserve better.