More on Net Neutrality, the Importance of Business Model Experimentation & Pricing Flexibility

by on May 9, 2012 · 13 comments

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:

 

 

Infrastructure socialism isn’t a sustainable alternative.

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Adam Thierer

Adam Thierer / Senior Fellow in Technology & Innovation at the R Street Institute in Washington, DC. Formerly a senior research fellow at the Mercatus Center at George Mason University, President of the Progress & Freedom Foundation, Director of Telecommunications Studies at the Cato Institute, and a Fellow in Economic Policy at the Heritage Foundation.

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