Network Neutrality and Termination Fees

by on March 5, 2007

Tim Wu has an interesting (rough draft of a) short paper here that re-conceptualizes the network neutrality issue as a question of termination fees. He draws a little diagram showing you connected to eBay like this:


And Wu says:

What is notable is the lack of termination fees, or fees charged to reach customers. That is, your ISP, ISP1, doesn’t charge eBay an additional fee to reach you. Similarly, eBay’s ISP, ISP2, doesn’t charge you any money to reach eBay.

Viewed from this perspective, much of the current network neutrality debate can be cast as a debate over termination fees. The “priority-lane” proposals advanced by AT&T and others can be understood as proposals to begin charging a fee, not for transport, but to reach their customers.

That charging such a fee is possible as a matter of technology and economic power is clear. In our diagram above, in order to reach you, eBay must go through ISP1. In telecom jargon, ISP1 has a “termination monopoly” over you. Provided eBay wants to reach you, it would have to pay the termination charge ISP1 wants to charge. The diagram below shows this.

It seems to me that Wu makes precisely the same conceptual error that Yochai Benkler makes in The Wealth of Networks.

As I said of Benkler’s argument:

Sometimes, highly styized examples like this can illuminate important points by removing extraneous details. In this case, Benkler has done just the opposite: he’s abstracted away all the real-world characteristics of the web that are relevant to this issue. When we add them back in, it becomes obvious that this argument doesn’t work.

I think it’s far from clear that ISP1 has the ability to charge a termination fee to eBay, and I think Wu’s simplified example obscures, rather than illuminates the essential features of the problem. Certainly, they have the ability to threaten to cut eBay off, and to follow through on the threat if they don’t get what they want, but that does not demonstrate that eBay would actually acquiesce.

This is a bilateral monopoly. It’s in the interests of both eBay and ISP1 that the customer be able to access eBay. eBay obviously cares because it loses a customer. ISP1 cares because the price it can charge its customer is proportional to the value of the service, and so the price it can charge for no-eBay Internet access is lower than the price it can charge for unfiltered Internet access.

Looked at from this perspective, it might seem that the ISP has the upper hand because eBay would completely lose access to its customer, while the price the ISP could charge its customer would be only slightly diminished. However, I think three factors are likely to tip things in eBay’s favor. First, ISP1 doesn’t, in fact, have a termination monopoly over the customer in the sense that ISP can entirely block the customer from accessing eBay. People can access the Internet from work, from their neighbors’ WiFi, from friends or families’ houses, from a coffee shop, or a public library. So for a lot of ISP1 customers, cutting off eBay would simply irritate the customer (thereby hurting ISP1) without having much negative impact on eBay’s business. Certainly, if my ISP cut off eBay access, I’d have no trouble doing my shopping at work or at my girlfriend’s house.

Second, the consumer’s reaction to the loss of service would be strongly influenced by whom she perceived to be at fault. If she heard the ISP had cut off service deliberately, she’d be far more likely to cancel her service, switch to another broadband ISP, or call her Congresscritter demanding NN legislation than if she perceived that it was an innocent. Even if none of those options were available to her, she would be far more likely to go out of her way to continue patronizing eBay as a way of sticking it to her greedy ISP. This is why when negotiations between a cable company and a TV network break down, both sides spend so much time and effort trying to convince the public that the other is to blame.

Finally, and I think most importantly, we have to keep in mind that the negotiation would not be between ISP1 and eBay. It would between ISP1 on the one hand and eBay, Google, Yahoo, Microsoft, AOL, Disney, Skype, Blizzard, Apple, etc on the other hand. This adds a serious layer of complication for ISP1. Because even if it can afford to shut off eBay, it certainly can’t afford to shut off the entire Internet (or any significant fraction of it). That would guarantee that a lot of its customers would switch, cancel, or call their Congresscritters.

But eBay knows this. The know that if no one coughs up any money, ISP1 will be stuck, because it won’t be able to switch off everyone’s service at once. Moreover, eBay would know that if it made a deal first, there would be a risk that its competitors might negotiate a lower fee, putting it at a competitive disadvantage. So each website would, individually and collectively, have a strong incentive to refuse to pay ISP1’s toll. And as long as no one broke ranks, there would be nothing ISP1 could do about it.

We also have to remember that there’s more than one company in ISP1’s position, and eBay knows that too. It knows that if it gives in to ISP1’s demands, ISPs 3-8 will smell blood in the water and come around demanding the same price. Therefore, it’s in eBay’s interest to resist ISP1’s demands—even if it costs them some money in the short run—to scare ISPs 3-8 off from trying the same trick.

As I’ve pointed out before, we already have a situation in which the owners of various networks on the Internet try to maximize their profits by charging other networks what the market will bear. So if the broadband ISPs had the market power they needed to charge other networks for access to their customers, that market power would already be reflected in the peering agreements they negotiate with other networks. The fact that tier 1 networks peer on a settlement-free basis is evidence that they have roughly equal bargaining power.

So it seems to me that Prof. Wu is not entitled to simply assume that ISP1 can charge eBay a termination fee. Maybe there’s some clever strategy ISP1 could employ to coerce eBay into paying up, but I haven’t seen anyone explain how such a scheme would work.

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