Corbin Barthold invited me on Tech Freedom’s “Tech Policy Podcast” to discuss the history of antitrust and competition policy over the past half century. We covered a huge range of cases and controversies, including: the DOJ’s mega cases against IBM & AT&T, Blockbuster and Hollywood Video’s derailed merger, the Sirius-XM deal, the hysteria over the AOL-Time Warner merger, the evolution of competition in mobile markets, and how we finally ended that dreaded old MySpace monopoly!

What does the future hold for Google, Facebook, Amazon, and Netflix? Do antitrust regulators at the DOJ or FTC have enough to mount a case against these firms? Which case is most likely to have legs?

Corbin and I also talked about the of progress more generally and the troubling rise of more and more Luddite thinking on both the left and right. I encourage you to give it a listen:

In my latest column for The Hill, I consider that dangers of government gambling our tax dollars on risky industrial policy programs. I begin by noting:

Roll the dice at a casino enough times, and you are bound to win a few games. But knowing the odds are not in your favor, how much are you willing to risk losing by continuing to gamble? This is the same issue governments confront when they gamble taxpayer dollars on industrial policy efforts, which can best be described as targeted and directed efforts to plan for specific future industrial outputs and outcomes. Throwing enough money at risky ventures might net a few wins, but at what cost? Could those resources have been better spent? And do bureaucrats really make better bets than private investors?

I continue on to note that, while the US is embarking on a major new industrial policy push, history does not provide us with a lot of hope regarding Uncle Sam’s betting record when he starts rolling those industrial policy dice. “How much tolerance should the public have for government industrial policy gambling?” I ask. I continue on:

Generally speaking, “basic” support (broad-based funding for universities and research labs) is wiser than “applied” (targeted subsidies for specific firms or sectors). With basic R&D funding, the chances of wasting resources on risky investments can be contained, at least as compared to highly targeted investments in unproven technologies and firms.

I also argue that “The riskiest bets on new technologies and sectors are better left to private investors,” and note how, “America’s venture capital industry remains the envy of the world because it continues to power world-beating advanced technology.” Accordingly, I conclude:

While some government investments will always be necessary, policymakers engaging in casino economics means bad industrial policy bets and taxpayer money squandered on risky ventures best made by private actors. We need to keep Uncle Sam’s gambling habits in check.

Read the whole thing here. And here’s a list of more of my recent writing on industrial policy:

• Adam Thierer & Connor Haaland, “Does the US Need a More Targeted Industrial Policy for AI & High-Tech?” Presentation for IHS Papers Workshop: Does America Need a New Industrial Policy?, forthcoming, July 23, 2021.
• Adam Thierer, “‘Japan Inc.’ and Other Tales of Industrial Policy Apocalypse,” Discourse, June 28, 2021.
• Adam Thierer & Connor Haaland, “Should the U.S. Copy China’s Industrial Policy?” Discourse, March 11, 2021.
• Connor Haaland & Adam Thierer, “Can European-Style Industrial Policies Create Tech Supremacy?” Discourse, February 11, 2021.
• Matthew D. Mitchell and Adam Thierer, “Industrial Policy is a Very Old, New Idea,” Discourse, April 6, 2021.
• Adam Thierer, “On Defining ‘Industrial Policy,’” Technology Liberation Front, September 3, 2020.
• “Skeptical Takes on Expansive Industrial Policy Efforts,” Technology Liberation Front, ongoing series.

Here’s a new animated explainer video that I narrated for the Federalist Society’s Regulatory Transparency Project. The 3-minute video discusses how earlier “tech giants” rose and fell as technological innovation and new competition sent them off to what the New York Times once appropriately called “The Hall of Fallen Giants.” It’s a continuing testament to the power of “creative destruction” to upend and reorder markets, even as many pundits insist that there’s no possibility change can happen.

This is an important lesson for us to remember today, as I noted in the recent editorial for The Hill about why, “Open-ended antitrust is an innovation killer“:

Those who worry about today’s largest tech giants becoming supposedly unassailable monopolies should consider how similar fears were expressed not so long ago about other tech titans, many of which we laugh about today. Just 14 years ago, headlines proclaimed that “MySpace Is a Natural Monopoly,” and asked, “Will MySpace Ever Lose Its Monopoly?” We all know how that “monopoly” ceased to exist. At the same time, pundits insisted “Apple should pull the plug on the iPhone,” since “there is no likelihood that Apple can be successful in a business this competitive.” The smartphone market of that era was viewed as completely under the control of BlackBerry, Palm, Motorola and Nokia. A few years prior to that, critics lambasted the merger of AOL and TimeWarner as a new corporate “Big Brother” that would decimate digital diversity and online competition.

Accordingly, policymakers should be humble and recognize that, “it’s better to let rivalry and innovation emerge organically,” and only bring in the wrecking ball of heavy-handed antitrust regulation as a last resort, I argued. Technological change and entrepreneurialism has a way of upending and reordering markets when we least expect it. Just ask all those members of the Hall of Fallen Giants.

Congress is considering reforming television laws and solicited comment from the public last month. On Friday, I submitted a letter encouraging the reform effort. I attached the paper Adam and I wrote last year about the current state of video regulations and the need for eliminating the complex rules for television providers.

As I say in the letter, excerpted below, pay TV (cable, satellite, and telco-provided) is quite competitive, as this chart of pay TV market share illustrates. In addition to pay TV there is broadcast, Netflix, Sling, and other providers. Consumers have many choices and the old industrial policy for mass media encourages rent-seeking and prevents markets from evolving.

Dear Chairman Upton and Chairman Walden:

Thank you for the opportunity to respond to the Committee’s December 2014 questions on video regulation.

…The labyrinthine communications and copyright laws governing video distribution are now distorting the market and therefore should be made rational. Congress should avoid favoring some distributors at the expense of free competition. Instead, policy should encourage new entrants and consumer choice.

The focus of the committee’s white paper on how to “foster” various television distributors, while understandable, was nonetheless misguided. Such an inquiry will likely lead to harmful rules that favor some companies and programmers over others, based on political whims. Congress and the FCC should get out of “fostering” the video distribution markets completely. A light-touch regulatory approach will prevent the damaging effects of lobbying for privilege and will ensure the primacy of consumer choice.

Some of the white paper’s questions may actually lead policy astray. Question 4, for instance, asks how we should “balance consumer welfare and the rights of content creators” in video markets. Congress should not pursue this line of inquiry too far. Just consider an analogous question: how do we balance consumer welfare and the interests of content creators in literature and written content? The answer is plain: we don’t. It’s bizarre to even contemplate.

Congress does not currently regulate the distribution markets of literature and written news and entertainment. Congress simply gives content producers copyright protection, which is generally applicable. The content gets aggregated and distributed on various platforms through private ordering via contract. Congress does not, as in video, attempt to keep competitive parity between competing distributors of written material: the Internet, paperback publishers, magazine publishers, books on tape, newsstands, and the like. Likewise, Congress should forego any attempt at “balancing” in video content markets. Instead, eliminate top-down communications laws in favor of generally applicable copyright laws, antitrust laws, and consumer protection laws.

As our paper shows, the video distribution marketplace has changed drastically. From the 1950s to the 1990s, cable was essentially consumers’ only option for pay TV. Those days are long gone, and consumers now have several television distributors and substitutes to choose from. From close to 100 percent market share of the pay TV market in the early 1990s, cable now has about 50 percent of the market. Consumers can choose popular alternatives like satellite- and telco-provided television as well as smaller players like wireless carriers, online video distributors (such as Netflix and Sling), wireless Internet service providers (WISPs), and multichannel video and data distribution service (MVDDS or “wireless cable”). As many consumers find Internet over-the-top television adequate, and pay TV an unnecessary expense, “free” broadcast television is also finding new life as a distributor.

The New York Times reported this month that “[t]elevision executives said they could not remember a time when the competition for breakthrough concepts and creative talent was fiercer” (“Aiming to Break Out in a Crowded TV Landscape,” January 11, 2015). As media critics will attest, we are living in the golden age of television. Content is abundant and Congress should quietly exit the “fostering competition” game. Whether this competition in television markets came about because of FCC policy or in spite of it (likely both), the future of television looks bright, and the old classifications no longer apply. In fact, the old “silo” classifications stand in the way of new business models and consumer choice.

Therefore, Congress should (1) merge the FCC’s responsibilities with the Federal Trade Commission or (2) abolish the FCC’s authority over video markets entirely and rely on antitrust agencies and consumer protection laws in television markets. New Zealand, the Netherlands, Denmark, and other countries have merged competition and telecommunications regulators. Agency merger streamlines competition analyses and prevents duplicative oversight.

Finally, instead of fostering favored distribution channels, Congress’ efforts are better spent on reforms that make it easier for new entrants to build distribution infrastructure. Such reforms increase jobs, increase competition, expand consumer choice, and lower consumer prices.

Thank you for initiating the discussion about updating the Communications Act. Reform can give America’s innovative telecommunications and mass-media sectors a predictable and technology neutral legal framework. When Congress replaces industrial planning in video with market forces, consumers will be the primary beneficiaries.

Sincerely,

Brent Skorup Research Fellow, Technology Policy Program Mercatus Center at George Mason University

If there is one thing I have learned in almost 23 years of covering communications and media regulation it is this: No matter how well-intentioned, regulation often has unintended consequences that hurt the very consumers the rules are meant to protect. Case in point: “universal service” mandates that require a company to serve an entire area as a condition of offering service at all. The intention is noble: Get service out to everyone in the community, preferably at a very cheap rate. Alas, the result of mandating that result is clear: You get less competition, less investment, less innovation, and less consumer choice. And often you don’t even get everyone served.

Consider this Wall Street Journal article today, “Google Fiber Is Fast, but Is It Fair? The Company Provides Neighborhoods With Faster and Cheaper Service, but Are Some Being Left Behind?” In the story, Alistair Barr notes that:

U.S. policy long favored extending service to all. AT&T touted its “universal service” in advertisements more than a century ago. The concept was codified in a 1934 law requiring nationwide “wire and radio services” to reach everyone at “reasonable charges.” In exchange for wiring a community, telecommunications providers often gained a monopoly. Cities made similar deals with cable-TV providers beginning in the 1960s.

The problem, of course, is that while this model allowed for the slow spread of service to most communities, it came at a very steep cost: Monopoly and plain vanilla service. I documented this in a 1994 essay entitled, “Unnatural Monopoly: Critical Moments in the Development of the Bell System Monopoly.” As well-intentioned regulatory mandates started piling up, competition slowly disappeared. And a devil’s deal was eventually cut between regulators and AT&T to adopt the company’s advertising motto — “One Policy, One System, Universal Service” — as the de facto law of the land.

It took us almost a century to dig ourselves out of that mess and move towards telecommunications competition. Alas, we’re still living with the vestiges of this old regulatory mentality. Cities and counties across America still impose a wide variety of “universal service” regulatory mandates. Again, their intention is noble: They want everyone in their community served. You can’t blame them for that. But the result is still the same: Limited facilities-based competition and investment.

And so we return to today’s Wall Street Journal story about Google Fiber, which explains how local officials are finally starting to understand these realities. The story notes:

In 2011, Google struck a deal with authorities in both Kansas City, Kan., and Kansas City, Mo., to build the service based on customer demand. City officials say they didn’t push hard for universal coverage because they thought faster Internet service would boost the local economy and they were competing against so many other cities. “The main point was to win and bring that infrastructure to our city,” said Rick Usher, assistant city manager of Kansas City, Mo. As phone and cable companies slowed their own expansion plans, more cities allowed the selective approach.

Google’s ‘build-to-demand’ model is catching on because it produces results: More infrastructure investment, innovation, and competition. Traditional telecom and broadband operators are prepared to step up investment, too, when the incentives are right:

Verizon was required by cities and some state laws to build and offer its FiOS service widely across cities. It stopped expanding to new cities in 2010; to date, it has spent more than $23 billion on the FiOS rollout. Chief Financial Officer Fran Shammo said in March that the company wouldn’t expand to additional markets until FiOS had “finally returned its cost of capital.” If Verizon resumes expansion, the company would consider Google’s build-to-demand model because it has the potential to be more profitable, said Chris Levendos, a Verizon executive overseeing the FiOS build-out in Manhattan. Others are doing just that. AT&T said in April it would offer Internet speeds of up to one gigabit in as many as 100 cities. It is building to demand and working with local authorities to reduce construction costs, the company said. Tuesday, it said it would bring the high-speed service to Cupertino, Calif., close to Google’s headquarters. This approach “starts to make this business model look quite attractive,” John Stankey, AT&T’s chief strategy officer, said at an investor conference on Aug. 13.

Again, when you get the incentives right and give investors and innovators a green light, they will seize the opportunity. And that’s even true — actually, it is especially true — for high fixed-cost investments like fiber networks.

But wait, aren’t there some pockets of the population that will fall through the cracks under this alternative arrangement? In the short-term, potentially yes. But the right answer to that “digital divide” problem is never to restrict short-term investment and innovation opportunities just because you think you have a better, more “well intentioned” plan. That is the crucial mistake policymakers made in the past. Their desire to get everyone served at the exact same time with the exact same plain vanilla service meant we got sub-optimal technologies and stagnant markets with little hope of any new innovation or investment over the long-haul.

This is how “universal service” consistently fails us. Universal service sells us short. It sells human ingenuity short. The logic that motivates universal service regulation is that: ‘Well, this is about the best we can do. Let’s just get everyone some basic level of service and that will be just and good.’  Can you imagine if we would have applied this logic to other major markets and technologies?!

But what about the under-served communities? First, when you allow new innovation in networks, you never know how or where they might spread next. If you have more competitors offering unique networks architectures and services, there is a very good chance that entrepreneurial minds will figure out how to push out the boundaries of what is possible, especially in terms of how the service is delivered.

Consider this: Back in the old days, did it really make sense to try to stretch a thin copper wire way, way out into the middle of every valley, desert, farm field, and mountain? The myopic universal service mindset says: ‘Well, that’s all we had at the time.’ Perhaps for a time it really was. But how much quicker might we have seen some sort of alternative system if we hadn’t locked in those old assumptions as policy requirements? Is it impossible to believe that wireless technologies might have developed much more quickly if the incentives would have been right? Again, there was no reason for any innovators or investors to even consider the idea at a time when policymakers were mandating copper wires be stretched to every corner of the land, and as they were showering favored companies with subsidies to achieve that goal. That’s not something a new innovator could compete with, and so no one did. It would have been like policymakers saying we needed a “universal service” policy for cheap hamburgers for the masses and then showering McDonald’s with subsidies since they were the first one in many local markets who could deliver on that promise. Had we had such a universal cheap hamburger policy, do you think any other fast food places would have ever come to town and tried to compete against those subsidized burgers? Not likely.

The lesson for today’s policymakers is clear: Open up markets, relax regulatory burdens, eliminate discriminatory taxes and subsidies, and clear away other barriers to investment. Then see what happens. As the Google Fiber experience suggests, innovative minds can and will emerge to offer constructive solutions and slowly spread new networks and technologies.

OK, but won’t there still be some communities that are underserved, even with all that new innovation and investment. It’s certainly possible. And where those communities exist, some government action may be necessary to incentivize the spread of some sort of network to them, or even have the government build it for the community. I’m not opposed to that. (Have you ever driven through the hills of West Virginia or the mountains of rural Western states? Hard places to get wired networks out to!) I’m not very optimistic local governments will do a very good job of building sophisticated networks because they already have a horrible track record in this regard. But, again, I don’t oppose local action on this front if no other alternatives appear after a certain period of time.

But, again, the answer here is not crazy national and state-based universal service mandates that regulate everyone in every community as if they had the same problem. Let competition and innovation work its magic where it can and do not mess that up. Where it proves much harder for that network competition and innovation to take root, use smart incentives to get companies to build out their networks further, or offer alternative wireless infrastructure of some sort, or just have the government build the networks themselves. But we should always give competition and innovation the benefit of the doubt and see what happens first.

So, let me perfectly clear what I am saying here: GOOD INTENTIONS ARE NEVER ENOUGH! [And yes, I am using all caps because I am shouting!] The next time somebody starts mouthing something about how they have the moral high ground in these debates because their intentions are supposedly pure as the driven snow, ask them to show you results. Tell them you want evidence that their intentions have actually produced something concrete and positive for society. If their answer is, in essence, ‘Well, with our regulatory mandates we can at least get everybody some basic level of really crappy monopoly service,’ then tell them that they can take their good intentions and shove them. We can do better.

Shortly after Tom Wheeler assumed the Chairmanship at the Federal Communications Commission (FCC), he summed up his regulatory philosophy as “competition, competition, competition.” Promoting competition has been the norm in communications policy since Congress adopted the Telecommunications Act of 1996 in order to “promote competition and reduce regulation.” The 1996 Act has largely succeeded in achieving competition in communications markets with one glaring exception: broadcast television. In stark contrast to the pro-competitive approach that is applied in other market segments, Congress and the FCC have consistently supported policies that artificially limit the ability of TV stations to compete or innovate in the communications marketplace.

Radio broadcasting was not subject to regulatory oversight initially. In the unregulated era, the business model for over-the-air broadcasting was “still very much an open question.” Various methods for financing radio stations were proposed or attempted, including taxes on the sale of devices, private endowments, municipal or state financing, public donations, and subscriptions. “We are today so accustomed to the dominant role of the advertiser in broadcasting that we tend to forget that, initially, the idea of advertising on the air was not even contemplated and met with widespread indignation when it was first tried.”

Section 303 of the Communications Act of 1934 thus provided the FCC with broad authority to authorize over-the-air subscription television service (STV). When the D.C. Circuit Court of Appeals addressed this provision, it held that “subscription television is entirely consistent with [the] goals” of the Act. Analog STV services did not become widespread in the marketplace, however, due in part to regulatory limitations imposed on such services by the FCC. As a result, advertising dominated television revenue in the analog era.

The digital television (DTV) transition offered a new opportunity for TV stations to provide STV services in competition with MVPDs. The FCC had initially hoped that “multicasting” and other new capabilities provided by digital technologies would “help ensure robust competition in the video market that will bring more choices at less cost to American consumers.”

Despite the agency’s initial optimism, regulatory restrictions once again crushed the potential for TV stations to compete in other segments of the communications marketplace. When broadcasters proposed offering digital STV services with multiple broadcast and cable channels in order to compete with MVPDs, Congress held a hearing to condemn the innovation. Chairmen from both House and Senate committees threatened retribution against broadcasters if they pursued subscription television services — “There will be a quid pro quo.” Broadcasters responded to these Congressional threats by abandoning their plans to compete with MVPDs.

It’s hard to miss the irony in the 1996 Act’s approach to the DTV transition. Though the Act’s stated purposes are to “promote competition and reduce regulation, it imposed additional regulatory requirements on television stations that have stymied their ability to innovate and compete. The 1996 Act broadcasting provision requires that the FCC impose limits on subscription television services “so as to avoid derogation of any advanced television services, including high definition television broadcasts, that the Commission may require using such frequencies,” and prohibits TV stations from being deemed an MVPD. The FCC’s rules require TV stations to “transmit at least one over-the-air video programming signal at no direct charge to viewers” because “free, over-the-air television is a public good, like a public park, and might not exist otherwise.

These and other draconian legislative and regulatory limitations have forced TV stations to follow the analog television business model into the 21st Century while the rest of the communications industry innovated at a furious pace. As a result of this government-mandated broadcast business model, TV stations must rely on advertising and retransmission consent revenue for their survival.

Though the “public interest” status of TV stations may once have been considered a government benefit, it is rapidly becoming a curse. Congress and the FCC have both relied on the broadcast public interest shibboleth to impose unique and highly burdensome regulatory obligations on TV stations that are inapplicable to their competitors in the advertising and other potential markets. This disparity in regulatory treatment has increased dramatically under the current administration — to the point that is threatening the viability of broadcast television.

Here are just three examples of the ways in which the current administration has widened the regulatory chasm between TV stations and their rivals:

• In 2012, the FCC required only TV stations to post “political file” documents online, including the rates charged by TV stations for political advertising; MVPDs are not required to post this information online. This regulatory disparity gives political ad buyers and incentive to advertise on cable rather than broadcast channels and forces TV stations to disclose sensitive pricing information more widely than their competitors.
• This year the FCC prohibited joint sales agreements for television stations only; MVPDs and online content distributors are not subject to any such limitations on their advertising sales. This prohibition gives MVPDs and online advertising platforms a substantial competitive advantage in the market for advertising sales.
• This year the FCC also prohibited bundled programming sales by broadcasters only; cable networks are not subject to any limitations on the sale of programming in bundles. This disparity gives broadcast networks an incentive to avoid limitations on their programming sales by selling exclusively to MVPDs (i.e., becoming cable networks).

The FCC has not made any attempt to justify the differential treatment — because there is no rational justification for arbitrary and capricious decision-making.

Sadly, the STELA process in the Senate is threatening to make things worse. Some legislative proposals would eliminate retransmission consent and other provisions that provide the regulatory ballast for broadcast television’s government mandated business model  without eliminating the mandate. This approach would put a quick end to the administration’s “death by a thousand cuts” strategy with one killing blow. The administration must be laughing itself silly. When TV channels in smaller and rural markets go dark, this administration will be gone — and it will be up to Congress to explain the final TV transition.

The Federal Communications Commission (FCC) recently sought additional comment on whether it should eliminate its network non-duplication and syndicated exclusivity rules (known as the “broadcasting exclusivity” rules). It should just as well have asked whether it should eliminate its rules governing broadcast television. Local TV stations could not survive without broadcast exclusivity rights that are enforceable both legally and practicably.

The FCC’s broadcast exclusivity rules “do not create rights but rather provide a means for the parties to exclusive contracts to enforce them through the Commission rather than the courts.” (Broadcast Exclusivity Order, FCC 88-180 at ¶ 120 (1988)) The rights themselves are created through private contracts between TV stations and video programming vendors in the same manner that MVPDs create exclusive rights to distribute cable network programming.

Local TV stations typically negotiate contracts for the exclusive distribution of national broadcast network or syndicated programming in their respective local markets in order to preserve their ability to obtain local advertising revenue. The FCC has long recognized that, “When the same program a [local] broadcaster is showing is available via cable transmission of a duplicative [distant] signal, the [local] broadcaster will attract a smaller audience, reducing the amount of advertising revenue it can garner.” (Program Access Order, FCC 12-123 at ¶ 62 (2012)) Enforceable broadcast exclusivity agreements are thus necessary for local TV stations to generate the advertising revenue that is necessary for them to survive the government’s mandatory broadcast television business model.

The FCC determined nearly fifty years ago that it is an anticompetitive practice for multichannel video programming distributors (MVPDs) to import distant broadcast signals into local markets that duplicate network and syndicated programming to which local stations have purchased exclusive rights. ( See First Exclusivity Order, 38 FCC 683, 703-704 (1965)) Though the video marketplace has changed since 1965, the government’s mandatory broadcast business model is still required by law, and MVPD violations of broadcast exclusivity rights are still anticompetitive.

The FCC adopted broadcast exclusivity procedures to ensure that broadcasters, who are legally prohibited from obtaining direct contractual relationships with viewers or economies of scale, could enjoy the same ability to enforce exclusive programming rights as larger MVPDs. The FCC’s rules are thus designed to “allow all participants in the marketplace to determine, based on their own best business judgment, what degree of programming exclusivity will best allow them to compete in the marketplace and most effectively serve their viewers.” (Broadcast Exclusivity Order at ¶ 125.)

When it adopted the current broadcast exclusivity rules, the FCC concluded that enforcement of broadcast exclusivity agreements was necessary to counteract regulatory restrictions that prevent TV stations from competing directly with MVPDs. Broadcasters suffer the diversion of viewers to duplicative programming on MVPD systems when local TV stations choose to exhibit the most popular programming, because that programming is the most likely to be duplicated. ( See Broadcast Exclusivity Order at ¶ 62.) Normally firms suffer their most severe losses when they fail to meet consumer demand, but, in the absence of enforceable broadcast exclusivity agreements, this relationship is reversed for local TV stations: they suffer their most severe losses precisely when they offer the programming that consumers desire most.

The fact that only broadcasters suffer this kind of [viewership] diversion is stark evidence, not of inferior ability to be responsive to viewers’ preferences, but rather of the fact that broadcasters operate under a different set of competitive rules. All programmers face competition from alternative sources of programming. Only broadcasters face, and are powerless to prevent, competition from the programming they themselves offer to viewers. (Id. at ¶ 42.)

The FCC has thus concluded that, if TV stations were unable to enforce exclusive contracts through FCC rules, TV stations would be competitively handicapped compared to MVPDs. ( See id. at ¶ 162.)

Regulatory restrictions effectively prevent local TV stations from enforcing broadcast exclusivity agreements through preventative measures and in the courts: (1) prohibitions on subscription television and the use of digital rights management (DRM) prevent broadcasters from protecting their programming from unauthorized retransmission, and (2) stringent ownership limits prevent them from obtaining economies of scale.

Preventative measures may be the most cost effective way to protect digital content rights. Most digital content is distributed with some form of DRM because, as Benjamin Franklin famously said, “an ounce of prevention is worth a pound of cure.” MVPDs, online video distributors, and innumerable Internet companies all use DRM to protect their digital content and services — e.g., cable operators use the CableCard standard to limit distribution of cable programming to their subscribers only.

TV stations are the only video distributors that are legally prohibited from using DRM to control retransmission of their primary programming. The FCC adopted a form of DRM for digital television in 2003 known as the “broadcast flag”, but the DC Circuit Court of Appeals struck it down.

The requirement that TV stations offer their programming “at no direct charge to viewers” effectively prevents them from having direct relationships with end users. TV stations cannot require those who receive their programming over-the-air to agree to any particular terms of service or retransmission limitations through private contract. As a result, TV stations have no way to avail themselves of the types of contractual protections enjoyed by MVPDs who offer services on a subscription basis.

The subscription television and DRM prohibitions have a significant adverse impact on the ability of TV stations to control the retransmission and use of their programming. The Aereo litigation provides a timely example. If TV stations offered their programming on a subscription basis using the CableCard standard, the Aereo “business” model would not exist and the courts would not be tying themselves into knots over potentially conflicting interpretations of the Copyright Act. Because they are legally prohibited from using DRM to prevent companies like Aereo from receiving and retransmitting their programming in the first instance, however, TV stations are forced to rely solely on after-the-fact enforcement to protect their programming rights — i.e., protected and uncertain litigation in multiple jurisdictions.

Localism policies make after-the-fact enforcement particularly cost for local TV stations. The stringent ownership limits that prevent TV stations from obtaining economies of scale have the effect of subjecting TV stations to higher enforcement costs relative to other digital rights holders. In the absence of FCC rules enforcing broadcast exclusivity agreements, family owned TV stations could be forced to defend their rights in court against significantly larger companies who have the incentive and ability to use litigation strategically.

In sum, the FCC’s non-duplication and syndication rules balance broadcast regulatory limitations by providing clear mechanisms for TV stations to communicate their contractual rights to MVPDs, with whom they have no direct relationship, and enforce those rights at the FCC (which is a strong deterrent to the potential for strategic litigation). There is nothing unfair or over-regulatory about FCC enforcement in these circumstances. So why is the FCC asking whether it should eliminate the rules?

The Supreme Court hears oral arguments today in a case that will decide whether Aereo, an over-the-top video distributor, can retransmit broadcast television signals online without obtaining a copyright license. If the court rules in Aereo’s favor, national programming networks might stop distributing their programming for free over the air, and without prime time programming, local TV stations might go out of business across the country. It’s a make or break case for Aereo, but for broadcasters, it represents only one piece of a broader regulatory puzzle regarding the future of over-the-air television.

If the court rules in favor of the broadcasters, they could still lose at the Federal Communications Commission (FCC). At a National Association of Broadcasters (NAB) event earlier this month, FCC Chairman Tom Wheeler focused on “the opportunity for broadcast licensees in the 21st century . . . to provide over-the-top services.” According to Chairman Wheeler, TV stations shouldn’t limit themselves to being in the “television” business, because their “business horizons are greater than [their] current product.” Wheeler wants TV stations to become over-the-top “information providers”, and he sees the FCC’s role as helping them redefine themselves as a “growing source of competition” in that market segment.

If TV stations share Chairman Wheeler’s vision for their future, the FCC’s “help” in redefining the role of broadcast licensees in the digital era could represent a potential win rather than a loss. If Wheeler truly seeks to enable TV stations to deliver a competitive, fixed and mobile cable-like service, it could signal a positive shift in the FCC’s traditionally stagnant approach to broadcast regulation.

Like all regulatory pronouncements, the devil is always in the details — notwithstanding the existing and legitimate skepticism that TV stations have as to whether the FCC can and will treat them fairly in the future. For better or worse, many will judge the “success” of the broadcast incentive auction by the amount of revenue it raises. This reality provides the FCC with unique incentives to “encourage” TV stations to give up their spectrum licenses. In Washington, “encouragement” can range from polite entreaty to regulatory pain.

After the FCC imposed new ownership limits on TV stations last month, some fear the FCC will choose pain as its persuader. Last month’s FCC action prompts them to ask, if Wheeler is sincere in his desire to help broadcasters pivot to a broader business model, why impose new ownership limits on TV stations that could hinder their ability to compete with cable and over-the-top companies?

Chairman Wheeler attempted to address this question in his NAB speech, but his answer was oddly inconsistent with his broader vision. He said the FCC’s new ownership limits are rooted in the traditional goals of competition, diversity, and localism among TV stations. That only makes sense, however, if you believe TV stations should compete only with other TV stations. Imposing new ownership limits on TV stations won’t help them pivot to a future in which they compete in a broader “information provider” market — it would hinder them.

I expect TV station owners are wondering: If we accept Chairman Wheeler’s invitation to look beyond our current product, will he meet us on the horizon? Or will we find ourselves standing there alone? It’s hard to predict the future, because the future is always just over the horizon.

Last December, it was my pleasure to take part in a great event, “The Disruptive Competition Policy Forum,” sponsored by Project DisCo (or The Disruptive Competition Project). It featured several excellent panels and keynotes and they’ve just posted the video of the panel I was on here and I have embedded it below. In my remarks, I discussed:

• benefit-cost analysis in digital privacy debates (building on this law review article);
• the contrast between Europe and America’s approach to data & privacy issues (referencing this testimony of mine);
• the problem of “technopanics” in information policy debates (building on this law review article);
• the difficulty of information control efforts in various tech policy debates (which I wrote about in this law review article and these two blog posts: 1, 2);
• the possibility of less-restrictive approaches to privacy & security concerns (which I have written about here as well in those other law review articles);
• the rise of the Internet of Things and the unique challenges it creates (see this and this as well as my new book); and,
• the possibility of a splintering of the Internet or the rise of “federated Internets.”

The panel was expertly moderated by Ross Schulman, Public Policy & Regulatory Counsel for CCIA, and also included remarks from John Boswell, SVP & Chief Legal Officer at SAS, and Josh Galper, Chief Policy Officer and General Counsel of Personal, Inc. (By the way, you should check out some of the cool things Personal is doing in this space to help consumers. Very innovative stuff.) The video lasts one hour. Here it is:

The Mercatus Center at George Mason University has released a new working paper by Daniel A. Lyons, professor at Boston College Law School, entitled “Innovations in Mobile Broadband Pricing.”

In 2010, the FCC passed net neutrality rules for mobile carriers and ISPs that included a “no blocking” provision (since struck down in FCC v. Verizon). The FCC prohibited mobile carriers from blocking Internet content and promised to scrutinize carriers’ non-standard pricing decisions. These broad regulations had a predictable chilling effect on firms trying new business models. For instance, Lyons describes how MetroPCS was hit with a net neutrality complaint because it allowed YouTube but not other video streaming sites on its budget LTE plan (something I’ve written on). Some critics also allege that AT&T’s Sponsored Data program is a net neutrality violation.

In his paper, Lyons explains that the FCC might still regulate mobile networks but advises against a one-size-fits-all net neutrality approach. Instead, he encourages regulatory humility in order to promote investment in mobile networks and devices and to allow new business models. For support, he points out that several developing and rich countries have permitted commercial arrangements between content companies and carriers that arguably violate principles of net neutrality. Lyons makes the persuasive argument that these “non-neutral” service bundles and pricing decisions on the whole, rather than harming consumers, expand online access and ease non-connected populations into the Internet Age. As Lyons says,

The wide range of successful wireless innovations and partnerships at the international level should prompt U.S. regulators to rethink their commitment to a rigid set of rules that limit flexibility in American broadband markets. This should be especially true in the wireless broadband space, where complex technical considerations, rapid change, and robust competition make for anything but a stable and predictable business environment.

Further,

In the rapidly changing world of information technology, it is sometimes easy to forget that experimental new pricing models can be just as innovative as new technological developments. By offering new and different pricing models, companies can provide better value to consumers or identify niche segments that are not well-served by dominant pricing strategies.

Despite the January 2014 court decision striking down the FCC’s net neutrality rules, it’s an issue that hasn’t died. Lyons’ research provides support for the position that a fixation on enforcing net neutrality, however defined, distracts policymakers from serious discussion of how to expand online access. Rules should be written with consumers and competition in mind. Wired ISPs get the lion’s share of scholars’ attention when discussing net neutrality. In an increasingly wireless world, Lyon’s paper provides important research to guide future US policies.

Sprint’s Chairman, Masayoshi Son, is coming to Washington to explain how wireless competition in the US would be improved if only there were less of it.

After buying Sprint last year for $21.6 billion, he has floated plans to buy T-Mobile. When antitrust officials voiced their concerns about the proposed plan’s potential impact on wireless competition, Son decided to respond with an unusual strategy that goes something like this: The US wireless market isn’t competitive enough, so policymakers need to approve the merger of the third and fourth largest wireless companies in order to improve competition, because going from four nationwide wireless companies to three will make things even more competitive. Got it? Me neither.

An argument like that takes nerve, especially now. When AT&T attempted to buy T-Mobile a few years ago, Sprint led the charge against it, arguing vociferously that permitting the market to consolidate from four to only three nationwide wireless companies would harm innovation and wireless competition. After the Administration blocked the merger, T-Mobile rebounded in the marketplace, which immediately made it the poster child for the Administration’s antitrust policies.

It also makes Son’s plan a non-starter. Allowing Sprint to buy T-Mobile three years after telling AT&T it could not would take incredible regulatory nerve. It would be hard to convince anyone that such an immediate about face in favor of the company that fought the previous merger the hardest isn’t motivated by a desire to pick winners in losers in the marketplace or even outright cronyism. That would be true in almost any circumstance, but is doubly true now that T-Mobile is flourishing. It’s hard to swallow the idea that it would harm competition if a nationwide wireless company were to buy T-Mobile —  unless the purchaser is Sprint.

The special irony here is that Son has built his reputation on a knack for relentless innovation. When he bought Sprint, he expressed confidence that Sprint would become the number 1 company in the world. But, a year later, it is T-Mobile that is rebounding in the marketplace, even though T-Mobile has fewer customers than Sprint and less spectrum than Sprint. Buying into T-Mobile’s success now wouldn’t improve Son’s reputation for innovation, but it would double down on his confidence. I expect US regulators will want to see how he does with Sprint before betting the wireless competition farm on a prodigal Son.

Google’s announcement this week of plans to expand to dozens of more cities got me thinking about the broadband market and some parallels to transportation markets. Taxi cab and broadband companies are seeing business plans undermined with the emergence of nimble Silicon Valley firms–Uber and Google Fiber, respectively.

The incumbent operators in both cases were subject to costly regulatory obligations in the past but in return they were given some protection from competitors. The taxi medallion system and local cable franchise requirements made new entry difficult. Uber and Google have managed to break into the market through popular innovations, the persistence to work with local regulators, and motivated supporters. Now, in both industries, localities are considering forbearing from regulations and welcoming a competitor that poses an economic threat to the existing operators.

Notably, Google Fiber will not be subject to the extensive build-out requirements imposed on cable companies who typically built their networks according to local franchise agreements in the 1970s and 1980s. Google, in contrast, generally does substantial market research to see if there is an adequate uptake rate among households in particular areas. Neighborhoods that have sufficient interest in Google Fiber become Fiberhoods.

Similarly, companies like Uber and Lyft are exempted from many of the regulations governing taxis. Taxi rates are regulated and drivers have little discretion in deciding who to transport, for instance. Uber and Lyft drivers, in contrast, are not price-regulated and can allow rates to rise and fall with demand. Further, Uber and Lyft have a two-way rating system: drivers rate passengers and passengers rate drivers via smartphone apps. This innovation lowers costs and improves safety: the rider who throws up in cars after bar-hopping, who verbally or physically abuses drivers (one Chicago cab driver told me he was held up at gunpoint several times per year), or who is constantly late will eventually have a hard time hailing an Uber or Lyft. The ratings system naturally forces out expensive riders (and ill-tempered drivers).

Interestingly, support and opposition for Uber and Google Fiber cuts across partisan lines (and across households–my wife, after hearing my argument, is not as sanguine about these upstarts). Because these companies upset long-held expectations, express or implied, strong opposition remains. Nevertheless, states and localities should welcome the rapid expansion of both Uber and Google Fiber.

The taxi registration systems and the cable franchise agreements were major regulatory mistakes. Local regulators should reduce regulations for all similarly-situated competitors and resist the temptation to remedy past errors with more distortions. Of course, there is a decades-long debate about when deregulation turns into subsidies, and this conversation applies to Uber and Google Fiber.

That debate is important, but regulators and policymakers should take every chance to roll back the rules of the past–not layer on more mandates in an ill-conceived attempt to “level the playing field.” Transportation and broadband markets are changing for the better with more competition and localities should generally stand aside.

It appears that Federal Communications Commission (FCC) Chairman Tom Wheeler is returning to a competition-based approach to communications regulation. Chairman Wheeler’s emphasis on “competition, competition, competition” indicates his intent to intervene in communications markets only when it is necessary to correct a market failure.

I expect most on both sides of the political spectrum would welcome a return to rigorous market analysis at the FCC, but you can’t please all of the people all of the time. The American Television Alliance (ATVA), whose FCC petition wouldn’t withstand even a cursory market power analysis, is sure to be among the displeased.

The ATVA petition asks the FCC to regulate prices for retransmission consent (the prices video service providers (VSPs) pay for the rights to provide broadcast television programming to pay-TV subscribers) because retransmission fees and competition among VSPs are increasing. Though true, this data doesn’t indicate that TV stations or broadcast television networks have market power — it indicates that legislative and policy efforts to increase competition among VSPs are working.

The increase in retransmission consent fees is the natural consequence of the increase in competition among VSPs. When incumbent cable companies were the dominant VSPs, they could use the threat of a blackout to force broadcasters to grant retransmission consent at extremely low prices (or even for free). If a TV station balked, it risked losing substantial advertising revenue because there was no other VSP to retransmit the station’s signal.

As a result of increasing competition among VSPs, broadcasters are finally in a position to negotiate fairer prices for their content. When a VSP threatens a blackout today, a broadcaster has the option of calling the VSP’s bluff, as Wall Street observed when Time Warner yanked CBS off the air during a dispute about wireless distribution rights last fall. Now that there are competitive VSPs in most markets, cable operators have something to lose from a blackout too — their subscribers.

VSPs have responded to increasing market competition by asking the government for special treatment. ATVA has cloaked their rent-seeking request in the language of market power, but haven’t provided any analysis supporting their contention that retransmission consent fees are “too high.” They appear to be hoping that, if they cry wolf loud enough, they can avoid paying a fairer price for television programming.

If retransmission fees were really “too high,” one would expect that they would be significantly higher than the fees VSPs charge for their own content. According to the data, however, VSPs charge significantly more for their affiliated content than broadcasters charge for retransmission consent. In 2012, VSPs paid an average of $1.50 for the top ten channels affiliated with cable networks. In comparison, VSPs paid an average of $0.58 in 2012 for the right to retransmit the channels of the top ten TV station companies (e.g., Sinclair) — sixty one percent (61%) less than VSPs were willing to pay for their affiliated content. (Sources: Kagan and SNL)

Are the significantly higher prices cable networks charged for their programming in 2012 driven by consumer ratings? No. Kagan data indicates that, in 2012, VSPs paid approximately the same amount — $0.57 per subscriber — for CNN (CNN en Español sold for $0.58) as the average for the top ten TV stations. Despite its similar price, however, CNN averaged only about 600,000 daily viewers during primetime whereas each of the national broadcast network news programs averaged over 8 million evening viewers daily. This viewership data, albeit limited, indicates that broadcasters are charging ten times less for their programming than VSPs charge for similar programming.

The premium VSPs pay for their own content reflects the economics of the video programming market. Though competition among VSPs has increased, there is still significantly greater concentration and market power in the video distribution market than in the video programming market. According to the FCC’s most recent video competition report, only about one-third (35%) of homes had access to at least four VSPs in 2011. (See Fifteenth Report at Table 2) The FCC found that, even in areas with four VSPs, the Herfindahl-Hirschman Index (HHI), a common measure of horizontal market concentration, was over 2,500 (a highly concentrated marketplace). (See id. at ¶ 37) In comparison, there were more than twenty national video programming networks. (See id. at App. B)

Even a cursory review of the data indicates that recent increases in retransmission consent fees are a sign of market success, not a failure. It should be no surprise that, as competition among VSPs has increased, the price of retransmission consent has increased with it. It is the predictable result of cable’s decreasing monopsony power.

On Saturday, C-SPAN aired a segment of The Communicators featuring me and Free Press’ Chance Williams. In the 30-minute segment, Chance and I discussed the future of net neutrality now that the FCC’s Open Internet rules are vacated. You can see the taping here or below.

Join TechFreedom on Thursday, December 19, the 100th anniversary of the Kingsbury Commitment, AT&T’s negotiated settlement of antitrust charges brought by the Department of Justice that gave AT&T a legal monopoly in most of the U.S. in exchange for a commitment to provide universal service.

The Commitment is hailed by many not just as a milestone in the public interest but as the bedrock of U.S. communications policy. Others see the settlement as the cynical exploitation of lofty rhetoric to establish a tightly regulated monopoly — and the beginning of decades of cozy regulatory capture that stifled competition and strangled innovation.

So which was it? More importantly, what can we learn from the seventy year period before the 1984 break-up of AT&T, and the last three decades of efforts to unleash competition? With fewer than a third of Americans relying on traditional telephony and Internet-based competitors increasingly driving competition, what does universal service mean in the digital era? As Congress contemplates overhauling the Communications Act, how can policymakers promote universal service through competition, by promoting innovation and investment? What should a new Kingsbury Commitment look like?

Following a luncheon keynote address by FCC Commissioner Ajit Pai, a diverse panel of experts moderated by TechFreedom President Berin Szoka will explore these issues and more. The panel includes:

• Harold Feld, Public Knowledge
• Rob Atkinson, Information Technology & Innovation Foundation
• Hance Haney, Discovery Institute
• Jeff Eisenach, American Enterprise Institute
• Fred Campbell, Former FCC Commissioner

Space is limited so RSVP now if you plan to attend in person. A live stream of the event will be available on this page. You can follow the conversation on Twitter on the #Kingsbury100 hashtag.  

When: Thursday, December 19, 2013 11:30 – 12:00Registration & lunch 12:00 – 1:45Event & live stream

The live stream will begin on this page at noon Eastern.

Where: The Methodist Building 100 Maryland Ave NE Washington D.C. 20002

Questions? Email contact@techfreedom.org.

Call it what you want: a bailout, a thumb on the scales, bidder restrictions–the FCC might conspicuously intervene in the 2015 incentive auctions at the behest of smaller carriers and public interest advocates.

Chairman Wheeler’s recent comments indicate the FCC may devise a way to prevent the largest two carriers–AT&T and Verizon–from purchasing “too much” of the television broadcasters’ spectrum at auction. AT&T likely sees the writing on the wall and argues that if there are auction limits, the restrictions should apply only to the auction, rather than more extreme restrictions that would penalize AT&T and Verizon, the largest carriers, for previously-acquired spectrum. As The Switch’s Brian Fung put it,

the small carriers favor what are called “asymmetric” spectrum caps that affect various carriers differently, while opponents prefer “symmetric” caps that don’t account for existing market positions.

While I wish AT&T put up more of a fight to auction interventions, they (and staff at the FCC) are handicapped in pursuing an unrestricted auction. The blame lies mostly with Congress who gave the FCC vague (thus ripe for abuse) and conflicting mandates spanning decades. The 1993 law authorizing auctions, for instance, requires the FCC to “avoid[] excessive concentration of licenses” and to “disseminat[e] licenses among a wide variety of applicants” among other regulatory carve-outs for smaller competitors. These latter requirements, if implemented as rigorously as smaller carriers would like, directly undermine the purpose of the 2012 American Taxpayer Relief Act that requires the upcoming spectrum auctions raise $7 billion for a public safety broadband network and $20 billion for deficit reduction.

By asymmetrically penalizing AT&T and Verizon, the FCC increases the probability the auction fails to raise the tens of billions of dollars needed (see Fred Campbell’s recent paper). I haven’t heard a policymaker speak about the incentive auction without remarking how extraordinarily complex it is. That complexity–as was made clear in this week’s Senate hearing on the subject–means no one knows how much spectrum will be auctioned off or how much money will be raised. I was doubtful the FCC would secure the called-for 120 MHz for auction in the first place, but the Senate hearing convinced me that they might not get even 60 MHz. If the FCC meddles too much and the broadcasters aren’t assured they’ll get top dollar for their spectrum, the broadcasters might not show up to sell.

For many reasons, the FCC should ignore the pressures to restrict the large carriers in bidding. Smaller carriers argue the large carriers will outbid them only to preclude competition and hoard the spectrum. Every major carrier is spending billions to expand its footprint and capacity rapidly so the hoarding argument is hard to accept (not to mention, carriers face FCC build out requirements). The hoarding argument also confounds me because AT&T and Verizon are at the forefront arguing for more spectrum auctions, particularly spectrum from federal agencies. Would they want the market flooded with new spectrum only so they could spend billions to hoard it?

Asymmetric auction restrictions also resemble a bailout for smaller carriers. T-Mobile and Sprint–who most actively lobby for auction restrictions–are not mom-and-pop establishments. Each is a sophisticated, powerful corporation with access to capital markets and backed by larger international telecoms–Germany’s Deutsche Telekom for T-Mobile and Japan’s SoftBank for Sprint. DT and SoftBank have both pledged to spend billions in the next few years to improve their American carrier’s competitive position. Such carriers do not need an FCC handout.

The bailout resemblance is more apparent when you realize Sprint has been hamstrung for nearly a decade with damaging business decisions. Three come immediately to mind: 1) the dreadful merger with Nextel in 2005; 2) the ill-fated bet in 2008 to forgo LTE rollout in favor of WiMax, a competing 4G standard; and 3) the loss of over one million customers when it discontinued its push-to-talk iDEN service for network upgrades. The losses from the Nextel merger alone approach $30 billion.

To be clear, I don’t second-guess Sprint’s decisions. They did what innovative firms are supposed to do in attempting big, risky investments. However, it should not be the job of the FCC to favor some firms through spectrum auctions because some carriers’ business decisions did not pan out. That is not a competitive wireless auction–that is an FCC-orchestrated bailout. Granted, the FCC has been handed conflicting mandates. The Commission has ample discretion, however, to conduct a competitive auction that both complies with the law and improves chances of reaching the ambitious revenue goals. Intense meddling with auction results could prove disastrous.

Last week, the House held a hearing about the so-called IP Transition. The IP Transition refers to the telephone industry practice of carrying all wire-based consumer services–voice, Internet, and television–via faster, better fiber networks and not on the traditional copper wires that had fewer capabilities. Most consumers have not and will not notice the change. The completed IP Transition, however, has enormous implications for how the FCC regulates. As one telecom watcher said, “What’s at stake? Everything in telecom policy.”

For 100 years or so, phone service has had a special place in regulatory law given its importance in connecting the public. Phone service was almost exclusively over copper wires, a service affectionately called “plain old telephone service” (POTS). AT&T became the government-approved POTS national monopolist in 1913 (which ended with the AT&T antitrust breakup in the 1980s). The deal was: AT&T got to be a protected monopolist while the government got to require AT&T provide various public benefits. The most significant of these is universal service–AT&T had to serve virtually every US household and charge reasonable rates even to remote (that is, expensive) customers.

To create more phone competitors to the Baby Bells–the phone companies spun off from the AT&T break-up in the 1980s–the Congress passed the 1996 Telecom Act and the FCC put burdens on the Baby Bells to allow new phone companies to lease the Baby Bells’ AT&T-created copper wires at regulated rates. The market changed in ways never envisioned in the 1990s however. Today, phone companies face competition–not from the new phone companies leasing the old monopoly infrastructure but from entirely different technologies. You can receive voice service from your cable company (“digital voice”), your “phone” company (POTS), your wireless company, and even Internet-based providers like Vonage and Skype. Increasingly, households are leaving POTS behind in favor of voice service from cable or wireless providers. Yet POTS providers–like Verizon and AT&T (which also offer wireless service)–must abide by monopoly-era regulations that their cable and wireless competitors–Comcast, Sprint, and others–don’t have to abide by.

Understanding the significance of the IP Transition requires (unfortunately) knowing a little bit about Title I and Title II of the Communications Act. “Telecommunications services,” which are the phone companies with copper networks, are heavily regulated by the FCC under Title II. On the other hand, “information services,” which includes Internet service, are lightly regulated under Title I. This division made some sense in the 1990s. It is increasingly under stress now because burdened “telecommunications” companies like AT&T and Verizon are offering “information services” like Internet via DSL, FiOS, and U-Verse. Conversely, lightly-regulated “information services” companies like Comcast, Charter, and Time-Warner Cable are entering the regulated telephone market but face few of the regulatory burdens.

Which brings us to the IP Transition. As Title II phone companies replace their copper wires with fiber and deploy broadband networks to compete with cable companies, their customers’ phone service is being carried via IP packets. Functionally, these new networks act like a heavily-regulated Title II service since they carry voice, but they also act like the Title I broadband networks that cable providers built. So should these new fiber networks be burdened like Title II services or deregulated like Title I services? Or is it possible to achieve some middle ground using existing law? Those are the questions before the FCC and policymakers. Billions of dollars of investment will be accelerated or slowed and many firms will live or die depending on how the FCC and Congress act. Stay tuned.

Jon Brodkin at Ars Technica and Brian Fung at The Switch have posts featuring a New America Foundation study, The Cost of Connectivity 2013, comparing international prices and speeds of broadband. As I told Fung when he asked for my assessment of the study, I was left wondering whether lower prices in some European and Asian cities arise from more competition in those cities or unacknowledged tax benefits and consumer subsidies that bring the price of, say, a local fiber network down.

The report raised a few more questions in my mind, however, that I’ll outline here.

The NAF report concludes that US consumers would see lower prices if there was more competition. Or, as Brodkin says,

What’s the takeaway from all this data? It’s not a surprising one: lack of competition makes for bad choices.

I don’t disagree with the sentiment but the report makes no mention of competition data that would tend to support their broad conclusion. How many wireline competitors are there in Paris, Seoul, NYC, and Prague? Is there correlation between more competitors and lower (quality-adjusted) prices? NAF never tells us.

I raise this because the US actually has more market fragmentation (measured by HHI, an established tool used by antitrust agencies) for wireless carriers than many European countries, yet higher prices. If the cause of relatively higher prices is lack of competition, per NAF, wouldn’t we expect lower advertised prices in the US for wireless subscriptions because there is more competition? The fact that the US has higher prices indicates there are other factors besides number of competitors that drive price.

This lack of discussion of competition data is the major gap of the NAF study. Despite concluding that lack of competition is the problem in the US, the authors seem uninterested in rigorously examining the state of competition in the cities and countries they highlight (but perhaps this will be taken up in their promised forthcoming full report).

Another problem is that the report mostly consists of documenting advertised download speeds. While sensible since it’s easily available, this reliance on advertised speeds warrants a warning. The FCC publishes an annual report comparing international broadband offerings and noted in its 2012 report that advertised speeds are a troublesome metric that often misrepresent what consumers actually see. Recently in the UK, for instance, broadband packages with an advertised speed of 24 Mbps featured an actual speed around 5 Mbps for the typical customer. (Recent truth-in-advertising reforms have made this problem less likely–but only in the UK.) Different countries have different methodologies and advertising standards, and the US carriers tend to have more “honest” advertised speeds. Unlike the FCC, which carefully notes issues with these sorts of measurements, NAF makes no mention of possible discrepancies despite letting advertised speeds do a lot of the work that leads to their conclusion.

My final dispute is with the inclusion of “triple play” subscriptions (combination voice, Internet, television service). Documenting the price for this bundle is next to worthless because the quality of the television package is a substantial reason for buying. For example, what do we learn from the fact that you can get phone service, 20 Mbps Internet speeds, and a television package in Riga, Latvia for $22? Is the $99 price in San Francisco high because of a lack of competition or because the television package is so much better than the channels offered in Riga? Or because of regulatory distortions in US television policy? (Retrans, anyone?) Without some measure of quality-adjusted price, the triple play comparisons are just noise.

Adam Thierer, Senior Research Fellow at the Mercatus Center discusses his recent working paper with coauthor Brent Skorup, A History of Cronyism and Capture in the Information Technology Sector. Thierer takes a look at how cronyism has manifested itself in technology and media markets — whether it be in the form of regulatory favoritism or tax privileges. Which tech companies are the worst offenders? What are the consequences for consumers? And, how does cronyism affect entrepreneurship over the long term?

Download

Related Links

• A History of Cronyism and Capture in the Information Technology Sector, Thierer
• Video: A History of Cronysim and Capture in the Information Technology Sector, Thierer
• Adam Thierer Biography, Mercatus Center
• Adam Thierer on Anti-Tech Grump Evgeny Morozov, Thierer

David Garcia, post doctoral researcher at the Swiss Federal Institute of Technology and co-author of Social Resilience in Online Communities: The Autopsy of Friendster, discusses the concept of social resilience and how online communities, like Facebook and Friendster, withstand changes in their environment.

Garcia’s paper examines one of the first online social networking sites, Friendster, and analyzes its post-mortem data to learn why users abandoned it.

Garcia goes on to explain how opportunity cost and cost benefit analysis can affect a user’s decision whether or not to remain in an online community.

Download

Related Links

• Social Resilience in Online Communities: The Autopsy of Friendster, Garcia, Mavrodiev, Schweitzer
• An autopsy of a dead social network, The Physics arXiV Blog
• Researchers conduct ‘autopsy’ of dead social network Friendster, Solon

This week at CTIA 2013, FCC Commissioner Jessica Rosenworcel presented ten ideas for spectrum policy. Though I don’t agree with all of them, she articulated a reasonable vision for spectrum policy that prioritizes consumer demand, incorporates market-oriented solutions, and establishes transparent goals and timelines. Commissioner Rosenworcel’s principled approach stands in stark contrast to the intellectually bankrupt incentive auction recommendation offered by the Department of Justice last month.

Commissioner Rosenworcel clearly defines three simple goals for a successful incentive auction:

• Raising enough revenue to support the nation’s first interoperable, wireless broadband public safety network;
• Making more broadband spectrum available through policies that are attractive to broadcasters; and
• Providing fair treatment to those broadcasters who do not wish to participate in the auction.

All three goals are consistent with consumer demand for wireless broadband services, the market-oriented reassignment of broadcast spectrum envisioned by the National Broadband Plan, and the will of Congress.

In comparison, the DOJ’s recommendation focuses on only one goal: Subsidizing two particular companies – Sprint Nextel and T-Mobile – to ensure they obtain spectrum in the auction. The DOJ claims these subsidies are necessary to promote competition. But, there is a substantial difference between fair government policies that promote competition generally and a policy of favoring foreign-owned companies over their domestic competitors.

Unfortunately, the DOJ is not alone in its belief that bestowing government benefits on favored companies is a legitimate goal in a free society. Some members of the House Commerce Committee believe the DOJ’s past merger reviews provide “a solid factual and analytical basis” for its current recommendation to the FCC.

The fatal flaw in this theory is that the DOJ’s recommendation to the FCC is inconsistent with the factual findings and analysis of the DOJ in its past merger reviews. As I’ve noted previously, in its complaint against the AT&T/T-Mobile merger, the DOJ found that, “due to the advantages arising from their scope and scale of coverage,” Sprint Nextel and T-Mobile are “especially well-positioned to drive competition” in the wireless industry. That finding doesn’t provide any factual or analytical basis whatsoever to conclude that Sprint Nextel and T-Mobile require special government treatment in the incentive auction in order to compete with Verizon and AT&T.

That’s why the DOJ recommendation relies on an irrational and discriminatory presumption that Verizon and AT&T are using spectrum less efficiently than Sprint Nextel and T-Mobile. A speculative presumption doesn’t require the DOJ to admit its own deceit. It merely requires audacity.

In an era when government officials routinely revise the facts to suit their preferred outcomes and disclaim responsibility for the actions of the agencies they’re charged with leading, Commissioner Rosenworcel’s speech required intellectual bravery and political courage. Her ideas deserve a fair hearing.

Gina Keating, author of Netflixed: The Epic Battle for America’s Eyeballs, discusses the startup of Netflix and their competition with Blockbuster.

Keating begins with the history of the company and their innovative improvements to the movie rental experience. She discusses their use of new technology and marketing strategies in DVD rental, which inspired Blockbuster to adapt to the changing market.

Keating goes on to describe Netflix’s transition to internet streaming and Blockbuster’s attempts to retain their market share.

Download

Related Links

• Netflixed: The Epic Battle for America’s Eyeballs, Keating
• Gina Keating’s New Book about the Rise of Netflix, Babayan
• ‘Netflixed,’ Book by Gina Keating, Describes CEO Reed Hastings As a Nasty Boss’ Liedtke

Frontline relied on the DOJ foreclosure theory to predict that the lack of eligibility restrictions in the 700 MHz auction would “inevitably” increase prices, stifle innovation, and reduce the diversity of service offerings as Verizon and AT&T warehoused the spectrum. In reality, the exact opposite occurred.

The DOJ recently recommended that the FCC rig the upcoming incentive auction to ensure Sprint Nextel and T-Mobile are winners and Verizon and AT&T are losers. I previously noted that the DOJ spectrum plan (1) inconsistent with its own findings in recent merger proceedings and the intent of Congress, (2) inherently discriminatory, and (3) irrational as applied. Additional analysis indicates that it isn’t supported by economic theory or FCC factual findings either.

Economic Theory

The Phoenix Center published a paper with an economic simulation that exposes the fundamental economic defect in the foreclosure theory underlying the DOJ recommendation. The DOJ implicitly recognizes that the “private value” of spectrum (the amount a firm is willing to pay) equals its “use value” (derived from using spectrum to meet consumer demand) plus its “foreclosure value” (derived from excluding its use by rivals). In its application of this theory, however, the DOJ erroneously presumes that Verizon and AT&T would derive zero use value from the acquisition of additional spectrum – a presumption that is inconsistent with the FCC findings that prompted the auction.

The Phoenix Center notes that  all firms – including Sprint Nextel and T-Mobile – derive a foreclosure value from the acquisition of spectrum due to its scarcity. When considering the benefits to consumers, it is the comparative use value of the spectrum for each provider that is relevant. If the use value of the spectrum to Verizon and AT&T exceeds that of Sprint Nextel and T-Mobile, economic theory says Verizon and AT&T would maximize the potential consumer benefits of that spectrum irrespective of its foreclosure value.

Of course, determining the differing use values of spectrum to particular firms is what spectrum auctions are for, which brings the DOJ’s argument full circle: If government bureaucrats at the DOJ and the FCC could accurately assess the use values of spectrum, we wouldn’t need to hold spectrum auctions in the first place.

The circularity of the DOJ theory explains its reliance on an unsubstantiated presumption that Sprint Nextel and T-Mobile have the highest use value for the spectrum. If the DOJ had instead (1) conducted a thorough factual investigation, (2) analyzed the resulting data to assign bureaucratic use values for the spectrum to each of the four nationwide mobile providers, and (3) compared the results to determine that Verizon and AT&T had lower use values, the DOJ would have engaged in the same failed “comparative hearing” analysis that Congress intended to avoid when it authorized spectrum auctions. Given the Congressional mandate to auction spectrum yielded by the broadcasters, the FCC cannot engage in a comparative process to pick winners and losers, and it certainly cannot substitute an unsubstantiated presumption for an actual comparative process in order to avoid the legal prohibition.

FCC Factual Findings

The foreclosure theory and DOJ presumption are also inconsistent with the auction experience and current factual findings of the FCC. The DOJ foreclosure theory has been presented to the FCC before and has proved invalid by the market.

When the FCC was developing rules for the 700 MHz auction in 2007, Frontline Wireless sought preferential treatment using the same foreclosure theory as the DOJ. Frontline submitted a paper (prepared by Stanford professors of economics and management) that relied on the same types of information and reached the same conclusion as the DOJ – that Verizon and AT&T were dominant “low-frequency” wireless incumbents with “strong incentives” to acquire and warehouse 700 MHz spectrum, and that their participation in the 700 MHz auction must be limited in order to “promote competition” and prevent “foreclosure.” Frontline predicted that, if Verizon and AT&T were not prevented from bidding in the 700 MHz auction, it would “inevitably lead to higher prices, stifled innovation, and reduced diversity of service offerings.”

The FCC rejected Frontline’s foreclosure theory. The FCC concluded that, “given the number of actual wireless providers and potential broadband competitors, it [was] unlikely that [incumbents] would be able to behave in an anticompetitive manner as a result of any potential acquisition of 700 MHz spectrum.”

The last five years have proven that the FCC was correct. Though Verizon and AT&T acquired significant amounts of unfettered 700 MHz spectrum, the auction results have not led to the “higher prices, stifled innovation, and reduced diversity of service offerings” predicted by Frontline. In its most recent mobile competition report, the FCC reported that:

• Verizon used its 700 MHz spectrum to deploy a 4G LTE network to more than 250 million Americans less than four years after Verizon’s 700 MHz licenses were approved (i.e., it didn’t warehouse the spectrum).

• Mobile wireless prices declined overall in 2010 and 2011, and the price per megabyte of data declined 89% from the 3^rd quarter of 2008 – a few months before Verizon received its 700 MHz licenses – to the 4^th quarter of 2010 (i.e., industry prices decreased).

• The number of subscribers to mobile Internet access services more than doubled from year-end 2009 to year-end 2011 (i.e., industry output increased).

• Prepaid services are growing at the fastest rate, and new wholesale and connected device services are growing significantly (i.e., providers continued to provide new and diverse service offerings).

• Market concentration has remained essentially unchanged since 2008 (the population weighted average of HHIs increased from 2,842 in 2008 to 2,873 in 2011 – a change of only 1 percent).

Remember: Frontline relied on the DOJ foreclosure theory to predict that the lack of eligibility restrictions in the 700 MHz auction would “inevitably” increase prices, stifle innovation, and reduce the diversity of service offerings as Verizon and AT&T warehoused the spectrum. In reality, the exact opposite occurred. Verizon and AT&T did not warehouse the spectrum, industry prices decreased while output increased, diverse new service offerings exhibited the strongest growth, and market concentration remained essentially unchanged. And, while competition thrived, consumers reaped the benefits.

So, why would the DOJ make the same failed argument for the 600 MHz auction (other than crony capitalism)? Some might say, “Even the boy who cried wolf was right once.” But, even if one were inclined to give the DOJ the benefit of the doubt, the theoretical possibility that the foreclosure theory could adversely impact the 600 MHz auction must be weighed against the potential harm of limiting participation in the auction.

The harm is well documented and could prove particularly problematic in this auction. A paper coauthored by Leslie Marx, who led the design team for the 700 MHz auction when she was the FCC’s Chief Economist, demonstrates that excluding Verizon and AT&T would have even more severe consequences in the incentive auction than in previous auctions.

A paper published by economists at Georgetown University’s Center for Business and Public Policy attempts to quantify the severity of these consequences. It estimates that excluding Verizon and AT&T from the auction could reduce revenues by as much as 40 percent ($12 billion) – a result that would jeopardize funding for the nationwide public safety network, reduce the amount of spectrum made available for wireless Internet services, and adversely affect more than 118,000 U.S. jobs. That is a steep price to pay for the privilege of seeing whether the boy is crying wolf again.

The Information Economy Project at the George Mason University School of Law is hosting a conference tomorrow, Friday, April 19. The conference title is From Monopoly to Competition or Competition to Monopoly? U.S. Broadband Markets in 2013. There will be two morning panels featuring discussion of competition in the broadband marketplace and the social value of “ultra-fast” broadband speeds.

We have a great lineup, including keynote addresses from Commissioner Joshua Wright, Federal Trade Commission and from Dr. Robert Crandall, Brookings Institution.

The panelists include:

Eli Noam, Columbia Business School

Marius Schwartz, Georgetown University, former FCC Chief Economist

Babette Boliek, Pepperdine University School of Law

Robert Kenny, Communications Chambers (U.K.)

Scott Wallsten, Technology Policy Institute

The panels will be moderated by Kenneth Heyer, Federal Trade Commission and Gus Hurwitz, University of Pennsylvania, respectively. A continental breakfast will be served at 8:00 am and a buffet lunch is provided. We expect to adjourn at 1:30 pm. You can find an agenda here and can RSVP here. Space is limited and we expect a full house, so those interested are encouraged to register as soon as possible.

In the upcoming issue of Harvard Business Review, my colleague Paul Nunes at Accenture’s Institute for High Performance and I are publishing the first of many articles from an on-going research project on what we are calling “Big Bang Disruption.”

The project is looking at the emerging ecosystem for innovation based on disruptive technologies.  It expands on work we have done separately and now together over the last fifteen years.

Our chief finding is that the nature of innovation has changed dramatically, calling into question much of the conventional wisdom on business strategy and competition, especially in information-intensive industries–which is to say, these days, every industry.

The drivers of this new ecosystem are ever-cheaper, faster, and smaller computing devices, cloud-based virtualization, crowdsourced financing, collaborative development and marketing, and the proliferation of mobile everything.  There will soon be more smartphones sold than there are people in the world.  And before long, each of over one trillion items in commerce will be added to the network.

The result is that new innovations now enter the market cheaper, better, and more customizable than products and services they challenge.  (For example, smartphone-based navigation apps versus standalone GPS devices.)  In the strategy literature, such innovation would be characterized as thoroughly “undiscplined.”  It shouldn’t succeed.  But it does.

So when the disruptor arrives and takes off with a bang, often after a series of low-cost, failed experiments, incumbents have no time for a competitive response.  The old rules for dealing with disruptive technologies, most famously from the work of Harvard’s Clayton Christensen, have become counter-productive.   If incumbents haven’t learned to read the new tea leaves ahead of time, it’s game over.

The HBR article doesn’t go into much depth on the policy implications of this new innovation model, but the book we are now writing will.  The answer should be obvious.

This radical new model for product and service introduction underscores the robustness of market behaviors that quickly and efficiently correct many transient examples of dominance, especially in high-tech markets.

As a general rule (though obviously not one without exceptions), the big bang phenomenon further weakens the case for regulatory intervention.  Market dominance is sustainable for ever-shorter periods of time, with little opportunity for incumbents to exploit it.

Quickly and efficiently, a predictable next wave of technology will likely put a quick and definitive end to any “information empires” that have formed from the last generation of technologies.

Or, at the very least, do so more quickly and more cost-effectively than alternative solutions from regulation.  The law, to paraphrase Mark Twain, will still be putting its shoes on while the big bang disruptor has spread halfway around the world.

Unfortunately, much of the contemporary literature on competition policy from legal academics is woefully ignorant of even the conventional wisdom on strategy, not to mention the engineering realities of disruptive technologies already in the market.  Looking at markets solely through the lens of legal theory is, truly, an academic exercise, one with increasingly limited real-world applications.

Indeed, we can think of many examples where legacy regulation actually makes it harder for the incumbents to adapt as quickly as necessary in order to survive the explosive arrival of a big bang disruptor.  But that is a story for another day.

Much more to come.

Related links:

1. “Creating a ‘Politics of Abundance’ to Match Technology Innovation,” Forbes.com.
2. “Why Best Buy is Going out of Business…Gradually,” Forbes.com.
3. “What Makes an Idea a Meme?“, Forbes.com
4. “The Five Most Disruptive Technologies at CES 2013,” Forbes.com

Christopher S. Yoo, the John H. Chestnut Professor of Law, Communication, and Computer & Information Science at the University of Pennsylvania and author of the new book, The Dynamic Internet: How Technology, Users, and Businesses are Transforming the Network, explains that the Internet that we knew in its early days—one with a client-server approach, with a small number of expert users, and a limited set of applications and business cases—has radically changed, and so it may be that the architecture underlying the internet may as well.

According to Yoo, the internet we use today barely resembles the original Defense Department and academic network from which it emerged. The applications that dominated the early Internet—e-mail and web browsing—have been joined by new applications such as video and cloud computing, which place much greater demands on the network. Wireless broadband and fiber optics have emerged as important alternatives to transmission services provided via legacy telephone and cable television systems, and mobile devices are replacing personal computers as the dominant means for accessing the Internet. At the same time, the networks comprising the Internet are interconnecting through a wider variety of locations and economic terms than ever before.

These changes are placing pressure on the Internet’s architecture to evolve in response, Yoo says. The Internet is becoming less standardized, more subject to formal governance, and more reliant on intelligence located in the core of the network. At the same time, Internet pricing is becoming more complex, intermediaries are playing increasingly important roles, and the maturation of the industry is causing the nature of competition to change. Moreover, the total convergence of all forms of communications into a single network predicted by many observers may turn out to be something of a myth. Policymakers, Yoo says, should allow room for this natural evolution of the network to take place.

Download

Related Links

• The Dynamic Internet: How Technology, Users, and Businesses are Transforming the Network, Yoo
• The Changing Patterns of Internet Usage, Yoo
• Network Neutrality and the Economics of Congestion, Yoo
• Cloud Computing: Architectural and Policy Implications, Yoo

Today marks the seventeenth birthday of the Telecommunications Act of 1996. Since it became law nearly two decades ago, the 1996 Act has largely succeeded in meeting its principal goals. Ironically, its success is becoming its potential failure.

By the time most teenagers turn seventeen, they have already begun planning their future after high school. Their primary school achievements are only a beginning in a lifetime of future possibilities. For most legislation, however, there is no future after the initial goals of Congress are achieved. Fortunately, the seventeen year-old 1996 Act isn’t like most legislation.

Congress recognized that when the goals of the 1996 Act were achieved, many of its regulations would no longer be necessary. In its wisdom, Congress provided the FCC with statutory authority to adapt our communications laws to future changes in the communications market. This authority includes the ability for the FCC to forbear from applying an unnecessary or outdated law.

Unfortunately, the FCC has been very reluctant to exercise this authority. It has instead preferred to remain within the familiar walls of stagnant regulations while the opportunity of Internet transformation knocks on the door. If the FCC refuses to use its forbearance authority, the only future for the 1996 Act is to live in the proverbial parents’ basement and eat 20 ^th Century leftovers. If the FCC instead chooses to act, it could accelerate investment in new broadband infrastructure and the transition to an all-Internet future.

Looking Back: The 1996 Act Changed the Economic Model

Ironically, the 1996 Act was intended to prevent its older sibling, the Communications Act of 1934, from facing a similarly bleak future. The 1934 Act was premised on the theory that communications networks are natural monopolies. That theory began eroding in the 1960s when competitors to the old telephone monopoly began providing “long distance” and “competitive access services” ( e.g., “special access”), which proved that facilities-based competition among multiple communications networks was sustainable. Although competition had developed in the long distance and special access markets, restrictions on competition in the 1934 Act, antitrust judgments, and state laws ensured that local markets remained closed to new entrants.

The 1996 Act was intended to transition our communications laws and regulations from the era of natural monopoly to an era of market competition by eliminating barriers to entry at the local level. At the signing ceremony, former President Clinton recognized that the “information revolution” was changing the old economic model and required a new regulatory approach:

 But this revolution has been held back by outdated laws, designed for a time when there was one phone company, three TV networks, no such thing as a personal computer. Today, with the stroke of a pen, our laws will catch up with our future. We will help to create an open marketplace where competition and innovation can move as quick as light.

Ironically, the changes wrought by the 1996 Act and Internet transformation are now threatening its legacy.

Looking Today: The 1996 Act Has Largely Met Its Principal Goals

The transition from natural monopoly to market competition envisioned by the 1996 Act is now largely complete. In its initial order implementing the Act, the FCC summarized the 1996 Act’s three principal goals for competition as follows:

 (1) opening the local exchange and exchange access markets to competitive entry; (2) promoting increased competition in telecommunications markets that are already open to competition, including the long distance services market; and (3) reforming our system of universal service so that universal service is preserved and advanced as the local exchange and exchange access markets move from monopoly to competition.

These goals have largely been met.

• Opening Local Markets: In 1996, many Americans had access to only one (1) local telephone network. Today, the FCC reports that more than 90% of residential Americans have access to at least six (6) facilities-based networks that provide affordable local voice services (a “telephone” company, a “cable operator”, and at least 4 mobile providers). Multiplying consumer choice by six is more than enough to conclude that local markets have been opened to competition.
• Increasing Competition in Long Distance: In 1996, there were four (4) facilities-based nationwide long distance networks: AT&T, MCI, Sprint, and WorldCom. Today, there are at least eleven (11) Tier 1 backbone providers (three more than in 2005). Though this market has been largely unregulated since the FCC completed its Section 271 market-opening proceedings in the early 2000s, the increase in facilities-based nationwide networks from four to eleven demonstrates increased competition in non-local markets since 1996.
• Universal Service: The FCC initiated a comprehensive overhaul of its universal service and intercarrier compensation mechanisms in 2011. Though the USF/ICC Transformation Order is an important step in reforming these policies, the process of achieving this goal of the 1996 Act is still ongoing. (Ironically, progress in achieving this goal may have been hindered by other outdated assumptions in the Act.)

Looking Forward: The 1996 Act’s Forgotten Future

“The world envisioned by the 1996 Act is one in which all providers will have new competitive opportunities as well as new competitive challenges.” In its initial order implementing the Act, the FCC recognized that opening all communications markets to all providers would “blur traditional industry distinctions.” It also recognized that, “given the dynamic nature of telecommunications technology and markets, it will be necessary over time to review proactively and adjust these rules to ensure both that the statute’s mandate of competition is effectuated and enforced, and that regulatory burdens are lifted as soon as competition eliminates the need for them.”

At times it seems the FCC has forgotten these words and the future Congress had envisioned. Seventeen years later competition has clearly eliminated the need for scores of regulatory burdens, yet those burdens remain in place. Rather than embrace ongoing market changes, the FCC has relied on sophistry to deny reality. For example, in a 2010 order denying a forbearance petition filed by Qwest, the FCC concluded that mobile consumers that have “cut the cord” shouldn’t be counted when calculating residential voice market shares absent an economic analysis showing that mobile service “constrains the price of residential wireline service.” With approximately 40% of U.S. households relying entirely on mobile for their voice service, a better question may be whether wireless-only consumers would be willing to purchase Qwest’s plain old telephone service at any price.

It’s time to stop moving the goal posts. With the exception of universal service (a work in progress), the competitive goals of the 1996 Act have already been met. Before the 1996 Act turns eighteen and finds itself stuck in the proverbial basement, the FCC should establish new goals for the Internet era and use its statutory authority, including forbearance, to start achieving those goals. If the FCC’s Technology Transitions Policy Task Force moves quickly, we might have something to celebrate on the 1996 Act’s eighteenth birthday.

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.

Unfortunately, most consumers won’t realize that Netflix is trying to impose its costs on all Internet consumers to gain an anticompetitive price advantage against its over-the-top competitors.

At the Consumer Electronic Show two weeks ago, Netflix announced that it would block consumer access to high definition and 3D movies (HD) for customers of Internet service providers (ISPs) that Netflix disfavors. Netflix’s goal is to coerce ISPs into paying for a free Internet fast lane for Netflix content. If Netflix succeeds, it would harm Internet consumers and competition among video streaming providers. It would also fundamentally alter the economics and openness of the Internet, “where consumers make their own choices about what applications and services to use and are free to decide what content they want to access, create, or share with others.”

Ironically, Netflix’s strategy is a variant of the doomsday narrative spun by net neutrality activists over the last decade. Their narrative assumes ISPs will use their gatekeeper control to block their customers from accessing Internet content distributed by competitors. Of course, ISPs have never blocked consumer access to competitive Internet content. Now that the FCC has distorted the Internet marketplace through the adoption of asymmetric net neutrality rules, Netflix, the dominant streaming video provider, has decided to block consumer access to its content.

This may not seem like a big deal given the relatively limited HD content currently available on Netflix. But that’s about to change in a very big way. Netflix recently announced a new multi-year licensing agreement that makes it the “ exclusive American subscription TV service for first run live-action and animated features from the Walt Disney Studios.” In addition to Disney-branded content (e.g., The Lion King), the deal includes content produced by Pixar (e.g., Brave), Lucasfilm (e.g., Star Wars), and Marvel (e.g., The Avengers). Netflix also announced a multi-year deal with Turner Broadcasting and Warner Bros. that includes the Cartoon Network and exclusive distribution rights to TNT’s television series Dallas. As an analyst recently told Ars Technica, “These movies, if you’ve got young kids—you’ve got to have Netflix.”

Netflix has decided to use this new market power to force ISPs to pay for its own Internet fast lane. In classic double-speak, Netflix calls its fast lane the “Netflix Open Connect” content delivery network (CDN). Though Netflix uses the word “open” to describe its CDN, it is not part of the open Internet. It is only “open” to Netflix for the delivery of its content, and it is only “open” to ISPs who connect to it on terms dictated by Netflix.

The costs of the ordinary CDNs (e.g., Level 3 and Limelight) that deliver Netflix are borne by Netflix and incorporated into the price of its retail service. Netflix pays these CDNs to deliver content to Netflix subscribers, and the CDNs pay the costs of delivering Netflix content on the Internet. With this model, the additional costs of delivering Netflix content (due to its desire for distributed content servers) are ultimately borne only by Netflix subscribers.

With its “Open Connect” model, Netflix is withholding content from the customers of ISPs that decline to accede to its demands. Though the details of its demands are unknown, it appears Netflix is requiring that ISPs “peer” with them or pay for the installation of Netflix equipment inside their networks as well as the ongoing costs of operating that equipment.

Netflix’s model is inconsistent with standard Internet peering arrangements, harmful to consumers, and blatantly anticompetitive. By shifting its costs to ISPs, Netflix is distributing the costs of delivering its service across  all Internet consumers. ISPs that agree to pay the installation and ongoing operational costs of hosting Netflix equipment inside their networks would have every incentive to pass these costs on to their subscribers as higher rates for Internet access. It would be one thing if ISPs were able to raise Internet access rates only for Netflix subscribers. Due to the FCC’s net neutrality rules, however, an ISP would likely be required to increase its rates for all of its subscribers to cover the additional costs imposed by Netflix – including its subscribers who don’t use the Netflix service. The result: ISP customers who subscribe to competitive streaming video providers would unwittingly be paying for the delivery of Netflix service as well, and Netflix would have a significant price advantage over its competitors.

Theoretically, streaming video competitors could mimic Netflix and try to force ISPs to cover the costs of private fast lanes for them as well. In reality, the combination of exclusive content arrangements, first mover advantages, and asymmetric net neutrality regulation enjoyed by Netflix make it unlikely that a new competitor could mimic Netflix’s strategy. Netflix admits it is the “world’s leading Internet subscription service for enjoying TV shows and movies,” and that its traffic accounts for more than 30 percent of peak Internet traffic on U.S. networks. According to Dan Rayburn at Streaming Media:

There are maybe half-a-dozen content owners who are delivering enough volume of bits, have the technical expertise and have the money to build out their own CDN. Only companies the size of Google, Apple, Microsoft, Netflix and Facebook can take on such a task.

He also notes that the average family of four likely has ten Netflix enabled devices in their home  today – something that “can be done by others, but it takes time, a lot of money and lots of development.”

The available evidence indicates Netflix is shamelessly leveraging its market power and its subscribers to cajole ISPs into paying for its private fast lane at the ultimate expense of all Internet consumers and its competitors. When I inquired about its “Super HD” service on the Netflix website, the website replied in ominous red text: “Your Internet Provider is not configured for Super HD yet.” (Screenshot available here.) In a subdued, friendly gray, it said:

Super HD requires that your Internet Provider is part of the Netflix Open Connect network. Please contact your Internet Provider to request that they join the Netflix Open Connect network so you can get Super HD.

Neither my ISP nor the open Internet is preventing Netflix from allowing me to access its HD content. Netflix is  choosing to block me from accessing its HD content because my ISP hasn’t agreed to host Netflix equipment for free and Netflix doesn’t want to pay another CDN to deliver HD content to my ISP.

Unfortunately, most consumers won’t realize that Netflix is trying to impose its costs on all Internet consumers to gain an anticompetitive price advantage against its over-the-top competitors. If most consumers end up blaming ISPs for Netflix’s choice, I expect Netflix will increase its demands along with its leverage as it secures exclusive access to even more “must have” content. I wouldn’t be surprised if Netflix attempts to graft the “basic tier” model used in traditional video subscription services on to the Internet.

Think Netflix doesn’t have enough muscle to bully ISPs? Think again. Although Netflix won’t disclose the full list of ISPs that have succumbed to its pressure tactics, Cablevision and Google Fiber in the U.S. and a host of global ISPs (including Virgin Media, British Telecom, Telmex, Telus, TDC, and GVT) have already agreed to install a “free” Netflix fast lane in their networks. The revenue and global scale provided by these deals combined with the asymmetric limitations of the net neutrality rules will make it even harder for the remaining ISPs in the U.S. to resist Netflix’s demands.

When the FCC considered adopting net neutrality rules, Commissioner Michael Copps warned of the potential for unintended consequences that attend asymmetric regulation: “In particular, we need to recognize that the gatekeepers of today may not be the gatekeepers of tomorrow.” Copps believed his “job [was] not so much to mediate among giants as it [was] to protect consumers.” Now that it is the Internet gatekeeper of Star Wars and other iconic films, what rule will stop Netflix from demanding additional payments from ISPs if net neutrality rules prevent ISPs from recovering the additional costs only from Netflix subscribers?

Why do mobile carriers sell phones with a subscription?  My roommate and I were debating this the other night.  Most other popular electronics devices aren’t sold this way.  Cable and satellite companies don’t sell televisions with their video service.  ISPs don’t sell laptops and desktops with their Internet service.  Bundling phones with mobile service subscriptions is pretty unique.  (The only mass-market analogs I can think of are satellite radio and GPS service.)

Why might this be?  Some might think that US carriers need control over the phones sold to their customers because roughly half of US subscribers use GSM phones (AT&T and T-Mobile) and half use CDMA phones (Verizon and Sprint), but that can’t be the reason because GSM is the standard in Europe yet bundling phones with subscriptions occurs.

Some say it occurs because it benefits carriers at the expense of consumers.  A law review article written a few years ago said bundling profitably exploits the misperceptions of consumers and the value they place on mobile services.  Tim Wu has said that selling phones is an anticompetitive response that allows carriers to control the platform and disable features (WiFi, Bluetooth, VoIP) that might eat into the carriers’ existing revenue streams.  But even if that’s true I don’t think that’s the whole answer.  If network services have that much control over the devices used for their services, why don’t cable, satellite, and Internet service providers sell TVs and computers that only work with their service?  At the very least, if we assume, as Wu does, that carrier control removes features consumers really want, consumers could simply purchase phones directly from phone makers–Apple, Motorola, Samsung, LG–with full functionality intact.

I don’t know the best answer, and maybe commenters can chime in, but I suspect phones and contracts are primarily sold together because of the engineering challenges presented by a device using radio spectrum.   (This would explain why GPS and satellite radio service providers also bundle devices with service.)  Different carriers purchase licenses to use different swaths of spectrum, and these different frequencies require different radio receivers.  Phones, then, need to have radios installed that are tailored for the particular carrier.

In any case, throughout most of the world, phones are sold with subscriptions.  Some on the left, like Wu, say that bundling shouldn’t be permitted because it enables large carriers to exclude competitors and remove functionality consumers want.  To that end, he proposes regulations that require all handsets to work with all carriers.  Despite these objections, I’ll push back on the claim that consumers are being duped or that competition is seriously harmed.  Bundling handsets with subscriptions has several pro-competitive and pro-consumer justifications.

1.  Acts as an installment plan

This may be the most powerful reason selling phones with subscriptions is near-universal:  consumers like it.  Modern smartphones are expensive consumer products costing hundreds of dollars.  Wherever you see expensive consumer products (home appliances, furniture, computers, clothes) you find retailers offering installment plans so that consumers don’t have to pay hundreds or thousands of dollars up-front.  By locking consumers into a two-year contract, carriers can offer heavily subsidized advanced handsets–that they usually sell at an initial loss–and charge more for services over two years.

Consumers seem to prefer bundling since it acts as a de facto financing agreement.  Noncontract prepaid plans are offered by every US carrier, yet the vast majority of Americans still use post-paid plans with contracts in large part because the (subsidized) phones offered are so much cheaper and more attractive deals.  (See my prior post on the subject.)  Further evidence that consumers really value this installment plan option comes from Belgium, where bundling phones with subscriptions was illegal years ago.  That all changed in 2008 when the iPhone 3G came out.  Belgians complained about the fact that their iPhones started at €525 when their neighbors, like those in the Netherlands (who allowed bundling), could get a subsidized phone for as little as €1.  Within a year, with support from a competition minister, the law was changed to allow phones to be sold with subscriptions.  Predictably, the up-front costs of Belgian phones subsequently dropped as carriers subsidized the phones, and broadband penetration increased.

2.  Reduces transactions costs for consumers

Consumers also benefit from having a one-stop shop for their mobile needs.  Instead of needing to go to a phone retailer like Best Buy and then to a carrier’s retail store, consumers can get everything at the carrier’s retail store.  This may sound like a small benefit, but I imagine this especially benefits rural Americans who don’t have the retail options city-dwellers do.

3.  Aids carriers’ marketing and improves competition

It’s probable that bundling phones with subscriptions makes carriers more competitive.  There’s a textbook antitrust justification for why this is true.  Vertical contracts with suppliers aligns the interests of the retailer (carrier) with the supplier (phone maker).  DROID is a good example.  It’s a brand used by Verizon to market higher-end Android smartphones to tech-savvy early adopters.  This is a case of vertical restraints that prevent free-riding on Verizon’s brand promotion since no other carrier can offer DROID phones.  By most accounts, creating the DROID brand was a lucrative marketing move that helped Verizon’s Android phones compete with iPhones.  While DROID is probably the most successful example, all carriers have phones they market and sell exclusively.

4.  Improves carriers’ bargaining power with handset makers (and improves phones)

Selling phones with subscriptions allows carriers to strengthen their position in the value chain.  Carriers don’t want to be passive bit-pipes.  They know crushing price competition between carriers would result.  (Not to mention, being “dumb pipes” would make carriers more susceptible to net neutrality rules.)  Carriers are already being squeezed by handset suppliers, namely Apple, with high prices, so it’s to their benefit to make the handsets complementary to a specific network and not easily interoperable with other carriers.  And by selling differentiated handsets to their customers, the carriers demand innovative handsets from suppliers to differentiate their brand from other carriers and make their network ecosystem attractive to consumers.  If phones worked on all networks, a mandate Wu and others seek, each carrier’s demand for innovative phones from their suppliers would subside.  (Then competition would be driven by consumer demands, but it’s my impression that phone makers prefer to deal with carriers.  Responding directly to consumer demands would tend to fragment the hardware market even more than the existing market, which would add to their costs.)

5.  Smooths revenue streams for carriers (and improves networks)

Finally, locking consumers into a two-year contract, with a subsidized phone as a carrot, gives some predictability to carriers’ revenue streams.  Lumpy revenue streams and high churn is a killer for long-term network investment plans.  Without the ability to sell phones with subscriptions, churn rates would be much higher since few customers would want to be in a long contract.

This is what happened in Finland for years, when regulators banned bundling.  After having one of the best networks when cell phones first became popular in the late 1990s, there was intense price competition for voice and text.  And while Finnish prices were low, the investments in a 3G data network fell far behind other countries.  No bundling led to very high churn rates and made price competition–not advanced services like broadband–the focus of carriers.  Seeing that the lack of network investment was brought on by the ban on bundling, the Finnish equivalent of the FCC repealed the anti-bundling law in 2005.  With the new ability to lock customers into contracts, phone prices fell and network investment into mobile broadband improved.

I expect selling phones with subscriptions will continue for the foreseeable future, absent regulation.  And, for the reasons I’ve outlined, the ability to sell phones with subscriptions is likely a good thing for consumers and the industry.

Finally, though, I’ll note that inexpensive high-end smartphones could upset this entire bundling regime.  Cheap phones would mean carriers are less able to lock consumers into contracts.  We’re not there yet, but phones like the LG Nexus 4–an unlocked high-end Android starting at $300–indicates the day may come when consumers can’t be bribed into contracts by subsidized phones any longer.  Consumers, at that point, will prefer to pay full price up-front and have the ability to switch carriers at any time.  I don’t know how the radio engineering issues would be overcome, but this would be a major disruption of the wireless market and would have some ambiguous effects on competition, network investment, and consumers.  And, it’s important to note that we may enter Wu’s desired world of phone interoperability without regulatory mandates.