Matt Yglesias today responded with a post of his own to a NYT article about sports channels and cable pricing by Brian Stelter that Yglesias believed had “bad analysis.” I’m here to defend Stelter a little bit because I think Yglesias was too harsh and that Yglesias erred in his own post about the nature of cable bundling. Yglesias’ posts on cable bundling are good, and especially valuable because his Slate and ThinkProgress audiences are not the most receptive to economic justifications for perceived unfair corporate pricing schemes. In part due to him I suspect, you rarely hear econ and business bloggers calling for a la carte pricing of cable channels.

And Yglesias is certainly right that you can’t really complain about the price of your cable package, which includes the few channels you watch plus the sports channels you don’t watch, because you obviously value the channels more than the price you pay per month, even if the sports are a “waste.” He falters when he says

So since those channels are worth $60 to you, even if unbundling happens your cable provider is going to find a way to charge you approximately $60 for them. Because at the end of the day, you’re paying your cable provider for access to the channels you do watch—not for access to the channels you don’t watch. The channels you don’t watch are just there. If the channels you do watch are worth $60 to you, then $60 is what you’ll pay for them.

It would be an amazing price discrimination scheme if it were true cable operators can figure out how to charge each subscriber the approximate price the subscriber values his favorite channels. Cable companies don’t currently have that ability. Even a la carte distributors, like Amazon Prime with their video offerings, don’t charge you exactly what you value TV shows and movies at. The efficiency of bundling cable channels arises not because cable companies are pricing everyone their reservation price, as Yglesias suggests. Bundling is efficient because in a high fixed-cost industry, like cable, cable channel bundles provide cost savings that outweigh the costs of providing “wasted” channels consumers don’t watch.

I think the main point of Stelter’s article is right and Yglesias is incorrect. It’s conceivable that most customers would actually see sustained lower cable prices if sports channels were someday offered as premium channels, like Showtime and HBO. If Stelter is faulted for anything, it’s that he mentioned the phrase “a la carte,” since it seems like his sources only alluded to a partial breakup of the current bundle–making sports a premium offering–not a wholesale a la carte offering. Stelter quoted a former DOJ antitrust lawyer and anonymous cable executives who say that increasing sports channel prices may make the cable bundle so pricey that cable operators will be forced to break up the bundle, and I see no reason to question their assessments.

I’ll attempt to illustrate what the cable executives are trying to avoid. Bundling components like cable channels lowers costs for providers. If you imagine an a la carte world, it’s plain the costs escalate. Instead of everyone picking from a menu of 3 or 4 bundles from a cable provider, every single subscriber household would have a different customized selection. Cable companies would have to ensure everyone is receiving their requested channels, frequently make corrections and updates, and incur other costs.

Not to mention, a la carte would eliminate many channels currently in existence because there is a cross-subsidy business model in place that makes low-demand channels available in the first place. (A la carte would especially harm religious, African-American, and other niche programming. Currently, these niche content creators have to market their channels only to a few cable and satellite companies for carriage. With a la carte, they would have to engage in nationwide and expensive marketing campaigns to all their likely customers, which is why these smaller firms typically oppose a la carte.) A la carte, then, is costly to both cable and content providers. Offering only a few bundles eliminates many costs.

However, when the price of the bundle increases with more expensive sports programming, as the Stelter piece describes, you lose customers because the bundle has become too expensive. Eventually, it becomes more cost-effective to spin off some sports channels as premium channels, charge those sports customers more, and offer a lower-priced package to everyone else and gain customers. And I suspect sports viewers have relatively inelastic demand (nothing ruins my fall weekend like a Bears black-out on the East Coast), so the losses from a sports unbundling could be minimal.

If there’s a lesson, it’s that this all goes back to Coase and his tautological but helpful theory of the firm. We know where efficient firm boundaries are based on where firm boundaries are. That is, the current cable packages could be disintegrated if it’s too costly to maintain them. In a dynamic market like cable, it may one day be efficient to break up the current bundle, charge everyone less, and make some sports channels premium channels.

We spend a lot of time here defending the simple proposition that flexible free-market pricing is a good thing. You would think that in 2012 we wouldn’t need to do so, but there’s a growing movement afoot today by some academics, regulatory activists, and public policymakers to have government start asserting more authority over broadband pricing. In particular, they want Congress, the FCC, or state officials to investigate and possibly even regulate efforts by wireline and wireless broadband carriers to use usage-based pricing and data caps as a method of calibrating supply and demand. This was the focus of my last weekly Forbes column, “The Specter Of Broadband Price Controls.” In the piece I note that:

Data caps and usage-based pricing are forms of what economists refer to as price discrimination. Although viewed with suspicion by some policymakers and regulatory-minded academics and activists, price discrimination is widely recognized to improve consumer welfare. Price-differentiated and prioritized services are part of almost every industrial sector in our capitalist economy. Notable examples include airline and hotel reservations, prioritized shipping services, amusement park passes, and fuel and energy pricing. Economists agree that price discrimination represents a sensible way to calibrate supply and demand while ensuring the fixed costs of doing business get covered. Consumers benefit from such pricing experimentation by gaining more options while firms gain more certainty about investment and service decisions.

This is confirmed by an excellent new Mercatus Center working paper on “The Impact of Data Caps and Other Forms of Usage-Based Pricing for Broadband Access,” by Daniel A. Lyons, an assistant professor of law at Boston College Law School. Lyons explains why a return to price controls for communications would be monumentally misguided. Lyons notes that “data caps and other forms of metered consumption are not inherently anti-consumer or anticompetitive. Rather, they reflect different pricing strategies through which a broadband company may recover its costs from its customer base and fund future infrastructure investment.” He notes that “by aligning costs more closely with use, usage-based pricing may effectively shift more network costs onto those consumers who use the network the most.”

What I find most interesting about the debate over broadband pricing flexibility is the way some so-called “consumer advocates” cannot seemingly wrap their heads around the fact that price discrimination can actually benefit most consumers by creating more and better pricing options and service alternatives. As I noted in my Forbes essay, “if policymakers lock-in flat rate pricing or regulate pricing such that it is not allowed to fluctuate with demand or investment needs, then it is likely that light users (including many lower income users) will end up paying more than they need to for their overall share of network costs. If that is also disallowed through rate regulation, then network investment will suffer and further innovation will be discouraged. Something has to give because, again, there really is no free lunch.”

It remains to be seen whether true free market pricing will be allowed to continue in this context, but make no doubt about it, this is the most important aspect of the ongoing debate about modern information economics. If America returns to price and rate controls for communications, innovation and investment will suffer greatly.

Oh, and here’s a video featuring Eli Dourado, who can explain this much more eloquently than me! …

Additional Reading

• More on Net Neutrality, the Importance of Business Model Experimentation & Pricing Flexibility (May 9, 2012)
• Real Talk on Net Neutrality (May 9, 2012)
• Netflix Falls Prey to Marginal Cost Fallacy & Pleads for a Broadband Free Ride (July 8, 2011)
• Smartphones & Usage-Based Pricing: Are Price Controls Coming? (July 12, 2011)
• Why Congestion Pricing for the iPhone & Broadband Makes Sense (October 7, 2009)
• The (Un)Free Press Calls for Internet Price Controls: “The Broadband Internet Fairness Act” (June 17, 2009)
• Free Press Hypocrisy over Metering & Internet Price Controls (June 18, 2009)
• Bandwidth Cap Hysteria & the Alternative (October 4, 2008)
• Once Again, Why Not Meter Broadband Pipes?  (September 7, 2007)
• Why Not Meter? (March 12, 2007)
• The Real Net Neutrality Debate: Pricing Flexibility Versus Pricing Regulation (October 27, 2005)

My most recent Forbes column is entitled, “We All Hate Advertising, But We Can’t Live Without It.” It’s my attempt to briefly (a) defend the role advertising has traditionally played in sustaining news, entertainment, and online service, and (b) discuss some possible alternatives to advertising that could be tapped if advertising starts failing us a media cross-subsidy.

What got me thinking about this issue again was the controversy over satellite video operator DISH Network offering its customers a new “Auto Hop” capability for its Hopper whole-home HD DVR system. Auto Hop will give viewers the ability to automatically skip over commercials for most recorded prime time programs shown on ABC, CBS, FOX and NBC when viewed the day after airing. It makes the viewing experience feel like the ultimate free lunch. Alas, something still must pay the bills. As innovative as that technology is, we can be certain that it will not make content consumption cost-free. We’ll just pay the price in some other way. The same is true for online services since it’s never been easier to use technology to block ads.

So, what is going to pay the bills for content as ad-skipping becomes increasingly automated and effortless? Stated differently, what are the other possible methods of picking up the tab for content creation? Here’s a rough taxonomy:

I.     CHARGES

A.     Direct Fees (Periodic billing / Pay-per-view)

B.    Indirect Charges (Tiers / Bundles / Package pricing)

II.     ADVERTISING

A.    General / Mass market ads (Billboards / Banner ads / Pop-up online ads)

B.     Targeted ads (Directed pitch)

C.     Integrated (Product placement / Payola)

D.     Sponsorship / Underwriting

III.     PHILANTHROPIC

A.     Individual  (ex: Arts & opera funding)

B.     Foundational (ex: Knight Foundation)

C.     Governmental  (ex: CPB / BBC model)

IV.     INTERNAL CROSS-SUBSIDY  (Profitable division subsidizes unprofitable / “loss leader” strategies)

There are probably other ways of subsidizing content creation, but those are the primary methods. I have no idea what combination of strategies will sustain content going forward, but I think advertising is likely to play a diminished role in the mix as it becomes increasingly easy for us to filter it out of the mix. But the content creators will just shift costs elsewhere and raise the prices for programming through direct and indirect pricing techniques. Do you like HBO’s pricing model? Pay-per-view? Paywalls? Well, it doesn’t make a difference whether you do or not because you’ll likely be seeing a lot more of those models in your life in coming years if advertising fades as a subsidization method.

Alternatively, as I also note in my Forbes piece, “we could see a lot more Texaco Star Theaters in our future, with major companies essentially owning specific shows or networks.” Such program sponsorship and content underwriting has always been with it, but it could really explode as a cross-subsidy method if traditional advertising starts failing. “But it will be challenging for every show or website to find its own corporate benefactor, and it will also raise issues about undue influence and bias,” I note in my essay.

I hope no one seriously believes that philanthropic models can fill the gaps. Even if we saw a significant uptick in voluntary charitable giving or even taxpayer support for the arts and media, there’s no way in hell it will possibly begin to cover the the bill for what advertising support covers today.

In the end, I can’t help but think how great we’ve had it when it comes to advertising. As I also noted in my essay, advertising has been “the great subsidizer of the press, entertainment, and online services” historically and benefited us tremendously even if we haven’t appreciated that fact. “It’s possible that no single industry — not newspapers nor search engines nor anything else — has done as much to advance the storehouse of accessible human knowledge in the 20th century as advertisers,” argues Washington Post columnist Ezra Klein. Klein is exactly right, yet it doesn’t really make a difference how important advertising has been to us if we fail to appreciate that fact and increasingly take steps to exclude it from our lives.

As that becomes easier and easier to accomplish, we shouldn’t bitch and whine when the bills (literally) come due for the content we all desire. As always, there is no free lunch. We’ll pay the price one way or another.

Additional Reading:

• my recent Charleston Law Review article on “Advertising, Commercial Speech & First Amendment Parity”
• Ezra Klein on the Importance of Advertising to Media
• The Hidden Benefactor: How Advertising Informs, Educates & Benefits Consumers
• There is No Free Lunch! No Advertising, No Media
• PFF’s Mega-Filing in the FCC’s “Future of Media” Proceeding

I wanted to follow up on Eli Dourado’s excellent previous post (“Real Talk on Net Neutrality“) to reiterate the importance of a few points he made and add some additional thoughts about the issues raised in that New York Times article on Net neutrality and forced access regulation that lots of people are talking about today.

What Eli’s post makes clear is that there are those of us who think about Net neutrality and infrastructure regulation in economic terms (a rapidly shrinking group, unfortunately) and those who think it about in quasi-religious terms. The problem with the latter ideology of neutrality uber alles, however, is that at some point it must confront real-world economics. This is Eli’s core point: Something must pay the bills. In this case, something must cover the significant fixed costs associated with broadband investments if you hope to sustain those networks. Unless you are ready to make the plunge and suggest that the government should cover those costs through massive infrastructure expenditures and even potential nationalization or municipalization of broadband networks — and some clearly would be — then you have to get serious about how those costs will be covered by private operators.

Thus, we come back to the importance of business model experimentation and pricing flexibility to this debate. I have been harping on this point for a long time now, going all the way back to this 2005 essay, “The Real Net Neutrality Debate: Pricing Flexibility Versus Pricing Regulation.” And there’s a litany of other things I’ve penned on the same point, many of which I have cited at the end of this essay.

Here are the core points I have tried to get across in those earlier essays:

• For progress to occur in any economic system, firms must be able to freely set prices for goods and services without fear of government price controls or micromanagement of business models. Heavy-handing tech mandates — especially Internet price controls — could have a profoundly deleterious impact on investment, innovation, and competition. After all, there can be no innovation or investment without a company first turning a profit.
• The Net neutrality debate is about whether the government will allow broadband services to be differentiated or specialized for unique needs. Differentiated and prioritized services and pricing are part of almost every industrial sector in a capitalistic economy. (ex: airlines, package shipping, hotels, amusement parks, grades of gasoline, etc.)  Why should it be any different for broadband? Indeed, it is essential that such flexibility be allowed precisely because it is the key to making sure more populations get served with more diversified offerings. Of course, advocates of neutrality uber alles think this is heresy, even if it is based on sound and widely-accepted economics. They just figure you can ban all sorts of business practices without it having any consequences.
• But, again, there is no such thing as a free lunch. Something has to pay for ongoing Internet investment. It doesn’t just fall like manna from heaven. Differentiated business services and pricing can help in this regard by allowing carriers to price more intensive or specialized users and uses to ensure that carriers don’t have to hit everyone – including average household users – with the same bill for service.  Why should the government make that illegal through Net neutrality regulation?
• Net neutrality can have, and already has had, unintended consequences. Consider bandwidth caps, which critics paint as some sort of nefarious, anti-consumer plot. In reality, they are just a tool to manage capacity; a tool that has been necessitated by Net neutrality regulation. When the law says you are not allowed to differentiate or specialize service offerings, you have to find other ways to manage capacity and make sure you can recoup fixed costs. In a world without the omnipresent threat of Net neutrality regulation, things might have played out quite differently. Broadband providers might have found creative ways to have other downstream providers help defray the costs of specialized services so that consumers weren’t stuck picking up the entire bill or being forced to deal with caps. For example, video game developers like Electronic Arts and Activision might be willing to help subsidize the costs associated with online gaming by picking up that expense and then amortizing the expense over a diverse universe of online gamers. Similarly, some content companies or video services could help cross-subsidize new online video ventures to ensure those costs do not have to be spread across all customers but instead only those who most demand those services. Again, this is the alternate universe that might have played out if not for the hyperventilating of vociferous regulatory advocates who worship at the alter of perfect “neutrality” in all things. To reiterate, this is not the way any other sector of our capitalist economy works. Service differentiation and price discrimination are not some sort of bizarre anomaly; they are the norm.
• When it comes to industrial organization questions, infrastructure socialism simply isn’t a sustainable long-term alternative. Sharing is not competing. We’ve tried line-sharing and forced access regimes before and they didn’t end well. Creating networks built on paper is a dangerous endeavor. In the short-term, you can milk existing infrastructures for every drop of value they have left, but eventually the bills will come due and something must pay for sustained investment and upgrades. Facilities-based competition, not infrastructure sharing is the path forward if we want truly robust and sustainable networks and markets.

Where will this debate turn next? As we saw in today’s New York Times piece, the regulatory proponents are turnung up the heat and asking for more day-to-day Net neutrality controls, making it increasingly difficult for differentiated service offerings to develop. That leaves broadband providers in the unenviable position of telling their customers that they’ll either have to live with caps or some variant of metered pricing. But bandwidth caps are increasingly controversial and, quite honestly, completely unnecessary if the carriers are at liberty to freely price their offerings to account for traffic.

Thus, I’d be willing to bet that we’ll see more broadband providers gradually phase in metered or two-part pricing schemes. Pure metering is a harder sell since many consumers resent it and it also remains unclear how easy it is to meter bits and communicate usage patterns to consumers. This leaves two-part pricing and tiered pricing. Two-part pricing would involve a flat fee for service up to a certain level and then a per-unit / metered fee over a certain level. I don’t know where the demarcation should be in terms of where the flat rate ends and the metering begins; that’s for market experimentation to sort out. But the clear advantage of this solution is that it preserves flat-rate, all-you-can-eat pricing for casual to moderate bandwidth users and only resorts to less popular metering pricing strategies when the usage is “excessive,” however that is defined. Or you can just go with tiers of service like wireless operators already have. Of course, if you have enough graduated tiers of service, it very quickly starts to resemble a metering scheme.

In the end, there’s just no way of escaping basic economics. If the law doesn’t allow service providers to use creative schemes to more efficiently allocate fixed costs, the end user will have to pick up the full cost of service. The only interesting question left is whether Net neutrality regulation will make that illegal too.

Additional Reading:

• Netflix Falls Prey to Marginal Cost Fallacy & Pleads for a Broadband Free Ride (July 8, 2011)
• Smartphones & Usage-Based Pricing: Are Price Controls Coming? (July 12, 2011)
• Why Congestion Pricing for the iPhone & Broadband Makes Sense (October 7, 2009)
• The (Un)Free Press Calls for Internet Price Controls: “The Broadband Internet Fairness Act” (June 17, 2009)
• Free Press Hypocrisy over Metering & Internet Price Controls (June 18, 2009)
• Bandwidth Cap Hysteria & the Alternative (October 4, 2008)
• Once Again, Why Not Meter Broadband Pipes?  (September 7, 2007)
• Why Not Meter? (March 12, 2007)
• The Real Net Neutrality Debate: Pricing Flexibility Versus Pricing Regulation (October 27, 2005)

Infrastructure socialism isn’t a sustainable alternative.

The Mercatus Center at George Mason University has just released my new white paper, “The Perils of Classifying Social Media Platforms as Public Utilities.” [PDF] I first presented a draft of this paper last November at a Michigan State University conference on “The Governance of Social Media.” [Video of my panel here.]

In this paper, I note that to the extent public utility-style regulation has been debated within the Internet policy arena over the past decade, the focus has been almost entirely on the physical layer of the Internet. The question has been whether Internet service providers should be considered “essential facilities” or “natural monopolies” and regulated as public utilities. The debate over “net neutrality” regulation has been animated by such concerns.

While that debate still rages, the rhetoric of public utilities and essential facilities is increasingly creeping into policy discussions about other layers of the Internet, such as the search layer. More recently, there have been rumblings within academic and public policy circles regarding whether social media platforms, especially social networking sites, might also possess public utility characteristics. Presumably, such a classification would entail greater regulation of those sites’ structures and business practices.

Proponents of treating social media platforms as public utilities offer a variety of justifications for regulation. Amorphous “fairness” concerns animate many of these calls, but privacy and reputational concerns are also frequently mentioned as rationales for regulation. Proponents of regulation also sometimes invoke “social utility” or “social commons” arguments in defense of increased government oversight, even though these notions lack clear definition.

Social media platforms do not resemble traditional public utilities, however, and there are good reasons why policymakers should avoid a rush to regulate them as such. Treating these nascent digital services as regulated utilities would harm consumer welfare because public utility regulation has traditionally been the archenemy of innovation and competition. Furthermore, treating today’s leading social media providers as digital essential facilities threatens to convert “natural monopoly” or “essential facility” claims into self-fulfilling prophecies. Related proposals to mandate “API neutrality” or enforce a “Separations Principle” on integrated information platforms would be particularly problematic. Such regulation also threatens innovation and investment. Marketplace experimentation in search of sustainable business models should not be made illegal.

Remedies less onerous than regulation are available. Transparency and data-portability policies would solve many of the problems that concern critics, and numerous private empowerment solutions exist for those users concerned about their privacy on social media sites.

Finally, because social media are fundamentally tied up with the production and dissemination of speech and expression, First Amendment values are at stake, warranting heightened constitutional scrutiny of proposals for regulation. Social media providers should possess the editorial discretion to determine how their platforms are configured and what can appear on them.

This 63-page paper can be found on the Mercatus site here, on SSRN, or on Scribd.  I’ve also embedded it below in a Scribd reader. Eventually, a shorter version of this paper will appear as a chapter in a MIT Press book.

Social Networks as Public Utilities [Adam Thierer]

Two data points in the news over the past 24 hours to consider:

• A new report on “Smartphone Adoption & Usage” by the Pew Internet Project finds that “one third of American adults – 35% – own smartphones” and that of that group “some 87% of smartphone owners access the Internet or email on their handheld” and “25% of smartphone owners say that they mostly go online using their phone, rather than with a computer.”
• According to the Wall Street Journal, the “Average iPhone Owner Will Download 83 Apps This Year.” That’s up from an average of 51 apps downloaded in 2010. (At first I was astonished when I read that, but then realized that I’ve probably downloaded an equal number of apps myself, albeit on an Android-based device.)

As I explain in my latest Forbes column, facts like these help us understand “How iPhones And Androids Ushered In A Smartphone Pricing Revolution.” That is, major wireless carriers are in the process of migrating from flat-rate, “all-you-can-eat” wireless data plans to usage-based plans. The reason is simple economics: data demand is exploding faster than data supply can keep up.

“It’s been four years since the introduction of the iPhone and rival devices that run Google’s Android software,” notes Cecilia Kang of The Washington Post. “In that time, the devices have turned much of America into an always-on, Internet-on-the-go society.” Indeed, but it’s not just the iPhone and Android smartphones. It’s all those tablets that have just come online over the past year, too. We are witnessing a tectonic shift in how humans consume media and information, and we are witnessing this revolution unfold over a very short time frame.

Unsurprisingly, therefore, “unlimited” wireless data plans are probably on the way out since, as I observe in my Forbes piece:

That model created unsustainable network traffic burdens and it’s surprising unlimited plans have lasted this long. With smartphone users increasingly using their mobile devices to access the Internet and consume more cloud-based services and mobile video than ever, the “all you can eat” data buffet eventually had to end.

But critics are far too quick to suggest this is some of nefarious, anti-consumer conspiracy. In reality, I argue:

Tiered and metered pricing schemes are a sensible way to price demand for bandwidth-intensive users and applications and, in the process, alleviate network congestion, encourage new investment, and ensure that average costs for consumers are more reasonable over time.

Using usage data provided by Nielsen, I document the dramatic traffic growth that carriers are struggling to deal with but also show how most average consumers will do better under the new tiered plans. That’s because, even with a significant uptick in wireless data demand, the vast majority of users will not exceed the lowest tier of service (2 GB) that carriers are pricing at $20-$30. That’s less than most of them pay today. Thus:

It’s only the most rapacious mobile data consumers who’ll pay the higher tier prices. Doesn’t it make more sense that the most intensive network users pay more instead of raising average costs for all consumers? Why should minimal data users subsidize the big eaters?

Instead of repeating it all here, I’d just encourage you to bounce over to Forbes to read my entire essay.

The interesting policy question raised by all this is whether critics and policymakers will give network operators the freedom to innovate and employ creative business models so market experimentation can determine which pricing schemes will best calibrate supply and demand while also ensuring optimal network investment. You may recall that usage-based pricing has already become a flashpoint in the Net neutrality wars, and just last Friday I wrote about Netflix’s shameless attempt to get the feds to regulate usage-based pricing on the wireline front.

So, stay tuned. This fight could really heat up. Perhaps it’s time to dust off the old books and papers about how to fight off government price controls!

Related Reading:

• Netflix Falls Prey to Marginal Cost Fallacy & Pleads for a Broadband Free Ride (July 8, 2011)
• Why Congestion Pricing for the iPhone & Broadband Makes Sense (October 7, 2009)
• The (Un)Free Press Calls for Internet Price Controls: “The Broadband Internet Fairness Act” (June 17, 2009)
• Free Press Hypocrisy over Metering & Internet Price Controls (June 18, 2009)
• Once Again, Why Not Meter Broadband Pipes?  (September 7, 2007)
• Why Not Meter? (March 12, 2007)
• The Real Net Neutrality Debate: Pricing Flexibility Versus Pricing Regulation (October 27, 2005)

The FCC proposed new rules today aimed at combating wireless “bill shock,” a term that describes mobile subscribers getting hit with overage charges they didn’t anticipate. The proposed rules would require wireless providers to create a system for alerting customers when they are about to incur extra usage charges for voice, text, data, or roaming.

I can certainly see why some consumers may be frustrated with wireless pricing practices. But this frustration hardly constitutes evidence that the mobile marketplace is actually failing. Yes, mobile carriers sometimes make mistakes, and they probably need to do more to ensure their customers understand how overage charges work.

Competitive forces, however, are far better equipped than federal regulators to punish providers that engage in
genuinely harmful practices. And if the federal government must “do something” about bill shock, educating mobile subscribers about where to locate and track their usage information is a far better approach than prescriptive, burdensome federal regulation.

Hypocritically, even as the FCC tries to reign in bill shock, its own policies are harming consumers far more than any wireless industry practices. The FCC has again and again put off spectrum auctions that would enable mobile providers to offer better services at lower prices. As a result, consumers are suffering to the tune of billions of dollars each year. Economists Thomas Hazlett and Roberto Munoz published a study last year in which they concluded that U.S. wireless prices would decline by 8% if the FCC were to allocate an additional 60mhz of spectrum to mobile telephony.

If the FCC truly cares about wireless subscribers, rather than simply grandstanding against competitive (if imperfect) mobile carriers, the Commission’s top priority should be to aggressively free up the airwaves.

Today I appeared on CNBC’s “Power Lunch” to debate Net neutrality issues and the specific role of pricing in this debate. Specifically, the producers wanted to know whether websites should be allowed to pay a higher fee to allow consumers faster access to their sites or should it be equal for every website.  The show was partially a response to the rumors that the may be some sort of deal pending between Verizon and Google about prioritized services. On the program, I was up against Craig Aaron of Free Press.  During the discussion I made several points, many of which first appeared in my 2005 essay on “The Real Net Neutrality Debate: Pricing Flexibility Versus Pricing Regulation.” Here are the key points I tried to get across:

• In a free-market economy, companies should be able to freely set prices for goods and services without fear of government price controls.
• This isn’t about consumers paying more for basic Internet access or having their connections “slowed down”?  This is about whether the government will allow some broadband services to be differentiated or specialized for unique needs, such as online gaming, live event telecasts, secure telepresence conferences, telemedicine, etc.
• Differentiated and prioritized services and pricing are part of almost every industrial sector in a capitalistic economy. (ex: airlines, package shipping, hotels, amusement parks, grades of gasoline, etc.)  Why should it be any different for broadband?
• It’s always important to remember that there is no such thing as a free lunch. Something has to pay for Internet access. It doesn’t just fall like manna from heaven.  Differentiated services may help in this regard by allowing carriers to price more intensive or specialized users and uses to ensure that carriers don’t have to hit everyone – including average household users – with the same bill for service.  Why should the government make that illegal through Net neutrality regulation?
• Heavy-handing tech mandates – especially Internet price controls – could have a profoundly deleterious impact on investment, innovation, and competition. After all, there can be no innovation or investment without a company first turning a profit.   We don’t want to return to the era of rotary-dial regulated monopoly, in which our choices were few and our services were standardized and rudimentary.  We should let our current experiment with facilities-based, head-to-head competition continue.

http://plus.cnbc.com/rssvideosearch/action/player/id/1559985749/code/cnbcplayershare

Interesting piece here from Slate’s Farhad Manjoo on why AT&T should dump unlimited data plans and end what he calls the “iPhone all-you-can-eat buffet.”  He notes that: “The typical smartphone customer consumes about 40 to 80 megabytes of wireless capacity a month. The typical iPhone customer uses 400 MB a month. AT&T’s network is getting crushed by that demand.” Because “some iPhone owners are hogging the network” and causing “a slowed-down wireless network,” Manjoo recommends a congestion pricing model as a method of balancing supply and demand:

How would my plan work? I propose charging $10 a month for each 100 MB you upload or download on your phone, with a maximum of $40 per month. In other words, people who use 400 MB or more per month will pay $40 for their plan, or $10 more than they pay now. Everybody else will pay their current rate—or less, as little as $10 a month. To summarize: If you don’t use your iPhone very much, your current monthly rates will go down; if you use it a lot, your rates will increase. (Of course, only your usage of AT&T’s cellular network would count toward your plan; what you do on Wi-Fi wouldn’t matter.) To understand the advantages of tiered pricing, let’s look at AT&T’s current strategy of spending billions to build more network space. Why won’t this work? For the same reason building more roads doesn’t reduce traffic—more capacity increases the attractiveness of driving, which brings a lot more cars to the road, which leads to more gridlock.

Congestion pricing and metering is something I’ve written quite a bit about here in the context of wireline broadband (1, 2, 3), but Manjoo is equally correct that it could be applied for wireless data plans.  It has the added value of taking pressure off lawmakers to impose Net neutrality regulation since pricing of the pipe becomes an effective substitute for most other forms of network management. In other words, price, don’t block bandwidth-hogging customers and applications.  The problem, Manjoo explains:

Of course, users would cry bloody murder at first. The traditional criticism of tiered pricing on telecommunications systems is that it’s too expensive and too annoying for customers; people don’t know how much they’re spending during the month, and then they’re smacked with huge bills. Most Internet companies aren’t big fans of tiered pricing, either. They worry that adding a meter to Internet time will reduce people’s propensity to try out new stuff online—killing innovation on the world’s most innovative communications platform. But tiered pricing on the iPhone doesn’t have to be onerous. I’d call on AT&T to create automatic tiers—everyone would start out on the $10/100 MB plan each month, and your price would go up automatically as your usage passes each 100 MB tier. The key to implementing this policy is transparency. The phone should have an indicator—sort of like the battery bar—that changes color as you pass each monthly tier. That way, people can adjust their usage to suit how much they’d like to pay—limiting surfing if they approach the next tier, or deciding to press on if money’s no object.

What Manjoo is getting at here is what economists refer to as a “Ramsey two-part tariff.” A two-part tariff (or price) would involve a flat fee for service up to a certain level and then a per-unit / metered fee over a certain level. It is widely regarded by most economists as the most efficient and pragmatic solution to high-fixed cost, low marginal cost investment conundrums.  It’s hard to know where the demarcation should be in terms of where the flat rate ends and the metering begins, but that’s for market experimentation to sort out. But the clear advantage of this solution is that it preserves flat-rate, all-you-can-eat pricing for casual to moderate bandwidth users and only resorts to less popular metering pricing strategies when the usage is “excessive,” however that is defined.

Some companies have shown signs of embracing it, but few have formally adopted congestion pricing or metering.  Worse yet, some of the regulation-happy activist groups in D.C. (like the neo-Marxist charlatans as the UnFree Press) have already made ridiculous accusations that metered pricing is somehow “unfair” when, in reality, it is the fairest system under the sun. There’s even been legislation introduced by Rep. Eric Massa (D-NY) that would forbid the practice through the imposition of Internet price controls.  Foreclosing experimentation with such innovative pricing schemes would be a real innovation-killer.

I hope we get there eventually for all high-speed data services, whether we are talking wireline or wireless. Although I generally try to be agnostic about business models, I think this one is worth doing a little cheerleading for because it helps take regulatory pressure off the marketplace.  Pricing also acts as a signal for others innovators and entrepreneurs in the market regarding how to adjust investment strategies or enter new markets.

In a past life — that is, from roughly 1994-2004 — I spent an enormous amount of time countering the proponents of “open access” regulation for communications and high-tech networks.  My work in that field culminated in the publication of a 2003 book with my old Cato colleague Wayne Crews entitled, What’s Yours is Mine: Open Access & the Rise of Infrastructure Socialism. We aimed to counter the efforts of bureaucrats and central planners to command technology companies and industry sectors to share networks, facilities, or specific technologies with rivals in the name of “competition.”  Simply stated, sharing is not competing, and competition in the creation of networks is just as important as competition in the goods, services, and information that move across those networks.  Moreover, there are property right considerations that come into play when governments seek to commandeer networks or take over network management decisions.

But let’s just stick to the economic issue here regarding the incentives created by the network-sharing mentality of the “forced access” movement and the fiction associated with the belief that network sharing can create competition.  My old PFF colleague Randy May, who currently serves as President of the Free State Foundation, continues to cover developments in this field far closer than I do, and has always done much better work on the subject than me.  Recently, Randy addressed some new fictions put forth by the radical Leftist activity group, the (Un-)Free Press who are, once again, spinning a revisionist history of telecom and media policy.  Specifically, Free Press has recently suggested that in the late 1990s we lived in a veritable communications nirvana, with thousands of Internet Service Providers and/or “competitive exchange carriers” hotly “competing” for our business.  Here’s how Randy May addresses this:

Let’s assume for the sake of argument that the 6000 figure for the number of independent ISPs is an indisputable fact. Nevertheless, I would not want the FCC’s development of a broadband plan to be “data driven” (in the wrong way) by this particular data point. Rather, I would want commissioners to understand that the 6000 ISPs existed merely at the sufferance of an agency policy of “managed competition” through regulated common carrier resale, and that such a “managed competition” policy does not provide incentives either for the incumbent providers to upgrade their networks or for the so-called “competitors” actually to build out their own network facilities. And I would want them to understand that, in the long run, which is what matters, consumers benefit more from facilities-based competition that supports sustainable competition than from managed resale that does not support sustainable competition.

As usual, Randy gets it exactly right.  Of course, it is certainly true that if you don’t give a damn about facilities-based innovation and the growth of networks at the core, not just the periphery, then forced access regulation may seem preferable.  If you want to treat the provision of broadband as a “plain vanilla” commoditized service, with just a basic level of service available from dozens of “competitors,” then forced access can maintain the illusion of “a market” for a time.  Indeed, this is essential what many foreign governments are still doing today; squeezing as much juice out of the old lemons as possible and hoping for a miracle when infrastructure upgrades are needed.  Some supporters of this regulatory model will say that government can always just pass a big tax increase or use a massive government outlay for new services, or something along those lines.  But even if you think government spending on high-tech infrastructure is the sensible way to go — and it certainly doesn’t seem to be going so well these days — you still have to hope that government bureaucrats will do a better job of directing investments and innovation than private network managers. Again, if you can believe in that fairy tale, then forced access is just your ticket. But don’t be surprised when the bubble bursts and investment dries up. [For the complete story on how all this unfolded here in the U.S. over the past decades, see Jeff Eisenach’s PFF paper, “Broadband Policy: Does the U.S. Have It Right After All?”]

Of course, these battles live on with the Net neutrality wars as the forced access crowd seeks to assert more government control over broadband networks by regulating terms of service or even price (see 1, 2, 3, 4).  I’ve become quite convinced that we’ll always have these forced access fights with us.  The network or service in question might change — broadband networks, operating systems, search engines, whatever — but the battle about control over digital technologies and networks will continue.  Here’s hoping that real Internet freedom prevails.

Web Pro News’ Jason Lee Miller seems to think he’s hoisted my colleague Bret Swanson, and The Progress & Freedom Foundation in general, on our own collective  petard.  Bret had responded to Tim Wu’s NYT op-ed by questioning Wu’s argument for developing “alternative supplies of bandwidth” to free us from the tyranny of the OPEC-like broadband cartel:

Unlike natural resources such as oil, which, while abundant, are at some point finite, bandwidth is potentially infinite. The miraculous microcosmic spectrum reuse capabilities of optical fiber and even wireless radiation improve at a rate far faster than any of our macrocosmic machines and minerals. It is far more efficient to move electrons than atoms, and yet more efficient to move photons. Left unfettered, these technologies will continue delivering bandwidth abundance.

Miller suggests that this response to Wu destroys arguments Bret and others at PFF have made against net neutrality regulation–a crusade led by Wu (who taught me Internet law, as it happens):

So what [Swanson is] saying is bandwidth scarcity is a notion invented by internet service providers and wireless providers to jack up prices and provide excuses for interfering with competing services on their networks. Nice. In a weird way, Swanson focuses so hard on disproving Wu’s analogy one way, he misses how the analogy is proved in another: a few organizations (government or not) controlling an important resource and forcing artificial scarcity in order to control the market for that resource is called a cartel.

Miller’s “Gotcha!” rests on the seemingly undeniable premise that broadband can’t be both abundant (as Bret argues) and scarce (such that ISPs must management traffic on their networks, however non-neutral that may be).   But in fact, this seeming contradiction is inherent in the very nature of the Internet–and the way Internet access is currently priced.

On the one hand, Bret is right that broadband is “abundant” in a way that resources in the real world cannot be:  Continued investments in broadband networks by network operators have dramatically increased the amount of bandwidth available–causing prices to plummet for both wireline and wireless broadband.  Consumers today enjoy greater download speeds while paying constantly decreasing prices per bit.  So much for Wu’s OPEC analogy.

But contrary to those defenders of net neutrality regulation who think we can somehow grow our way out of the problem of network congestion merely by increasing the amount of bandwidth available, the demand for bandwidth is also infinitely elastic.  Making more bandwidth available simply encourages the development of new services and content whose use and consumption requires more bandwidth.  The significant advances in bandwidth available to U.S. broadband consumers in recent years have made it possible for us all to share huge amounts of data through peer-to-peer file-sharing services, view essentially infinite amounts of video back up hundreds of gigabytes on online storage services like Amazon’s reasonably-priced S3, and even begin moving our most basic computing tools like email and word processing into the “cloud.”  One has only to contemplate the kind of bandwidth that will be required when YouTube goes hi-def (something the less-popular Vimeo has already done) to realize that, from the network operator’s perspective, trying to solve network congestion problems simply by increasing the amount of bandwidth available is like a pie-eating contest where the prize is… more pie.

Thus, broadband can be increasingly “abundant” in the sense that there is always more of it available than ever before and, in the narrow and particular sense of Internet network congestion, “scarce” ( i.e., unlimited) at the same time.  This apparent contradiction stems from three facts:

1. Internet content and services are increasingly free to the user, either supported by advertising revenues or by some “up-sell” of additional features beyond the basic, free version.  This means that consumers have no economic reason not to gobble up the “new, new thing”–which usually consumes more bandwidth than whatever content or service it replaces.
2. Similarly, and more importantly, data use is priced on an all-you-can-eat basis.  Consumers pay a flat monthly fee for essentially “unlimited” broadband.
3. The secret to the Internet’s efficiency lies in its architecture as a packet-switching network of networks:  Unlike the circuit-switched traditional telephone network, the Internet works precisely because only a small fraction of its users are sending or requesting bits at any particular moment.  If everyone tried to watch a hi-def video at once (or watch any video, for that matter), the Internet would simply crash to a screeching halt.  Thus, even “abundant” bandwidth is necessarily scarce in terms of how many people can try to use it at any particular moment for a particular application.  Yes, it’s conceivable that in some future world with orders of magnitude more bandwidth than exists today, every person could indeed watch a classic YouTube video from 2008, but if they all tried to host holographic conference calls…  the same basic limitation would apply.

Thus it is that a tiny number of network users can consumer the vast majority of its bandwidth.  Since fact #1 is essentially a law of the Internet universe, and since no amount of additional bandwidth will overcome the constraints inherent in fact #3, ISPs must find some way of dealing with the problem of network congestion if they are to satisfy the vast majority of their customers whose network use is degraded by those who use more bandwidth than they do.  Proponents of network neutrality regulation like Wu would limit the ability of ISPs to deal with this problem through traffic management by putting government bureaucrats in charge of deciding which forms of management are benign and which are not.  (On this very day, the FCC is about to hold Comcast in violation of a non-binding 2005 policy statement for throttling, but not blocking, certain bandwidth-hogging users of the peer-to-peer file-sharing system BitTorrent.)

While some amount of traffic management will always be necessary, the need for it can certainly be reduced by changing fact #2:  moving to a different pricing structure for Internet access.  As my PFF colleague Adam Thierer has explained,

a “Ramsey two-part tariff” … would involve a flat fee for service up to a certain level and then a per-unit / metered fee over a certain level. I don’t know where the demarcation should be in terms of where the flat rate ends and the metering begins; that’s for market experimentation to sort out. But the clear advantage of this solution is that it preserves flat-rate, all-you-can-eat pricing for casual to moderate bandwidth users and only resorts to less popular metering pricing strategies when the usage is “excessive,” however that is defined.

Experiments in this area are indeed underway (and see further discussion here).  Their ultimate success will likely depend on setting the all-you-can-eat threshold high enough that ordinary users (say, 90-95% of all users) are not affected.

In the meantime, those of us who defend the accelerating abundance of broadband as the result of ongoing investments by network operators while opposing net neutrality regulation as an impediment to such investments clearly have our work cut out for us in explaining the apparent contradiction of “scarcity”-in-abundance that is unique to Internet bandwidth.