Communications Insights: Trends and Cool Stuff

The recent legislative proposal on Network Neutrality proposed by Google and Verizon would “allow broadband providers to offer additional, differentiated online services, in addition to the Internet access and video services (such as Verizon’s FIOS TV) offered today.”  Some critics have argued that that the deal would create a two-tiered Internet, one upper tier for differentiated services and one lower tier for commodity packets.  The first could swallow the second, as ISPs try to up-sell their customers to higher margin products.  So, in short, the basic Internet will get crappier and the managed Internet will get more expensive and less open to competing sources of content and applications.

There is some strong precedent for this criticism since it is not a new economic phenomenon.  Emile Dupuit observed of the French rail system in 1849:

It is not because of the few thousand francs which would have to be spent to put a roof over the third-class carriage or to upholster the third-class seats that some company or other has open carriages with wooden benches … What the company is trying to do is prevent the passengers who can pay the second-class fare from traveling third class; it hits the poor, not because it wants to hurt them, but to frighten the rich … And it is again for the same reason that the companies, having proved almost cruel to the third-class passengers and mean to the second-class ones, become lavish in dealing with first-class customers. Having refused the poor what is necessary, they give the rich what is superfluous.

As I wrote in a previous Cool Stuff, I am not inherently opposed to two tiered pricing.

Sometimes even an economist will spend £5 to ride in an open carriage, if it makes his kid happy.

Even in common carriage networks there has been tiering and prioritization, such as business and economy classes in rail and air transport, for example.  In traditional a telephone networks, there was tiering. Although every one got VGS (voice grade service), under the Bell System there was still business and residential classes of service.  The network was capable of certain forms of call prioritization in emergencies, calls to 911, calling out prioritization over calling in, and GETS (Government Emergency Telecommunications Service).  There was also prioritization based on first-in-time.  The telephone network was designed to handle only fraction of capacity, and on occasion, you might get an “all circuits are busy” message when your call was blocked.

More troubling than a two-tiered Internet is the in the way which the deal could misalign economic incentives.  The Google-Verizon deal could change to the way networks compensate one another for carrying traffic to their respective customers, if the content or application provider is paying for better service on the enduser’s network.  There are basically three ways networks can compensate one another: calling-party-pays; receiving-party-pays; and bill-and-keep.  Money changes hands as their names suggest.  Bill-and-keep is the way most Internet traffic is exchanged (peering).  It works well when the networks are roughly equivalent in size, traffic flows, and cost-causation.  Receiving party pays is how most cell phone networks exchange traffic in the US.  It provides pretty good economic incentives.  The problem with the Google-Verizon deal is that it could be, in effect, a calling-party-pays arrangement.  Without regulation, these arrangements provide the opportunity for carriers to shift costs to rival networks and engage in other system-gaming.  When dealing with a “termination monopoly” such as an Internet connection, traffic should be exchanged under receiving party-pays or bill-and-keep arrangements.  The termination monopoly exists anytime there is only one network which can terminate traffic to a network end point.  It is surprisingly durable.  Even when there is a healthy number of competitors in access networks (fixed or wireless), once a subscriber chooses a particular network, he forecloses all other ways for other network participants to send him traffic.  It is in the termination network’s interest to keep prices low for its subscribers and charge high costs to other networks’ subscribers. In the current case, this fact is Okay for Google because it has lots of cash.  However, its competitors and start-ups might not be able to pay for such termination.  In this way, the Google-Verizon deal could in the long run serve to limit others from the market place.

In the end, either competition or regulation has to constrain this behavior.

Insight: Google Verizon proposal is not so much a threat to network neutrality (lower case) as it is to network economics.  Part of this is the public face of a private bargaining game. Players in the value chain are using the political and regulatory process as they struggle to gain a larger share of that chain.  It is not evil, merely self-interested.  That is fine.  At some level, Google and Verizon should be lauded for working towards a compromise and to move things forward.  But, they should not get to make public policy.  That is the exclusive domain of Congress and the FCC.  The FCC should take those views into account then offer its own independent decision to impose regulation or not.  Professors Susan Crawford and Lawrence Lessig (both of whom I admire very much) get this exactly right in their Op-Ed last week.  If Google and Verizon want to offer an internet without a roof, the FCC should make sure that another company is able to offer a competing one with a roof.