November 27, 2009 8:52 PM

Net Neutrality: Down the Rabbit Hole (Vertical Integration Ignored)

"In another moment down went Alice after it, never once considering how in the world she was to get out again.
The rabbit-hole went straight on like a tunnel for some way, and then dipped suddenly down, so suddenly that Alice had not a moment to think about stopping herself before she found herself falling down what seemed to be a very deep well.

Either the well was very deep, or she fell very slowly, for she had plenty of time as she went down to look about her, and to wonder what was going to happen next. First, she tried to look down and make out what she was coming to, but it was too dark to see anything . . .

'Well!' thought Alice to herself 'After such a fall as this, I shall think nothing of tumbling down-stairs! How brave they'll all think me at home! Why, I wouldn't say anything about it, even if I fell off the top of the house!' (which was very likely true.)

In keeping with our Adventures in Wonderland approach to the Net Neutrality NPRM, it only seemed appropriate to keep the long quote from Down the Rabbit Hole (Chapter 1) intact--especially when discussing vertical integration.  As noted in the last post, we'll look at real harms caused by vertical integration in one market--and not addressed by the Commission--and compare these circumstances to the empty theories posited in the NPRM.

You see, so many of the potential "threats" to the public that are postulated in the world of Internet commerce are only speculative in the NPRM . . . BUT . . . the Commission is in possession of a great deal of "data driven" information on the harms to consumer welfare resulting from unhealthy vertical integration.  Where?  Why in the only communications market where prices have been escalating in both real and nominal terms since Congress passed the Telecommunications Act of 1996--the market for subscription TV services.  This is a market characterized by unchecked price hikes resulting from a lack of competition in the programming and distribution markets.  We've been over the Commission's data before, and don't need to repeat it in this post.

Suffice it to say, though, that the Commission could look back on their previous failure to pursue a "data-driven" pro-consumer approach to much steeper prices caused by vertical integration in a real industry subject to the FCC's regulation, and (rather than sound the alarm about consumer welfare concerns related to vertical integration in any Internet-related market)--like Alice--say "[a]fter such a fall as this, I shall think nothing of tumbling down stairs!"  Later on, I'll put on my Nostradamus hat and predict--but with much more specificity--why the first problem, the real, data-driven, harms to consumers in the subscription TV business--may well continue to go unaddressed, as the Commission thinks nothing of "tumbling down the stairs" of imagined vertical integration in the Internet ecosystem.

Not to beat a dead horse, but take a look at the "data-driven" chart in the post addressing the consumer harms of vertical integration ignored in the subscription television market. There is considerable concentration in both the cable programming, and cable distribution markets.  These facts have been documented in this blog in multiple posts (look at the tag cloud under "high subscription TV prices."  Moreover, according to some of the same parties supporting the Net Neutrality NPRM, this concentration is only increasing with the recently proposed Comcast-NBC merger. Comcast is already the largest single owner of cable television programming, and, unlike Internet backbone services, there does seem to be some scarcity/exclusionary value in vertical integration through ownership of cable programming, rather than simply purchasing it through contract.
On the other hand, there is no broadband Internet access provider that has any serious market power over any geographic, or product, market large enough to threaten consumer welfare vis-à-vis the cable and wireless broadband providers that are in the market, and that are entering the market through advances in technology and continued spectrum deployments.  Moreover, backhaul continues to be augmented with fiber from a number of sources, including both incumbent and competitive wireline and fixed wireless wholesalers.  Similarly, it is not clear whether any broadband Internet access provider has any market power in any adjacent upstream or downstream market in which broadband Internet access is a critical input.

Yet, the Commission "understand[s] the term 'nondiscriminatory' to mean that a broadband Internet access service provider may not charge a content, application, or service provider for enhanced or prioritized access to the subscribers of the broadband Internet access service provider . . . . " NPRM, ¶ 106.  This "nondiscrimination" rule--or "fifth principle"--would seem to foreclose broadband Internet access service providers from competing for providing higher quality services to customers of services traditionally provided by Internet backbone network owners--devaluing these investments.  Moreover, since the proposed Net Neutrality rules are not limited to mass market broadband providers, all competitive backbone providers will see their networks devalued, and their incentives to expand last mile access to business customers will also be diminished.  These rules are not "nondiscrimination" rules, because the broadband Internet access service providers would be foreclosed from competing to provide superior service to any content, application, or service providers--even if the broadband Internet access provider offers the service on the same terms to all potential customers.  Foreclosure from a market protects competitors, not consumers.

Finally, here's my attempt at crystal ball gazing.  I've had some luck before, but I hope I'm wrong this time.  Let's assume the Commission takes a year or more to analyze the Comcast-NBC merger--which regulatory investment analysts predict will pass FCC scrutiny, though perhaps with some conditions--this time period may coincide with the Commission's consideration of its proposed Net Neutrality rules. If this is the case, the Commission will be looking for some support for the proposed Net Neutrality rules.  The proposed rules devalue integrated telecom providers' networks--including the networks of competitive providers of Internet backbone service and competitive last mile service--much more than cable providers' networks (because the cable companies have less integrated network facilities with which to sell high quality services to content, applications, and service providers).
It does not stretch the imagination for the Commission to hold the Comcast-NBC merger hostage in exchange for gaining some support (or at least no resistance) to the Commission's proposed Net Neutrality rules.  Say the Commission imposes some limited, short term, conditions on the merger.  In exchange, Cable provides some tepid support for the proposed Net Neutrality rules, and Comcast (and others, presumably) would be free to acquire more content, with which to raise the input costs to video competitors.  Politically, it works, and the only parties that lose are the ones that are losing now, the parties not "at the table"--the American subscription video consumer, and the potential customers of content delivery networks services, new applications, and/or new services offered over the Internet, which could be optimized by custom-tailored Internet delivery services.

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