What Is The Fuss About “Net Neutrality?”

January 2011

The Federal Communications Commission (FCC) has long sought to impose rules requiring Internet Service Providers (ISPs) to continue to offer equal treatment to all traffic. You will be hearing more about this important issue. At the core of this dispute is lots of money. Not atypically, the numerous sound bites being reported by politicians, consumer advocates, and businesses do little to educate one about the real and substantial issues that are at play. We hope this article will help you understand the debate.

The concept of allowing equal treatment of all internet traffic has become known as network (or net) neutrality. Net neutrality sounds nice (what is there not to like about being neutral?), but the label does little to explain what is at issue. At times, both sides of the issue use this label to describe themselves. For this reason, we will not embrace this label in this article.

By a vote of 3-2 held on December 21, 2010, the FCC passed a new rule that:

1. Prevents wired service providers like Comcast and Verizon from blocking their competitors’ content;
2. Allows wireless service like AT&T, Verizon Wireless, and T-Mobile to block competitors’ voice and video services, and
3. Prohibits “unreasonable discrimination” in prices charged. In this context, discrimination means letting some packets of data travel faster than others. In short, the rules do NOT prevent ISPs from charging more for faster access.

As noted in the second point above, the FCC's new regulations contain a broad exception for wireless Internet. If you have a wi-fi hub or router connected to your DSL or cable modem, then you have a wired Internet connection. Wireless Internet refers to Internet provided over the cell phone system. That can be confusing because an increasing number of devices, like the iPad, can have both wi-fi and cellular connections and switch from one to the other seamlessly.

Wireless firms correctly note that their bandwidth is less abundant than what is available through fixed-line connections. Undeniably, providing reliable high-speed, high-capacity Internet over cellular networks is a far greater challenge than over wires, and wireless networks are more vulnerable to data hogs that use too much capacity. Consequently, giving cellular data providers more flexibility over managing capacity is justified. But, that does not justify the complete carte blanche that the FCC provided wireless services when compared to the wired carriers.

The FCC's decision to restrict the wired web and to give a broad exemption to wireless may cause the wired and wireless web to become different experiences. The wired Internet could remain the wide-open spaces we have come to expect. In contrast, the wireless Internet might become more like cable TV, with premium packages of select sites and services that run well, and the rest seeming more like fuzzy public access channels. Perhaps because of this, the wired internet may not be quite as doomed for obsolescence as its detractors say.

More Controversy around the Corner

The new FCC rule does not end the controversy. Republicans in Congress indicate that the FCC did not have the authority to make this rule, and they plan to reverse this new rule through legislation. In response to the FCC’s decision, House Speaker-to-be John Boehner (R-OH) said,

“Federal bureaucrats should not be in the business of regulating the Internet, and the new House majority will work to reverse this unnecessary and harmful federal government power grab next year.”

In a somewhat typical argument for limited government, opponents to the new FCC rule state that if the market demands Internet speed and access, the market will provide it without any help from the government. Under this thinking, the growth of Internet-related offerings is proof that innovation and investment occurs best without the government’s oversight, and should be allowed to continue without new regulation. Additionally, for those who distrust the government, free speech occurs better without government regulation.

On the other side of the isle, Senator Al Franken (D-MN), who has been quite vocal on these issues, thinks that the new FCC rule did not go far enough. He provided the following reaction:

“The FCC’s action today is simply inadequate to protect consumers or preserve the free and open Internet. I am particularly disappointed to learn that the order will not specifically ban paid prioritization, allowing big companies to pay for a fast lane on the Internet and abandoning the foundation of net neutrality. The rule also contains almost no protections for mobile broadband service, remaining silent on the blocking of content, applications, and devices. Wireless technology is the future of the Internet, and for many rural Minnesotans, it’s often the only choice for broadband.”

Opposition to the ruling will certainly also follow in the courts. In an April 2010 case, Comcast asserted that it had the right to slow its cable customers’ access to a file-sharing service called BitTorrent. The U.S. Court of Appeals for the District of Columbia unanimously ruled that the FCC lacks the authority to force ISPs to keep their networks open to all forms of content. This ruling has not been overturned.

The positions taken by corporate America on this issue are entirely predictable. Expect lots of lobbyist money on both sides, as follows:

1. The opponents to the FCC’s current rule argue that prioritization of bandwidth is necessary to facilitate transactions which will allow substantial future investment in Internet infrastructure. The added revenue from now-prohibited agreements could be used to pay for the building of increased broadband access to more consumers, including those in remote locations. Companies taking these positions are the cable companies, telephone companies with substantial wired connections, and technology companies that supply equipment to these companies. Their position is not entirely unreasonable; if you establish regulations that prevent owners of Internet infrastructure from sharing in the Internet’s massive revenue, then users should find someone else to build this expensive network.
2. Supporters of the FCC’s rule are those that provide the content that the Internet distributes. Not shockingly, they like the status quo since they are on the list of those who will be paying in the now-outlawed arrangements. YouTube, Google, Yahoo!, Skype, eBay, Amazon, Microsoft, and Netflix are examples of companies that call themselves net neutrality proponents.

What Changed to Cause this Controversy?

The Internet was developed as DARPANET. It was essentially a way for academics and private industry scientists working on non-classified defense department projects to communicate and collaborate. These academics were an egalitarian bunch and would never have thought of giving one university or one researcher priority to their communications. Besides, just the challenge of getting information routed reliably from source to destination was plenty for the technology of the time. When the Internet was opened to the public, there was not much money involved in the content but more in the transmission.

The FCC was established by the Communications Act of 1934, as the successor to the Federal Radio Commission. The Telecommunications Act of 1996 amended the Communications Act of 1934, and was the first major overhaul of U.S. telecommunications law in nearly 62 years. In 1996, the internet was used much differently than what occurs today. Then, you bought merchandise from Amazon.com, traded collectibles on eBay, looked up news and stock quotes, and explored new information. Viewed when the FCC had its 1996 authority update, the Internet could properly (albeit narrowly) be viewed as an information service.

The Internet in 2010 is a communications carrier. Today, thanks to Vonage, Skype, and others, the Internet is a telephone. Thanks to Netflix, YouTube and Hulu, the Internet is a television. Thanks to Live365 and Pandora, the Internet is a radio. You could build a new city, equip it with only high speed Internet, and the residents would not be lacking in any form of communications or entertainment. However, they would likely be at the mercy of just one provider. Since the FCC has regulatory authority over these other communication mediums, it is not surprising that the FCC would like to have the authority to regulate the Internet.

With this background in mind, the reason regulation is now being proposed to keep the Internet the same is:

1. Internet technology improved, allowing detailed discrimination regarding traffic to become feasible.
2. Mergers concentrated the ownership of the major Internet backbones into few companies. If one or two of these companies start bottle-necking one category of traffic, there are no alternate routes to take up the slack. Effectively, the mergers have begun to re-create what the famous 1970s breakup of Ma Bell sought to eliminate; namely, that your service provider, the intervening communications network, and the service on the opposite end are all the same company (such as Verizon).
3. Consent decrees included by the FCC as part some of the major telecom mergers requiring them to adhere to net neutrality principles have expired.

What is the concern?

Imagine you are watching a video on Netflix and it is frequently pausing. There could be several reasons for this. Your connection to the Internet may not be fast enough. Netflix's servers may be overwhelmed. Netflix may not have purchased enough bandwidth to service all its customers. There could be congestion at some point in between affecting all customers. But there are three things that it is not currently:

1. It is not a matter of not paying a Netflix surcharge that your ISP demands for good Netflix performance.
2. It is not a matter of somebody making a business decision to make Netflix run slow.
3. It is not a matter of somebody being paid to make Netflix run slow.

Absent any restrictions, no one knows what the major data providers will do, since these data providers have not yet cut any major controversial deals. But, here is a scenario that the regulators are trying to avoid. Again, the following uses the example of Netflix video streaming.

1. The ISP might decide that it would like to compete with Netflix. It establishes its own video streaming service, except that its service has the priority bandwidth to supply 1080p video with 5.1 stereo, while Netflix is constricted to a point where low visual resolution and low quality stereo sound has trouble.
2. The ISP might decide that Netflix needs to become a “premium partner” at an additional cost of several million dollars annually. The agreement ensures Netflix that their videos stream smoothly.

Another example involves restricting access to additional competitors. Let's say it is 2005 and you are News Corp. You have just spent over half a billion dollars buying MySpace.com because high school kids spend millions of hours a year at that site. Along comes a competitor named Facebook, which initially appeared on college campuses. Facebook recently moved to Palo Alto, expanded beyond colleges, and obtained serious venture capital. What to do?

Well, absent any restrictions, you could create special relationships with the major trunk line providers to insure that only MySpace users could have videos that ran smoothly and music that sounded good. The result is that Facebook (as we know it today) never happens. Ditto for any other future web site that threatens an established player. Who knows, maybe GeoCities or Friendster would still be the dominant social network site, still with their 1990s site design because their position is locked in with their strategic relationships with the ISPs. Maybe the old AOL or Compuserve could have locked up all the bandwidth so the web itself as we know it today would not exist.

The hallmark of Internet innovation has been the low entry cost. Somebody with a great idea can register a domain, buy a hosting plan, and give it a go. Nobody had to buy his way past the entrenched providers for the right to have his traffic run smoothly.

An alternative to government regulation

The Internet has a business model and it is not broken. You pay for bandwidth. The company providing Internet services also pays for bandwidth. And between them, there is a series of transfer payments that allows the data carriers to make money. For those having monopolistic positions (like fixed-wire telephone and cable companies), there is ample precedent for government regulations. There is plenty of good reason to forbid the possible special deals and partnerships described above.

Our current availability of bargain-price, high-speed unlimited Internet service occurs because of overcapacity in the major data trunks, combined with the fact that few people were using more than a tiny fraction of their bandwidth most of the time. Video and other streaming services are changing both of those. Thus, it is likely that the price of Internet plans is going to increase in the near future in order to help pay for network expansion. Many ISPs currently offering unlimited use might offer lower priced plans with monthly caps on traffic and raise the price of unlimited usage plans. Doing so will provide the necessary capital to expand Internet capacity.

As allowed by the FCC’s new rule, ISPs should get the money they need for future investment by selling monthly data limits on both fixed and mobile networks, and charge for usage above the amount already purchased. The ability to charge for usage provides an alternative to additional government regulation. In most things that we purchase, a greater quantity costs more, and a smaller quantity costs less. There is no good reason that a company should not be able to charge more money from a customer using larger amounts than is charged to a customer than does not have this larger need.

The evolving Internet may force a paradigm shift for mobile providers. If Skype works smoothly, do you need 500 calling minutes each month? If Twitter works smoothly, do you need thousands of texts a month? If Hulu and Netflix work smoothly, do you need the cell company's own video streaming? Could the mobile communications companies convert to a business model where data is their only product? Quite likely, but the status quo is always more comfortable.

The December 29, 2010 print edition of the magazine, The Economist, compares the U.S. to other developed countries on the question of net neutrality, and concludes as follows:

“These details are important, but the noise about them only makes the omission more startling: the failure in America to tackle the underlying lack of competition in the provision of internet access. In other rich countries it would not matter if some operators blocked some sites: consumers could switch to a rival provider. That is because the big telecoms firms with wires into people’s homes have to offer access to their networks on a wholesale basis, ensuring vigorous competition between dozens of providers, with lower prices and faster connections than are available in America. Getting America’s phone and cable companies to open up their networks to others would be a lot harder for politicians than prattling on about neutrality; but it would do far more to open up the net.”

Fulcrum Inquiry performs economic analysis in litigation, and appraises businesses and intangible assets.