Results tagged “fcc”

November 18, 2016 3:37 PM

Wheeler's FCC: Decisionmaking by Political Favoritism

An independent, "expert agency," like the FCC, is at its most effective when it is focused on keeping the industries it regulates running smoothly, in the interests of consumers, by filling policy "potholes."  On the other hand, nothing incites partisan rancor like addressing "problems" that look a lot more like ideological crusades, rather than good faith efforts to address genuine consumer grievances.  

Under Chairman Tom Wheeler, the FCC became a battlefield for "proxy wars" pitting business interests against each other in the name of ideology--that, itself, was a disguise for transparent political favoritism.  These battles were fought not by the traditional strength of evidence and argument, but instead through PR campaigns, produced social media outrage, and 3rd party Hessians claiming the "public" or "progressive" interest mantle. This approach has devalued the deliberative process and the role of  the majority and minority commissioners in driving consensus at the expert agency.

A Regulatory "Pothole"

A good example of a regulatory "pothole" is the agency's response to rapid adoption of VoIP technology by consumers in the early 2000's.  Though VoIP calls were a cheaper substitute for PSTN calls in most respects, because VoIP calls didn't use the PSTN, consumers could not access E911 service.  

After some well-publicized tragedies, the FCC quickly focused on this specific issue (out of a larger number of issues) in its already-pending 2004 VoIP NPRM.  Acting quickly, and unanimously, the FCC issued an Order in 2005, adopting some interim measures to: 1) better inform consumers of the limits of nomadic VoIP services, and 2) to ensure that "interconnected" VoIP providers quickly became able to offer E911 service to their customers by terminating calls through CLECs.  

But, if the VoIP 911 matter was an example of interested stakeholders (carriers and public safety/law enforcement) forthrightly putting their interests on the table, and the FCC balancing those interests to find the best solution for consumers, the FCC's recent Broadband Privacy Order provides a good illustration of the exact opposite type of proceeding. 

Broadband Privacy ≠ Internet Privacy

The Commission's classification of broadband Internet access service as a "telecommunications service," in its 2015 Open Internet Order, in turn, allowed the FCC to define what information, with respect to this service, it would define as "customer proprietary network information" ("CPNI") under Section 222 of the Act.  Section 222 defines CPNI as, essentially, information that the service provider knows by virtue of providing a telecom service to a customer, and requires the carrier to obtain customer permission before selling the customer's CPNI to a third party.  

The Interent Service Providers ("ISPs") argued that consumer Internet usage information is not information uniquely held by the ISP, in the way that CPNI was uniquely in possession of a telecommunications carrier in 1996 (when Congress wrote the law).  See, e.g., AT&T Comments pp.9-30.  Rather, the primary market for consumers' internet usage information is the online advertising market. , in which the ISPs do not possess sufficient unique, or valuable, consumer information to even possess a measurable share of the market.

Indeed, consumer Internet usage information is "monetized" in the online advertising market--a market in which almost 2/3's of all revenue, and 90% of growth since 1Q 2015, is controlled by Google and Facebook!  Significantly, the online advertising market is also one in which no ISP even possess a measurable share of the market.  Not surprisingly, according to Princeton University researchers, Google and Facebook account for all of the top 10 third party trackers on the Web

 The ISPs explained that, despite the FCC's rhetoric in its NPRM about consumer "privacy,"

[n]o matter what the Commission does in this proceeding, major actors in the Internet ecosystem will continue to track and use all of the same information the proposed rules would keep ISPs from efficiently tracking and using.

See, e.g., AT&T Comments at p. 35 (emphasis added).  Thus, they argued, the FCC's proposed rules would not enhance consumer privacy, but merely foreclose competition in the online advertising market.

Party Participation vs. Proxy Participation

Given the competitive significance of the FCC's proposed rules, you might think the record in this proceeding would pit edge providers and ISPs against each other, with each side trying to show why the ISPs do/don't possess some unique information about their customers that is worthy of rules protecting its disclosure.  If this was your guess, you'd be half right; the ISPs definitely showed up with their best information/arguments.  

On the other side, though, neither Google/Alphabet, nor Facebook appears in any search of this docket.  Yet, the FCC had no trouble finding support in the record for its contention  that it is the ISPs from whom consumers' information needed protection, and not the two dominant firms in the business of collecting and selling that information.  If you look through the Order, you'll see that a majority of the support the FCC cites is supplied by parties with ties to Google, Facebook, or other edge providers.

For example, the Electronic Frontier Foundation (cited 45 times in the Order) is a frequent advocate for, and recipient of funding from, both Google and Facebook.  We've discussed Public Knowledge (56 cites) here before, but it and other groups that the Commission cites frequently, like the Center for Democracy & Technology (61 cites),  and the New America Foundation Open Technology Institute (72 cites) are also supported by Google.  The Commission also cited a paper filed by Upturn, which is a legal/policy advocacy group, whose involvement was sponsored by the Media Democracy Fund (supported by edge providers Microsoft and Tumblr.) 

Even groups with names as innocuous as Consumer Federation of America/California, Consumer Watchdog, and National Consumers League are groups for which Google discloses support.  Academics, as well, may have more than an "academic" interest.

Princeton University Professor, Nick Feamster comments, but doesn't disclose that he has received $1.6  million from Google over the past 5 years.  Other Princeton faculty members filed comments similar to Feamster's.  And, in May, Princeton's Center for Information Technology Policy, of which Feamster is Acting Director, was a co-sponsor, along with Google-funded Center for Democracy and Technology, of a policy conference on the topic of "broadband privacy."  The Google Transparency Project notes that 5 of the 7 panelists at the event had received support from Google.   

You Need Not Be Present to Win

The reasons behind some parties' participation doesn't mean that their advocacy/arguments were wrong, but the FCC woud have benefited more from a direct exchange between both sides with first-hand knowledge of the consumer information they track.  And, why weren't Google and Facebook in the record, making these points, themselves? 

One reason could have been that more information about these firms' dominance in online advertising came out over the summer, including a paper by one of the Princeton academics in this proceeding, noting that Google and Facebook controlled all the top 10 third-party trackers.  Another reason for Google's absence may have been that it went back on its self-imposed ban on using consumers' personally-identifiable information in its web tracking, according to this ProPublica report

Would it have been embarrassing for the leading edge providers to ask the government for protection from competition?  Maybe, but consumers deserved the ability to transparently see which side--between two interested parties--the government was choosing, and why.  

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The FCC's leadership has been willing to undertake ideological crusades for the sole purpose of advantaging politically-favored firms.  The transparent nature of the FCC's actions ensure that they will quickly be undone by a subsequent Commission.  The legacy of such leadership leaves only acrimony among the majority of Commissioners trying to put consumers first.  Hopefully, the next FCC will  learn from history.


  

October 26, 2015 3:08 PM

Why Is the FCC Hiding the Ball on Special Access Price Regulation?

On October 16th, the FCC issued an Order Initiating Investigation and Designating Issues for Investigation ("Investigations Order") concerning the provision of point-to-point data transmission services ("special access") by the country's largest incumbent LECs (AT&T, CenturyLink, Frontier, and Verizon).  These services, when provided by ILECs, are still subject to FCC price regulation.  Although the FCC has "de-tariffed" many of these services, much like the recently re-classified "Broadband Internet Access" service, ILEC special access services remain subject to Section 201's requirement that they be "just and reasonable."  

The Commission's Non-Price "Concern"

Superficially, the FCC's investigation is about the ancillary effects of the volume and term commitments that some CLECs have agreed to in order to receive the ILECs' lowest prices on special access services.  However, the Commission's overview and explanation of its concerns suggest that its inquiry is much broader than the competitive concerns with discount contracts that have been identified in the case law, and associated economics literature, the Commission briefly discusses.  See, Investigations Order at n. 54.

The Commission's only potentially-legitimate non-price concern is succinctly stated only once in the entire first 12 pages of the Investigations Order.  The FCC quotes a CLEC ex parte letter arguing that the term and volume commitments in the ILEC tariffs "shrink[ ] the addressable market for competitive wholesale special access providers (thereby preventing them from achieving minimum viable scale), and cause[ ] special access prices to remain higher than would otherwise be the case."  Investigations Order, Paragraph 12 [internal citation omitted].  

Everything else the Commission identifies as a question, or unresolved contention between the ILECs and CLECs, is more properly classified as "something that the CLECs don't like having to do in order to get the lowest possible prices."  The CLECs' gripes are certainly reasonable (from their perspective), but they are not competition-affecting issues; they are bargaining issues.

When Good Discounts Go Bad

One issue (out of many the FCC identifies) is that conduct that is otherwise competitively benign "may be impermissibly exclusionary when practiced by a monopolist." See, U.S. v. Dentsply, 399 F.3d 181, 187 (3d Cir. 2005).  Sometimes monopolies (firms with market shares approaching, or greater than, 80%) will use "discount contracts" as a way to limit the ability of new entrants to enter the market for the product/service being offered through the discount contracts.  The FCC references some of these cases in n. 54.  Let's take a closer look at a representative case in order to better understand situations in which these agreements can injure competition.

In ZF Meritor, LLC v. Eaton Corp., 696 F.3d 254 (3d Cir. 2012), the product market was heavy duty transmissions for big trucks, such as 18 wheelers, cement mixers, and garbage trucks.  The defendant, Eaton, was a monopolist in the U.S. heavy duty transmissions market from the 1950s until Meritor entered in 1989.  By 1999, Meritor had garnered a 17% share of the heavy duty transmissions market.  In mid-1999, Meritor and a leading European heavy-duty transmissions manufacturer, ZF AG, formed a joint venture to adapt a popular ZF AG model to the U.S. market.

In the U.S. market for heavy duty transmissions, there are 4 direct purchaser customers; these firms are the original equipment manufacturers ("OEMs").  Truck buyers, the ultimate consumers of heavy duty transmissions, purchase trucks from the OEMs by "assembling" components from the OEMs' catalogs.  It is, therefore, vitally important for a component part manufacturer to be listed in the OEM catalog--and on reasonable terms.  

From late 1999-2000, the U.S. trucking industry experienced a 40-50% decline in demand for new vehicles.  Shortly thereafter, Eaton entered into new long term agreements ("LTAs") with the 4 OEMs.  Long term agreements were not uncommon in this industry, but Eaton's new agreements were "unprecedented" in their length (the shortest were for a minimum of 5 years).

The new LTAs provided the OEMs with substantial up-front cash "rebates" of $1-2.5 million.  In exchange, the OEMs agreed to use Eaton transmissions in a very high percentage (usually, >90%) of their vehicles sold.  If an OEM missed its sales targets in any year, it was required to return in full all "advance" rebates it had received from Eaton.  Finally, the agreements required OEMs to artificially increase the price of ZF Meritor transmissions by $150-200, and to impose additional "penalties" on customers that still chose ZF Meritor transmissions.

By 2003, ZF Meritor determined that it was limited to no more than 8% of the market due to the Eaton's agreements with the OEMs.  ZF Meritor needed to get at least 10% of the market in order to remain viable, so it adopted a strategy of trying to sell directly to the end-user customers.  Nonetheless, at the end of 2005, its market share had dropped to 4%, and, in January of 2007, ZF Meritor exited the market.  Shortly thereafter, ZF Meritor sued Eaton on antitrust grounds. A jury returned a verdict in favor of ZF Meritor, which was upheld on appeal by the 3d Circuit Court of Appeals.

The Commission's Investigation of Dissimilar Discounts

Every antitrust case involving discount contracts, as well as the economic literature cited by the Commission, has several facts in common with the ZF Meritor case. First, the product or service has to be an input to the product or service the customer sells to its customers.  Second, it must be the case that only 1 firm can supply the majority of any customer's demand for the input, and, that firm almost always has a market share of 80% or greater.  Third, the primary "victim" of the contracts is not the purchaser, but rather the direct competitor, of the seller.

Finally, and this last condition is implicit, but the most important for our purposes.  In every instance where discount contracts have been found to harm competition, these contracts affect the entire relevant market for the product or service (or a very high majority of that market)If a new entrant can enter the market (for the same service the dominant firm is supplying through its "discount contracts") without selling to the same customers, then the discount contracts can have only a speculative and de minimus effect on competition--regardless of  how "unfair" they may seem to an outside observer.

Do CLECs Represent the Majority of Demand for Wholesale Data Transmission Services?

This, of course, is the first question the FCC should have addressed if it was genuinely concerned about competitive conditions in the wholesale transmission market.  To understand the importance of CLEC demand to the capital deployment decisions of competitive wholesale network service providers, let's look at a competitor that successfully entered the market after the FCC started its special access inquiry.  Zayo, according to the company history on its website,

was founded in 2007 in order to take advantage of the favorable Internet, data, and wireless growth trends driving the demand for bandwidth infrastructure, colocation and connectivity services.

So, if the ILECs have tied up the demand of some CLECs--which could otherwise go to competitors like Zayo, then who is buying from Zayo instead of the ILEC?  Fortunately, Zayo solves this mystery in a presentation to investors in May of this year.  
zayo_sales channels from pdf.jpg

What?  Zayo is selling to some of these same CLECs and those wascally ILECs?   In fact, as we can see, while wireline providers--including those same special access sellers that are under investigation--do constitute the largest group of potential customers for a new entrant, they are still only a minority of total market demand.  Moreover, it is hard to say how much the incremental CLEC demand would be--if not "locked down"--but it's doubtful that it would make the pie a whole lot wider. 

Why Does the FCC Insist on Its Ruse of an Investigation?

We've previously pointed out that "ILEC special access" is not a relevant product market.    Because "ILEC special access" is not a relevant market, it's not at all surprising that the FCC cannot point to a single, specific, direct competitor victim.  Instead, the Commission seems quite willing--perhaps too willing--to simply accept the purchasers' assurances that a victim exists; just a more "theoretical" victim than the antitrust laws protect.   

So, if the Commission's ostensible question for "investigation" is nothing more than the thinnest veneer to disguise price regulation, why is the FCC even bothering with the pretense of an investigation?  While it doesn't make much sense to price-regulate a fraction of a "market," if that's what the FCC wants to do, then it should at least regulate prices in a transparent manner.  Good government isn't always smart, but it should always be transparent to its citizens.
 

October 5, 2015 11:46 AM

Special Access Regulation: Always Best for Retail Customers?

The notion that extending regulation of ILEC special access could be bad for anyone (who's not an ILEC), much less retail business customers, may seem incongruous.  After all, if the competitors--who are serving real business customers--are in favor of imposing regulations on ILEC special access, then how could it possibly hurt their customers? 

Competition, Contracts, and Consumer Inertia

Last September, Chairman Wheeler described the mass market for broadband Internet access as so non-competitive that it made little difference if a customer faced a monopoly, or had a choice of service provider.  The Chairman stated,  

[c]ounting the number of choices the consumer has on the day before their Internet service is installed does not measure their competitive alternatives the day after.

Speech at 4.  The reason, he explained, is that "[o]nce consumers choose a broadband provider, they face high switching costs [like] . . . early-termination fees. . . .  Id.  Interesting observation, but is it accurate?   

Well, in April of 2010, the FCC surveyed a representative sample of broadband subscribers about their broadband purchasing/switching behavior over the prior 3 years.  The Commission found that 36% of customers had switched broadband providers in the past 3 years (compared with 19% of mobile customers switching providers over the same period). Survey at 6, 10.  Of the consumers that had switched ISPs, the overwhelming majority (86%) said the process of switching providers was either "very easy" (56%) or "somewhat easy" (30%).  Survey at 10.

Instead of describing any unique market failure in the consumer broadband Internet market, what Chairman Wheeler intuitively sensed was the phenomenon of "consumer inertia."   Consumer inertia is a behavioral tendency in markets where products are purchased through contracts--like cable TV, or insurance.  In these markets, consumers may aggressively shop for their initial service, but then neglect to continue to monitor market prices and, thereby, over time receive less competitive terms.

Consumer Inertia Is Good for Competitors, But Not Customers

The effect of customer inertia--on their service providers--is best illustrated by the fact that there are a lot of locations where competitors are serving retail customers with ILEC special access, even though competitive fiber is available.  See, e.g., T-Mobile example in last blog.  One reason that a CLEC will not automatically use competitive fiber when it becomes available is that each time a retail customer location switches to a different physical transmission line, the CLEC must physically "groom" the retail customer's premise equipment (modems/servers/PBXs) onto the new network.
groom5.jpgCarriers Hate Physical Grooms.  A physical groom is a hassle for both the CLEC and the customer.  To better understand why, let's consider a hypothetical example. 

Let's say you're a CLEC, and you're serving a customer with 5 locations in a metro area.  Your own fiber is serving 3 of the customer's locations, and the other 2 are served via ILEC special access.  To get those 2 special access locations on anyone's fiber, you (and your customer) have to physically be present to: 1) allow physical access/wiring by the new access vendor, and 2) configure/test the customer's new service.  Also, to mitigate the consequences of any service disruption, this usually happens at 3:00 in the morning, preferably on a weekend.

falling down2.jpgIf the worst happens, the business customer could temporarily lose service, lose business, or even end up causing their IT guy to turn into the Michael Douglas character from Falling Down.  The risk varies, but it's always there, and that's without the nastier risk of . . . competition. 

Customers Love New Fiber Facilities.  Physical grooms are hard on carriers, but customers love how a groom just "wakes them up!"  You see, the retail business market works kind of like Chairman Wheeler imagined the mass market for broadband Internet service to work--at least in the sense that business telecom contracts really do have high termination penalties.  See, e.g., these small business customer complaints to the BBB about tw Telecom.  Early termination penalties--after the original contract term--may even promote consumer inertia.  But, things change when the service provider wants to change the customer's physical service configuration.

In fact, nothing disrupts consumer inertia like the customer spending a lot of time on the phone with their current supplier (as a customer might do to prepare for a coordinated service cutover).  In fact, since the CLEC is only coordinating with the customer because it has alternatives, it's only a matter of time before the customer starts thinking the same thing.

So, referring back to our previous example, let's say you're the CLEC and have been serving this customer for 7 years.  And, let's say that the customer has had no disruptions/complaints in that 7 years.  You've been sending out bills and they've been sending out checks; it's every carrier's "fairy tale" customer relationship! 

Then, you try to do something nice by putting the customer's special access locations onto competitive fiber, and what happens?  The customer's eye starts wandering, suddenly nothing in your contract is good enough for them anymore, you become clingy, and, before you know it . . . the "fairy tale" unravels in tears and bitter rancor?!
    
groom4.jpgWell, it's not always that bad.  But, at best, if you want to keep the customer, you're probably going to have to lower their price, and stop coming home drunk (or the telecom equivalent).  So it's kind of easy to see--from the CLEC's point of view--why, if a customer's service was initiated using ILEC special access, they would need a really good reason to take the customer off that service.
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Some carriers are lobbying for the blanket extension/expansion of special access regulation, because this service fits comfortably with the network architecture they decided on 15-20 years ago.  But, Chairman Wheeler recognizes the limiting effects of inertia on retail consumers, and he knows better than to simply assume that the outcome favored by service providers is also the best outcome for their customers.  If the effect of extending special access regulation is to keep retail customers believing that their choices are no different than "the day before they had their service installed" many years ago, do these carriers really believe the FCC will think this is the best choice outcome for consumers? 


September 24, 2015 11:10 AM

ILEC Special Access: Is It a "Relevant Market?"

I was troubled to see the FCC, in its Technology Transitions Order, tell ILECs that they would not get the full benefit of their new fiber deployments until the Commission concludes its "review" of competition in the "special access market."  Order, paras. 101-143. Then, last Thursday, the FCC announced that it had taken a "major step" in its review of competition in the special access "market" by making its collected data available to the parties.  And, that made me feel a lot better.  (just kidding!)

The FCC should be moving forward with its review, if only because it's been 14 years since AT&T first petitioned the FCC to revisit its 1999 Pricing Flexibility Rules.  However, the fact that the FCC has not, more recently, focused on the threshold question of whether ILEC special access service is even a distinct "relevant market" should give the public doubts about how quickly this matter will conclude.

You see, the FCC can never justify economic regulation for the benefit of "consumers" if the regulation does not apply throughout the entirety of a rationally-defined market.  For example, last September, Chairman Wheeler explained in a speech that he believed cable to be dominant over the most important part of the consumer broadband market (25Mbps and above), yet the FCC's Open Internet rules applied much more broadly.  Likewise, the last time the FCC made rules affecting ILEC special access, point-to-point data transmission was only widely available from the ILEC.

As a rational matter, unless the Commission's rules cover (at least the majority of) an entire relevant market, its rules cannot possibly provide benefits to consumers in that market.  Here's why it's doubtful that "ILEC special access" services constitute a relevant product market in most parts of the country.   
 
It's Not a Market If Similarly-Situated Customers Don't Use It

Several years ago, the FCC had a "forum" on special access, and you know what?  Everyone was old!  And, so are the companies and carriers that buy a lot of ILEC special access.  The next time you see a story about special access, look at the age of the companies complaining.  I guarantee you that they all started before 2000.

Why aren't there any "young" companies complaining about special access?  Well, probably for the same reason there's no young Bingo players:  it's not that fun, and younger gamblers had better alternatives when they picked up the habit.

bingo lady1.jpg
switchboard operator1.jpgBandwidth Intensive Customers Don't Need ILEC Special Access.  If this isn't obvious, just look at the blog where I explained why Google (and other content delivery companies) took Netflix's "interconnection service" candy at the 11th hour of the net neutrality proceeding.  Netflix was trying to obtain--through regulatory pan-handling--the same benefits that these companies had invested so much capital to create through their own networks. 

The appendix at the end of the blog shows network investment by companies that were new enough to not need special access, but yet old enough to have purchased high-bandwidth transmission capacity at "rock bottom" prices in the wake of the 2002 telecom meltdown.  These companies would never have invested that kind of money to build their own networks if they were destined to be dependent on ILEC special access.

Small/Medium Retail Customers Have Non-Special-Access Competitive Alternatives.
One might argue that it's unfair to just look at the most bandwidth-intensive customers, because CLECs often rely on special access to serve fairly small (in terms of number of locations) business customers.  I couldn't agree more.  That's why it was interesting that just last week, Comcast Business Services announced that they are able to serve multi-location business customers throughout the country through wholesale agreements they have struck with other large regional incumbent cable companies.   

While Comcast's announcement focused on the fact that it could now (with out-of-region wholesale agreements) serve large national multi-location customers, the more interesting point was that it's in-region business unit (small/medium customers) has been the fastest growing part of its business for the last several years.  Similarly, the success of "bring your own access," web-based business providers, like RingCentral and ShoreTel is further testament to the fact that small and medium business customers generally do have choices for competitive phone service--regardless of whether the customer's existing CLEC provider can use these substitutes as wholesale inputs for their retail service.

The bottom line is that it's not a "market" if not everyone needs it--then it's just a brand.  But, even old customers of old brands can find it in themselves to switch brands . . .  

It's Not a Market If There Are Substitutes

You know what's interesting if you compare who filed comments in this proceeding 10 years ago with the companies that are still active now?  It's who's missing.  Any guesses?  Hint: what's different between these two?

John_Legere1.jpgchristopher_walken1.jpgNo matter what your lyin' eyes are telling you, these are not a "before and after" picture of the same guy.  One is T-Mobile Chairman John Legere (before he became a hippie), and the other is John Legere look-alike Christopher Walken.  

When the FCC kicked off its special access review, in 2005, T-Mobile filed essentially the same special access comments as Sprint.  But, after the introduction of the iPhone in 2007, it became clear (to everyone not named Sprint) that mobile data was the future of wireless, and bandwidth constrained cell-sites would not satisfy, or attract, customers for long.

Hence, T-Mobile took its first major step in quitting special access in the Fall of 2008, when it named 6 new vendors of advanced fiber backhaul solutions.  By February of 2010, it was reported that T-Mobile had replaced copper backhaul with fiber in 7% of its towers, with plans to raise that number to 25% of its towers by the end of 2010.  Finally, in August of 2012, T-Mobile announced that it had upgraded all of its cell sites to advanced backhaul services, 95% of which were served by fiber.

The T-Mobile example is indeed dramatic.  But, just as T-Mobile switched tens of thousands of locations to fiber, there are other successful wireless competitors that entered the market after T-Mobile, like Cricket and Metro PCS (acquired by AT&T and T-Mobile, respectively), that never used ILEC special access (or at least never complained about it to the FCC).

*    *    *

Some CLECs have pointed out that there are always going to be some significant number of buildings that will only be accessible via ILEC facilities. But, this fact does not make those locations a "market,"  because, there is no evidence that the ILECs price services to these locations any differently than they do for the bulk of their customers that do have access to competitive alternatives. 

Thus, the FCC cannot rationally conclude that there is a separate "market" for a subset of an ILEC's customers (that the ILEC does not treat differently) for a service that not all of the ILEC's competitors, or retail customers, need to use.  And this is why this proceeding will not conclude anytime soon.
 







May 22, 2015 3:23 PM

The FCC Should Not Use the AT&T-DirecTV Merger to Weaken Internet Interconnection

Over a year ago, I explained why the Comcast-TWC merger may present regulators with concerns.  On the other hand, I also explained that the AT&T-DirecTV merger presented consumers with nothing but opportunities.  As noted earlier this week, those opportunities have only expanded with ISP/MVPD competition and increased pressure on the programming bundle.  The post-merger AT&T-DirecTV would be a tempting target that may well give some programmers an incentive to "cheat" the industry-standard distribution agreements, and finally let go of the Bundle.

But, recently, news reports have said the FCC may require AT&T to accept "interconnection conditions" as a prerequisite to granting its approval to AT&T's acquisition of DirecTV.  This would be a mistake, because it would also undermine the careful restraint the Commission showed in its (still overly-broad-for-the-purpose) Open Internet Order

In a general sense, all regulations distort economic incentives; and overly broad regulations create more profoundly-distorted incentives.  Still, the FCC did show some restraint--with respect to Internet interconnection--in its ultimate Order.  The Commission should decline invitations to undo its previous well-considered reservations, as it will only promote moral hazard and careless network practices by those it has been asked to "help." 

Regulations Shouldn't Distort Market Discipline--Lessons from the Mortgage Crisis

Overly-broad regulations--designed to minimize one market risk--can easily distort incentives in adjacent markets (or market participants) in ways that create worse problems than the one the regulation was supposed to address.  This was the message of Charles Plosser, the President and CEO of the Federal Reserve Bank of Philadelphia, as he reflected on the role of prior government regulations in contributing to the mortgage crisis.   

In a speech entitled, "Responding to Economic Crises:  Good Intentions, Bad Incentives, and Ugly Results," Plosser considers why we continue to see financial crises, despite the fact that each crisis inevitably brings its own new regulations.  He concludes that, it's "[b]ecause the public and our lawmakers seldom recognize that attempts to insure against bad economic outcomes can sometimes be counterproductive."

Plosser (quoting economist Allan Meltzer) says, "Capitalism without failure is like religion without sin. It doesn't work."  He explains that regulations cannot insure "all manner" of market participants against bad outcomes (or limit the ability of firms to take risks); because while such rules might reduce market volatility, they would also limit innovation and economic growth. 

Plosser offers a number of examples where regulations undermined market discipline, making the overall system more vulnerable.  For example, in the decades preceding the crisis, the government provided numerous implicit and explicit subsidies to financial firms (Fannie/Freddie) and others that became "too big to fail."  By limiting these firm's risk, the subsidies gave lenders the impression that the government would always bail these firms out.  Thus, those lending the money to these firms had little incentive to limit the amount of debt they allowed the firms to accept.   

Plosser concludes that better regulations, and not simply more regulations, are the proper response to market failures.  He cautions,

If regulation distorts incentives, it can create moral hazard problems whereby firms don't bear the costs they impose on others. Such regulations can have unintended consequences that interfere with achieving the regulations' goals. 

The Commission's Invitation to Create Moral Hazard

Of course, there aren't perfect parallels between the financial system and the Internet, but there are enough similarities to draw some useful lessons.  The financial markets function best when they keep money flowing to efficient uses from efficient sources.  Similarly, the Internet, especially the market for Internet interconnection, has become the world's most efficient system for the routing and delivery of data traffic. 

As we have explained previously (see, here and here), the market for Internet interconnection works well, and has its own market discipline, which serves consumers well.  Where the financial markets efficiently reward accurate risk evaluation, the market for Internet interconnection rewards those firms that invest in the most efficient networks to provide valuable traffic routing to prospective interconnection partners. 

Thus, the FCC wisely decided not to regulate Internet interconnection as a separate "service," despite being heavily lobbied to do so by a tiny minority of firms."  In its recent Open Internet Order, the Commission, also wisely, declined to impose any specific interconnection obligations on ISPs, choosing to "rely on the regulatory backstop prohibiting common carriers from engaging in unjust and unreasonable practices." Order ¶ 203.

Recent events have vindicated the Commission's restraint.  Some of the same firms requesting regulation have, indeed, been able to reach fair terms with large ISPs.  Level 3 and Comcast, as well as Cogent and Verizon, have recently been able to reach mutually-beneficial, long-term agreements. 

Unfortunately, though, a few parties, including one (Cogent) that has had found itself on the "disciplined" end of  Interconnection market discipline more than any other (see, e.g., problems with Level 3, Sprint, generally, going back to AOL as a dial-up ISP), and another best known for recently gaming the Commission's own competitive bidding system, have asked the FCC to supplant competitive market discipline with extraordinary relief in the form of conditions to an otherwise pro-competitive merger.  These parties have nothing to lose by asking for relief

However, if the FCC accedes to these demands, AT&T's broadband Internet consumers can only lose.  Because, notwithstanding any evidence that AT&T is acting unjustly or unreasonably with respect to Cogent or Dish, these firms are asking the Commission to impose different terms on AT&T than other ISPs.  It is, therefore, more than likely that the FCC--if it agreed to do so--would be imposing a weaker link (through non-competitive interconnection terms) into some retail customers' supply chain.  This is no way to ensure consumers have the best end-to-end broadband Internet access.  It will, however, ensure that the FCC gets more requests to regulate outcomes best decided by a more efficient market. 


May 20, 2015 6:01 PM

Bundle This! Broadband ISPs v. Big Media Content

Recently, we showed how the broadband market is more competitive than the FCC wants to admit, and we've explained why the Big Media companies have a much greater profit incentive (than ISPs) to see the continuation of the (largely artificial) separation of content delivery into two businesses (subscription TV and broadband Internet access).  But, the fact is that broadband Internet access does compete with pay-TV video; the FCC's just wrong about whose side ISPs are on.

Channel Bundling:  Consumers (and ISPs/MVPDs) Hate It

Nielsen reports that consumers are buying more channels than ever, yet watch the same number that they always have.  The reason: big content companies require MVPDs to buy, and resell, all their channels ("the Bundle") in order to get the few channels that their customers want.  The Bundle is so important to media companies that they all use the same restrictive distribution contracts to protect it.  

Buzzfeed collected an excellent compendium of quotes about the Bundle late last year.  If you click on the article, you'll see that the only ISP/MVPD defending the Bundle was Comcast (who also produces a significant amount of content).  Consumers--and their retailers, MVPDs/ISPs--don't like the Bundle.

Cablevision v. Viacom

In 2013, Cablevision filed an antitrust case against Viacom over Viacom's requirement that Cablevision buy, and carry, a package of its least-watched channels in order to be able to buy any of its most-watched channels. See Cablevision statement and Complaint (redacted version).   Cablevision's antitrust claim is that the companies' 2012 distribution contract is an illegal tying agreement under Section 1 of the Sherman Act.  

Cablevision says that, in order to get access to the 8 Viacom channels it needs to be able to offer, Viacom requires it to purchase (and carry) 14 other channels that Cablevision's customers don't want.  The "standalone" price of the 8 channels Cablevision wanted to buy was set high enough to subsume Cablevision's entire programming budget; thus, it's only option was to buy all 22 channels. Complaint ¶ 8, ¶ 28.  

Cablevision argues that the capacity it must dedicate to the 14 channels it does not want prevent it from competitively differentiating itself by purchasing better content from Viacom's competitors.  As Cablevision explains, its channel capacity is finite;

Cablevision can devote only a portion of its available capacity to channels because Cablevision also offers other bandwidth intensive services (including high-speed Internet access). Cablevision would not reallocate bandwidth from these other services, which consumers increasingly demand, to carry more channels.

Complaint ¶ 27.
 
Tying agreements are "per se" illegal under the antitrust laws.  This means that a plaintiff does not have to demonstrate that the agreement actually had the effect of reducing competition in any market.  Instead, the plaintiff need only demonstrate the existence of the agreement, that plaintiff was economically "coerced" to buy the tied product, and that it suffered damages as a result. 

Accordingly, last June, a federal district court in Manhattan denied Viacom's motion to dismiss, finding that Cablevision had sufficiently plead a plausible violation of the antitrust laws.  Cablevision's claim has moved on to discovery, but its ultimate success is far from guaranteed.  However, regardless of Cablevision's ultimate success, it would be a mistake to assume that the converse claim--if Viacom were seeking strict enforcement of all contractual provisions--would be any easier to prove.   

Verizon's Skinny Bundles 

Perhaps this was Verizon's insight, when it announced its new "Custom TV" offers last month, allowing customers to choose their own "customized" channel package that includes more channels they want, and less of those they do not want.  For the basic price, Verizon's Custom TV customers get a general selection of popular cable news/entertainment channels, and can choose 2 (out of 7) channel groupings ("skinny bundles"), organized by topic/genre.  Customers can add other skinny bundles for $10/bundle/month. 

The reaction from the content owners was predictably swift, and angry.  Disney, Fox, and NBC were quick to condemn what they perceived as Verizon's reckless disregard for the Bundle.  Disney quickly sued Verizon for breach of contract. 

Is Verizon Breaching It's Contracts?

Verizon has said repeatedly that it is not breaking its contracts with programmers.  Therefore, we have to believe that Verizon is buying all the channels for all the customers it is required to pay for; even if that means every customer.  This seems likely, because, while the Custom TV promotion may "break the Bundle," some say it won't save you a bundle. 

Other MVPDs have also said that Verizon may be within its rights under the contracts.  Cox Communications told Fierce Cable that its agreements typically require the MVPD to buy and deliver channels to 85% of MVPD customers.  If the bundles are as valuable to consumers as Disney seems to think, then it's possible that 85% of Verizon's customers are buying ESPN.  Still, Disney isn't betting on it.

Will a Court Enforce the Bundle?

The news reports  have said that Disney is suing Verizon for breach of contract, and is seeking money damages and an injunction.  I haven't seen Disney's complaint (a public version has not yet been filed), but I'm guessing that the injunction would be to prevent Verizon from continuing to sell channel packages that don't conform to the parties' contract. 

If Disney is really dead set on preserving the Bundle, or preventing a jailbreak among its distributors, it's going to have to convince a court to order Verizon to 1) transmit content to at least some customers who have said they don't want it, and/or 2) limit customers' ability to decline unwanted content.  This is a real longshot. 

Courts are very reluctant to award specific performance if money damages will adequately compensate the aggrieved party.  Furthermore, courts are reluctant to grant any remedy that would result in "economic waste."  If I'm right about the relief Disney wants, it might as well have listed "economic waste" in its prayer for relief.   

If Verizon has breached its contracts with Disney, Disney will get money damages for any measurable loss it has suffered.  But, an important part of the Bundle is the deadweight loss that channel bundling imposes on MVPDs, and their subscribers, and the protection from competition that it affords programmers. Unless a court finds it worth rescuing, this part of the Bundle may well be gone; and that's a good thing.   

*     *     *

Every time a piece of the Bundle breaks off, consumers benefit and programmers get closer to having to compete on price as well as quality.  The fact that Cablevision and Verizon have been motivated to take up for consumers--and take on the Bundle--is another example of the competitive performance of the broadband Internet market.  Still, it's a good thing the FCC was spent the same time drafting more pervasive regulations for ISPs--so they wouldn't favor the Bundle . . . just in case? 
 
March 4, 2015 12:42 PM

The FCC Avoided a Bigger Disaster on Interconnection . . . for Now

In case you didn't notice, the FCC's press release describing its decision to reclassify broadband Internet access is a little different on the subject of interconnection than Chairman Wheeler's "Fact Sheet" 3 weeks earlier.  The FCC's press release from last week is substantially similar to the Chairman's fact sheet, except that it contains no reference to the classification of  the "service that broadband providers make available to 'edge providers.'"

The Chairman's "Edge Service" Classification Proposal Was Really Unpopular

On the last day that parties could lobby the Commission, (February 19th) Google had meetings with senior advisors for the Chairman and the two Democratic Commissioners.  In these meetings, Google persuasively argued that "the Commission should not attempt to classify a "service that broadband providers make available to 'edge providers,'" because "this supposed additional service does not exist." Ex Parte (Internal quote to Chairman's "fact sheet.")   On the eve of the Commission's vote, the Wall Street Journal reported that "the FCC tweaked its language to address Google's concern."  

Without this report, it would be hard to know who to credit for killing a truly reckless idea.   That's because the following 5 parties all made arguments against the Chairman's proposed "new service" on the same day as Google:  Akamai, Free Press and New America's Open Technology Institute, National Hispanic Media Coalition, and Cox Communications.

When you somehow manage to get Free Press, New America, and the National Hispanic Media Coalition to oppose an additional Title II regulatory classification--because it makes your original Title II reclassification look even more legally suspect--that's when you know you've gone too far.  

The Importance of Direct Interconnection Agreements

The scariest aspect of the Commission's proposal must have been the FCC's casual willingness to disturb these companies' existing arrangements with ISPs by mandating the future terms on which they and others would be able to obtain interconnection.  For companies with little to no regard for the terms of their existing interconnection agreements, like Netflix and its transit vendors, the Commission could not make their situation worse.  But, for the leading Internet companies, the Commission must have appeared alarmingly ignorant of/indifferent to the importance of these agreements to Internet traffic delivery.

Reason 1:  The Disintermediation of Internet Traffic

In 2009, the University of Michigan, Arbor Networks, and Merit Network presented the results of the largest traffic study since the advent of the commercial Internet.  The study showed that, between 2007 and 2009, Internet traffic delivery changed radically.  Over only 2 years, Internet transit (the traditional "intermediary" between ISPs) became dramatically less important as a traffic delivery vehicle.  

Instead, major content providers began delivering more and more content directly to the consumer's ISP (either through their own networks or CDNs).  Accordingly, since 2009, the "tech giants" have been accelerating their investment in network assets and data centers to route their high bandwidth traffic directly to efficient delivery points in the ISP's networks.

Reason 2: Interconnection Agreements Reflect Valuable Investment

As the Internet has evolved to more efficiently deliver high-bandwidth content to consumers, the largest content providers--including Netflix for the first 4 years of its streaming service--have placed a premium on placing content closer to the customer.  Therefore, the largest traffic sources have entered into agreements to directly exchange traffic with their customers' ISPs.  When these agreements provide for the settlement-free exchange of traffic, it is because this reflects the mutual benefits received by both parties.  

CapEx Graph 1.jpgSince parties to settlement-free "peering" arrangements each provide the other with valuable network facilities, or other benefits, this value can be observed by looking at the investment the parties put into their networks (i.e., capital expenditures).  To get an idea of the importance of those agreements to Internet companies, consider the increase in capex by the largest Internet companies since 2009.

Regulation of Interconnection Terms Could Devalue Previous and Future Investment

As we can see from the chart above the major Internet companies have undertaken a massive amount of capital spending over the past 6 years in order to efficiently deliver content and services to consumers.  To be sure, not all of the Internet companies' capex is driven by traffic delivery interconnection concerns, but the increase in these companies' capex since 2009 correlates with the findings of the University of Michigan, et al., traffic study referenced above.  Moreover, news reports have confirmed spending on improved data networking infrastructure as a capex driver. See, e.g., here and here.   

This capital investment has been made by edge companies and CDNs with the expectation that it will allow these firms to provide a better experience to their customers than their competitors provide.  Indeed, Google notes that it has entered into peering agreements with some of the largest ISPs because it is "unable to use transit to reach users on those networks with reasonable quality." Ex parte at 2 (emphasis added.)

The risk of requiring ISPs to provide interconnection as a separate common carrier service was articulated succinctly by Akamai, which handles 15-30% of the world's Internet traffic.  Akamai argued that the FCC must not mandate the terms and conditions of ISP interconnection, because if the ISPs are required to provide access on equal terms to all:   

This is not technically feasible and the result could be access for none, which would decrease the performance, scalability, reliability and security of the Internet.
Akamai, February 20th ex parte at 1 (emphasis added).  In other words, Akamai understands and accepts that it "must often compete with others for access to ISP facilities."  Akamai, February 9th ex parte, at 3 (emphasis added). But, does the FCC accept interconnection as a legitimate element of competition?

CapEx Graph 2.jpgThe Commission Should Not Displace Competition with Regulation

Netflix, Cogent, and Level 3 assert that they cannot get interconnection with the ISPs--on the terms they would prefer--because of a lack of competition.  But, as Akamai explained, companies seeking the most efficient terms of distribution to the ISP's customers are competing with each other for the best access to these customers.  Could it be that competition is the reason the transit companies aren't getting the terms they want?

Compare the sum of the capex of Netflix's distribution chain over the relevant time period, with their competitors.  Is it surprising that Internet transit wants the FCC to "level the playing field?" 

Transit is at a disadvantage relative to direct interconnection because the Internet has evolved.  For the content distributors sending the most traffic, transit has not been the preferred solution for a long time.  But competition, and not a lack thereof, produced this outcome.  

Unlike the major focus of the larger net neutrality debate--which is concerned with adopting rules to foreclose future ISP service offerings--the regulation of interconnection terms and conditions is fraught with risks to existing service configurations.  The FCC must be careful not to use prescriptive regulation of ISP interconnection terms--in the name of competitive "neutrality"--to foreclose innovative firms (and their customers) from reaping the benefits of their own ideas, risks, and investments.

******************************

CapEx Data Table.jpg


December 23, 2014 1:07 PM

The Netflix/Comcast Dispute Pt. 3: Did Netflix Mislead Its Customers?

We've, so far--in parts 1 and 2 of this series--looked at some of the justifications Netflix provides for providing inferior service to its customers served by Comcast for months on end, beginning at some time in 2013.  See, e.g., this Netflix ex parte letter, at p. 2. also, slides 33/34 of this ex parte presentation.   We could finish up by taking a look at each side's claim that the other was the real "cause" of the congestion--but that would miss the point of whether interconnection rules, or the lack thereof, were responsible for consumer service disruptions in this case.

Absent any truly shocking new information coming to light (such as learning that Netflix's contract with Cogent was intended to harm consumers, for example, by expressly forbidding Cogent from purchasing supplemental capacity to relieve congestion for its retail customers), it doesn't matter which party is "right" as a matter of Internet policy.  Rather, the immediate question is whether consumer disruption was the unavoidable consequence of this "policy dispute" (though it was unclear whether the dispute between Netflix, Cogent, and Comcast was a "policy," or ordinary business, dispute when it was settled).  

Netflix Knew Congestion Would Impair It's Service

In its Terms of Use for its customers, Netflix designates that Delaware law control any dispute with its customers.  See, Netflix Terms of Use, para. 11.b.  As was mentioned in the blog  dealing with the Cogent-Comcast interconnection agreement, Delaware law holds that "[a] party does not act in bad faith by relying on contract provisions for which that party bargained, where doing so simply limits advantages to another party."  

Thus, Netflix should/would have anticipated that Comcast would "rely[] on contract provisions for which [it] bargained."  Given that Comcast's actions were entirely predictable (and not in bad faith), Netflix would also have known that adherence to its "principle" (of not paying the ISP for transit) would lead to service-affecting levels of congestion for its customers.  So, if Netflix knew that the combination of its planned course of action and Comcast's predictable reaction would cause its customers to receive congestion-degraded service, did Netflix have any obligation to its customers under Section 5 of the FTC Act?

Was Netflix's Failure to Disclose Congestion an Unfair or Deceptive Practice?

Section 5 of the FTC Act prohibits "unfair or deceptive acts or practices" that affect commerce.  An act or practice may be found to be unfair where it "causes or is likely to cause substantial injury to consumers which is not reasonably avoidable by consumers themselves and not outweighed by countervailing benefits to consumers or to competition."  See, FTC Unfairness Statement.   The FTC is likely to find an act or practice to be deceptive if "there is a representation, omission or practice that is likely to mislead the consumer acting reasonably in the circumstances, to the consumer's detriment." FTC Deception Statement

It seems fairly clear that Netflix's provision of compromised service, without disclosure, was an "unfair practice" in the sense that consumers could not have anticipated, or avoided injury.  Moreover, it would be hard to speculate that Netflix's actions--of not notifying consumers to expect degraded service--had some countervailing consumer benefit.  Thus, let's look at whether Netflix also engaged in a deceptive act or practice.  

Netflix Knew It Was Selling Inferior Service.  According to Netflix, for the entire history of its streaming service, someone (a 3d party CDN) has always paid the ISP for the incremental capacity necessary to ensure its traffic was delivered without congestion. Florance Declaration  ¶¶ 29-41.  Furthermore, as even Comcast points out, Netflix's decision to artificially limit its transit vendors--based on Netflix's "principle" of not paying for ISP capacity or paying anyone that does--meant that these vendors' capacity between their networks and Comcast were bound to become overwhelmed, resulting in congestion.  See, e.g., Declaration of Kevin McElearney, Comcast, at ¶¶ 23-25  

Netflix has established that its Comcast customers received a "substandard" grade of service even though the consumer was paying for, and expected, the "standard" grade of service.  Florance Declaration ¶¶ 51-55.  Nonetheless, Netflix kept selling service to Comcast customers, knowing that--as long as its transit vendors' lacked sufficient throughput capacity at points of interconnection with Comcast--each incremental customer would contribute to the service degradation experienced by all Netflix/Comcast customers.  

Netflix Deceptively Failed to Disclose Its Comcast-Specific Service Level.  The FTC, in its 1983 Deception Statement, states that "the practice of offering a product for sale creates an implied representation that it is fit for the purposes for which it is sold." Deception Stmt., n.4.   The FTC has further explained that,

Where the seller knew, or should have known, that an ordinary consumer would need omitted information to evaluate the product or service . . . materiality will be presumed.
Id. Under the circumstances, and without knowing the extent, length, or degree of degradation to expect, it was impossible for an "ordinary" Comcast broadband consumer to evaluate prospective Netflix service.  Thus, Netflix's knowledge of, and omission of, relevant information about Netflix's Comcast-specific congestion service impairment was "material" and, therefore, deceptive.  

Consumer Protections Can't Be Ignored and Be the Basis for Interconnection Rules

Netflix tells the FCC that, "when Netflix's traffic was congested it did everything in its power--short of paying Comcast an access fee--to alleviate the congestion . . . ."  Netflix Petition to Deny at 62. (emphasis added).  The notion that Netflix "did everything in its power"--short of doing the one thing it knew would resolve its service disruptions, and what it ultimately did do--is fallacious, and simply another way of stating that Netflix did just what it intended to do.  

If the FCC believes that consumers will benefit from interconnection rules, it should adopt rules after careful consideration.  But the Commission should not to deceive itself into thinking that "consumer welfare" is served by preemptively granting concessions to prevent behavior that is otherwise flatly proscribed by existing consumer protection laws.

December 4, 2014 3:05 PM

Internet Interconnection: Bad Faith Is No Basis for Good Policy

A few weeks ago, President Obama, acting on some seriously bad advice, formally urged   the FCC to, among other things, consider regulating Internet interconnection agreements.  The "facts" that brought an ordinarily well-functioning market, based on two decades of voluntary agreements, into the President's regulatory cross-hairs were, of course, the highly-publicized disputes surfacing earlier this year involving Netflix, Cogent (one of Netflix's primary Internet transit vendors), and Comcast (at first, and then a series of other large ISPs).  

The only thing that is clear at this point is that there is a lot more information for the FCC to gather, especially from Netflix and Cogent.  The information that is available strongly indicates that the Comcast episode (and each subsequent ISP-specific iteration) was an anomaly, and not likely to repeat itself.  This, alone, should tell us to be wary of rushing to supplant a competitive market with regulation.

Moreover, because of the unique nature of this congestion event--and the fact that such an event had not happened before--the FCC must try to understand everything it can about this event before the Commission even thinks about adopting new rules.  Comprehensive rules are only the answer if the problem is that market participants have no ability/incentive to reach mutually-beneficial voluntary agreements.

Yet, in the present case, the parties were able to reach voluntary agreements; Netflix with Cogent, and Cogent with Comcast.  Therefore, before the Commission concludes that carrier-to-carrier agreements cannot work, it must ask: why didn't the voluntary interconnection agreements produce a timely, efficient outcome in the present instance?    

The Relevant Cogent-Comcast Congestion Facts

For our purposes, we only need to focus on a limited set of facts.  We'll take our facts exactly as presented by Netflix and Cogent (in their bid to obtain regulatory concessions in the FCC's review of the Comcast/TWC merger).  Specifically, we will refer to the Declaration of Ken Florance, Netflix's Vice President of Content Delivery, and the Declaration of Henry Kilmer, Cogent's Vice President of IP Engineering.

--In February, 2012, Netflix signed an agreement with Cogent for Internet transit service, which it would use to deliver traffic coming off CDN agreements later that year.  Cogent began transitioning traffic to Netflix in August 2012.  Florance Declaration ¶ 41.

--Cogent does not provide specific information about its settlement-free agreement with Comcast, but we can discern: 1) the agreement applies to traffic falling within a certain inbound/outbound ratio, 2) the agreement has been in place since sometime in 2008; and 3) for the first 5 years of the agreement, the parties were able to abide by the mutually-agreed-upon terms without issue.  Kilmer Declaration ¶¶ 17, 55, 61-64 and the attached Letter from Arthur Block, General Counsel, Comcast Corp. to Robert Beury, Chief Legal Officer, Cogent, dated June 20, 2013 ("Block Letter").

--Cogent also points out that: 1) it does not believe Comcast is its "peer" and that Cogent only agreed to exchange traffic with Comcast on a settlement-free basis because of Comcast's "market power," and 2) Cogent does not believe there is any reasonable basis for "in/out ratio," which defines the range of traffic volumes subject to exchange on settlement-free terms. Kilmer ¶¶ 42-45, and ¶¶ 55-60.

--According to the Block Letter, Comcast states that, in a capacity planning meeting in the fall of 2012, Cogent told Comcast it did not anticipate needing additional capacity in 2013.  Kilmer at pp. 17-18 of 18.

--In a recent ex parte letter, Cogent only disputes that it affirmatively represented that it would not need additional capacity in 2013. Here at 3.  Cogent does not dispute that it failed to provide any advance notice to Comcast that it anticipated needing additional capacity.   

Good Faith and Bad Faith in the Performance of Contracts

In contract law, there is a general presumption that parties to an agreement will perform their duties fairly and honestly, so as not to deprive the other party of the benefits of their bargain.  This presumption is a part of every contract, and is called the implied covenant of good faith and fair dealing. 

The converse of the implied covenant of good faith is, of course, bad faith.  Bad faith, however, goes beyond simply failing to perform a substantive provision in a contract.  Rather, it is defined as an "intentional dishonest act . . . misleading another, entering into an agreement without the intention or means to fulfill it, or violating basic standards of honesty in dealing with others."   

Defining bad faith in novel circumstances can be difficult, but Professor Stephen Burton, in a Harvard Law Review article in 1980, observes that parties frequently relinquish "future opportunities" to enter into contracts, and these same parties also have some discretion as to how they perform the contract.  Therefore, Professor Burton explains, "[b]ad faith performance occurs precisely when discretion is used to recapture opportunities foregone upon contracting." This test has become a widely-employed benchmark for determining bad faith by state courts. (The Burton article is not available online, but here is a great article by Prof. Robert Summers discussing the Burton test and Good Faith generally).

Did Cogent Exercise Bad Faith By Intentionally Disregarding the Terms of Its Settlement-Free Interconnection Agreement with Comcast?

As an experienced provider of Internet transit services, Cogent would have known how much Netflix traffic it could carry and still be within the terms of its settlement-free interconnection agreement with Comcast.  Instead of limiting the amount of traffic it would accept from Netflix, Cogent went ahead and agreed to accept as much as Netflix wanted to send.  Considering, as well, Cogent's expressly-stated contempt for the traffic ratio (which limited Cogent's future opportunities), it is impossible not to construe Cogent's willful disregard of the traffic ratio as an attempt to "recapture opportunities forgone upon contracting."  

While Cogent tries to insist that Comcast was being unreasonable by asking Cogent to observe the terms of the parties' agreement, the Delaware Supreme Court, not long ago, affirmed that "[a] party does not act in bad faith by relying on contract provisions for which that party bargained, where doing so simply limits advantages to another party." Here, n. 26.  The opinion of the Delaware Supreme Court is relevant because many firms, including Netflix, designate Delaware in contracts designating a choice of law.

Fool Comcast Once . . .

It seems obvious, in retrospect, that Comcast could not anticipate--and was not willing, or prepared, to deal with--Cogent's level of bad faith performance.  It is clear from Comcast's response to Cogent's escalation letter, in June 2013, that Comcast has no intention of treating Cogent's persistent disregard of a crucial term as a "total breach."  Comcast asks only that Cogent purchase transit for that amount of traffic which exceeds the parties agreed-upon ratio.

But, when Cogent refused Comcast's option for preserving the original agreement, while accommodating Cogent's demand for greater capacity, Comcast would have been within its rights to give Cogent notice of its intent to terminate direct interconnection with Cogent.  Because, if Comcast's customers were hitting The Pirate Bay a little too hard (demanding more Cogent-bound capacity), that's what Cogent would have done.  

In 2008, Cogent apparently decided that its settlement-free interconnection agreement with European ISP TeliaSonera had become unappealingly one-sided.  Cogent (probably?) provided whatever notice its agreement with Telia required, and then--fairly suddenly (according to reports)--Cogent simply stopped carrying Telia's traffic. 

In hindsight, Comcast would have best served its customers by simply terminating the agreement.  Though, this course of action would have led to a temporary disruption in service--as Cogent's customers sought other alternatives--it would not have led to the protracted degradation in service that consumers instead had to suffer.  

Nonetheless, the existence of this event will make the system of voluntary network interconnection that comprises the Internet less vulnerable to a future bad faith breach in a critical portion of the supply chain.  Parties to future voluntary interconnection agreements are now much more likely to craft agreements so as to insure against protracted periods of deteriorated service.  A few isolated instances of bad faith should not cause the FCC to abandon its faith in the fundamental structure of the Internet as we know it.  

September 2, 2014 3:50 PM

Free Press's Mistaken (and Misleading) Theory on Title II and Investment (Pt. 1)

It's no secret that Net Neutrality pressure group Free Press would like the FCC to revisit the 2002 Cable Modem Order, in which the FCC classified broadband Internet service over cable as an "information service."  Nor is it a secret that the largest broadband ISPs oppose such a reclassification.  

The ISPs often contend that a reclassification of broadband Internet service as a Title II, or "common carrier" service, would open the door to a range of regulations that could dampen or distort their incentives to invest in network improvements.  But, in its comments on the FCC's Net Neutrality NPRM, Free Press intends to conclusively vanquish the "investment fear" arguments of the ISPs once and for all.  

Free Press believes it can "debunk" the "myth" that Title II discourages regulated firms from investing in their networks if it can show that the broadband ISPs invested heavily in their networks at a time when the ISPs' broadband services were (pretty much) subject to Title II classification.  Free Press relies on revenue and capital expenditures from the annual reports of a cross-section of large, publicly-traded, telecom and cable companies to tell the Commission a fairy tale.

Perhaps everything that could be wrong with Free Press's facts and theory about ISP network investment over the last 20 years is wrong--starting with the theory itself.  This blog will focus on the problems with Free Press's theory, and its limited set of "facts" in support of its theory.  Tomorrow, we'll explain what really happened (using Free Press's data, along with other relevant historical facts), and why Free Press's narrative is so misleading.
 
Investment Itself Is Never an Appropriate Regulatory Goal

Free Press seems to equate periods of rising capital investment as a "good" outcome, and periods of falling investments as a "bad" outcome.  However, regardless of whether the investment was efficient or not (it isn't), the FCC should never try to assume the role of central economic planner.  The FCC's only interest in investment should be to make sure that consumer interests are served in the manner that least distorts company investment incentives.

CapEx from Financial Statements Doesn't Show What Free Press Thinks It Does

Even if stimulating investment was the right focus for the Commission, the capex information Free Press presents does not prove that Title II is the answer.  If Free Press is trying to show that the regulatory classification of consumer broadband service affects how much a firm invests in that service, then aggregate, firm-wide network investment wildly overstates mass-market broadband investment in any period.  

In Fig. 1 (Comments p.100), Free Press tracks capex for a number of telecom carriers over time.  But, by using aggregate enterprise capex, Free Press is primarily tracking capex for Title II services in all relevant periods.  Notwithstanding the regulatory classification of one residential service, the majority of the revenue produced by these firms' networks still comes from Title II services (e.g., both AT&T and CenturyLink reported record numbers of residential broadband customers in 2Q 2014, but this service only comprised ~16.5% of total firm revenues for both firms). 

A more accurate estimate of the capex devoted to the Title I service would focus on correlations between significant broadband subscriber growth and increased (decreased) capital investment over the same period of time.  For example, CenturyLink has tripled its broadband subscribers (from ~2m to ~6m) over the last 5 years; during this same period, capex has grown at a CAGR of over 60%. See here (figures are from 2013 Annual Report, and the 2Q 2014 Earnings Supp. spreadsheet).  A more careful review of the companies' data, however, may not support the story that Free Press wants to tell.

Investment and Revenue Figures from the Late '90s Are Not Entirely Accurate

Even if we accept that "investment" is a worthy regulatory goal, Free Press paints a misleadingly "rosy" picture of the era.  Free Press concludes its recasting of the "golden age of investment under Title II" by simply stating that, "the 2001 recession and the economic impact of the September 11th attacks took their toll on the U.S. economy, and the telecom sector wasn't spared." (Comments at 101) 

Free Press neglects to mention the devastating accounting scandals that would surface right after 9/11, or the massive layoffs, bankruptcies, and distress sales that would follow, and cascade through the industry over the next two years.

On October 16, 2001, Enron announced it would have to restate its earnings for the prior 2 years.  This statement, and the subsequent SEC investigation, would uncover widespread accounting fraud throughout America's largest companies.

When you look at this list of the accounting scandals that were exposed in the 11 months after 9/11, don't focus solely on the telecom and cable companies.  Keep in mind that every energy company on this list also owned significant telecom network assets.  (See this 2002 study at p. 21/38).

Bandwidth trading.  If you're wondering why most of the accounting scandals involved telecom or energy firms, that's because they had a common thread.  Most of the telecom-related accounting fraud was related to "bandwidth trading."  If you don't know what bandwidth trading is, just listen to Enron explain it. 



The idea of bandwidth trading was just a few years ahead of its time.  In practice, it would take BitTorrent and The Pirate Bay to make using someone else's capacity while they were sleeping a reality. 

Early bandwidth traders, like the modern P2P thieves users, did not actually exchange money.  Rather, if you had bandwidth on one route, and another company had capacity on a route you wanted, you could just swap capacity--but that's boring.  Instead, each party would "pretend pay" the other for the prevailing value of the capacity (which still seems kind of dull). 

The real fun came with the accounting.  Both parties could record each other's pretend payment as real revenue, and record the capacity they were giving up as a capital expenditure; winning!  For more, see this 2002 Wall Street Journal article.  Oh, and when I say "could record," I mean literally; not legally.

As you can see, Free Press makes a number of mistakes in its attempt to prove that their Net Neutrality opponents could never justifiably fear Title II regulation--from trying to prove that a fear of undefined future regulations is unwarranted, to a misunderstanding of what their data actually show.  Tomorrow, we'll explain what actually happened in the golden age of Title II and why Free Press's narrative is so deceptively misleading.
 
April 10, 2014 2:19 PM

Comcast Wins When "Net Neutrality" Issues Take Center Stage

I guess everyone that watched yesterday's Senate Judiciary Committee hearing on the Comcast-Time Warner Cable merger had a different opinion on it.  I had prepped myself by reading all of those "Comcast owns Washington" and "David Cohen is The Man" articles, but I really wasn't prepared . . . for the awful truth.  See and believe (whole hearing here).


Maybe I'm reading this all wrong, but it looked like the Committee Chairman, Sen. Patrick Leahy (D-VT) pretty much indicated that he's cool with the deal--just, you know, as long as they include some net neutrality commitments, or something.  It was almost as if Senator Leahy was listening to Comcast's radio commercial as he spoke.  So, yeah, that pretty much set the tone.

The only Senators that represented my consumer interests, i.e., unchaining broadband Internet customers from the pay-TV business model, were Sen.'s Blumenthal (D-CT), Franken (D-MN), and Lee (R-UT).  I've already explained that the real problem here is the accretion of power that cable-affiliated RSNs have over pay-TV/broadband competitors.  In other words, this merger will harm the ability of consumers to ever use broadband Internet access--from any broadband provider--as a substitute for subscription TV service. 

The rest of the Committee members were distracted--like toddlers chasing soap bubbles--by the agenda of net neutrality "concerns" that we've seen hyped and re-hyped by the press for the last 3 months.  The reason that these "distractions" consumed the attention they did is, some believe, a sign of Comcast's power to intimidate the "real" witnesses away.  

And, according to this report, Comcast's "casting" of the issues covered in the hearing could not have worked out better for them.  Unfortunately, if the only people who are going to speak up about this merger can't pass up a public platform for their "net neutrality/broadband is a utility" shtick--then Comcast really is in great shape.  

3 Reasons Why "Net Neutrality" Is Comcast's Best Friend

1. The only "managed service" Comcast needs is the one they already have.  I can't say it any simpler than that.  When Prof. Susan Crawford went off the handle a couple weeks ago, at the rumor that Apple might have requested a "managed service" from Comcast, she failed to understand that this is precisely what is needed if the Internet is ever going to become a content delivery rival to TV.  If Comcast made "TV quality content delivery" available to some third party, then it would be available--and that's the point.

If a "managed" video delivery service is not available for wholesale purchase by Apple, then it's not available to any competitor to Comcast's cable service.  The fact is that Comcast will be happy to "swear off" offering managed services, because that's just like telling them to shut the door behind them for all those new markets where they'll be the dominant broadband and subscription TV company. 

2. Internet interconnection is not a merger issue (either).  Senator's Klobuchar (D-MN) and Franken (D-MN) wasted a fair amount of their time and attention on this little canard.  In fact, I'd say this line of questions, more than any other, made David Cohen look like the most reasonable person in the room. 

In the media, this issue is hyped a lot by Stacey Higginbotham from GigaOm.  She loves this issue--writes about it constantly (see), even when Comcast isn't buying its rivals.  Not surprisingly, a few days before the hearing, she writes, "expect more questions about paid peering and the Comcast merger."  

The reason this line of inquiry helps Comcast avoid harder issues is that buying transit is a long-established, industry-wide practice, and would exist even if Comcast was a "common carrier." Neither the FCC nor the DoJ, is going to do anything to change this practice in a merger review.

3. Data Caps.  The essence of this complaint is that the heaviest users don't like the ISP's pricing structure.  This complaint, like the previous issue, is a quixotic attempt to establish price regulation on ISPs. 

The "data caps" issue is only an issue for the highest use consumers--who want the lower use consumers to subsidize their consumption.  These people share the Reed Hastings view of net neutrality--averaging out the restaurant bill is fair, especially if you're the only guy drinking $100 champagne. 

At the hearing, TWC said they deal with this issue in an interesting way: they don't impose caps, but if a customer agrees to not exceed a certain amount of data downloads (and be subject to throttling, if they go over), the consumer gets $5 off their monthly bill.  My guess is that Comcast will have no problem offering this one up. 

Prognosis

Look, the net neutrality people aren't the "bad guys" here.  But, if a significant part of the merger opposition is ceded to the usual suspects--the same folks that seem intent on recycling their same net neutrality arguments, no matter the forum--then that's a shame. 

This merger squarely presents the DoJ and the FCC with a very fundamental "crossroads" choice--the future of competition for the broadband Internet versus the cable TV business model.  The public interest cannot settle for a bunch of buttercup-and-whipped-cream "commitments" to net neutrality.  The consequences are too high. 

I wanted to end on a cheerful note, so I'll leave it at this.  Remember, kids, while advocacy from 2005 ages poorly, this still-super fly Chamillionaire video never will.  Enjoy!
 

Maybe, I'll send some "Chamillitary" gear over to Prof.'s Crawford/Wu, and Free Press.  So, you know, at least the crew can be dressed in the "era-appropriate" pop fashion when they hit the NPR circuit.

March 27, 2014 11:11 AM

The FCC Doesn't Need a Bigger Budget to Limit Lifeline Waste

This morning, FCC Chairman Wheeler and Commissioner Pai spoke to the House Appropriations Subcommittee on Financial Services and General Government to make a formal request for the agency's FY 2015 budget allocation. View hearing here.  Today's hearing was a more formal re-run of the briefing that the Chairman and Commissioner Pai gave the Subcommittee on Tuesday, when the FCC provided information on the agency's request for a $36 million increase in the FCC's allocation in the FY 2015 budget.  The Commission's total budget request for 2015 was $375 million.  

First among the FCC's budget priorities was securing an additional $10.8 million for USF improvement, directed mostly at policing the Lifeline program (which is intended to provide discounted telephone service for low income Americans).  As this Bloomberg BNA article  reports on the Tuesday briefing, the Chairman told the Subcommittee,

"We need more muscular enforcement about what is going on in universal service," Wheeler said. "The Lifeline program has been abused. My line from day one is, 'I want heads on pikes' and we need enforcement capability we don't have."

The Chairman's statement that he "want[s] heads on pikes" is a nice, political thing to say, given that the program has been under scrutiny, after ballooning in the wake of the Commission's decision to allow program participation by wireless carriers in 2008.  The Commission took major steps to reform the Lifeline program rules in 2012, which led to a decline in total (non-Tribal) Lifeline subsidies from a peak of $2.13 billion in 2012 to $1.77 billion last year. See app. LI07 here.  

The Commission, however, has yet to complete the most basic part of its Lifeline reform NPRM initiated in 2011--determining the correct subsidy for wireless carriers. Given that the growth in the Fund has come entirely from wireless services, one would think that getting the wireless carrier subsidy correct would be job #1. 

Tom Wheeler facing camera_caption.pngThe FCC Is Required to Establish Prudent Carrier Reimbursement Costs

The Lifeline program subsidizes consumer discounts through reimbursement payments to the consumers' service providers. The relevant statutory provision that deals with Lifeline provider reimbursement is 47 U.S.C. Section 214(e), which says,

A carrier that receives such support shall use that support only for the provision, maintenance, and upgrading of facilities and services for which the support is intended. Any such support should be explicit and sufficient to achieve the purposes of this section.

(emphasis added).  The plain language of the statute indicates that Congress didn't want the FCC to be deliberately spending more than was necessary for the provision of the relevant facilities/services.

This only makes sense. After all, if the subsidy is in excess of wireless carrier costs, then the Commission is not only failing to implement the law, but is (effectively) subsidizing wireless carrier profits rather than merely reimbursing service costs.  The distorted incentives that excessive subsidies create also contribute to an even greater need for the enforcement resources the Commission is currently seeking.  

Wireless Reimbursement Costs Should Be Lower than Current (Wireline) Subsidies

In this post from several months ago, I explained--with numbers--how the wireless lifeline business is able to make money off "free" service.  The 2012 Lifeline Reform Order retained, but simplified, pre-existing average "per customer" reimbursement rates of $9.25--which were originally established to offset costs to serve wireline customers.

As I explained in more detail in the earlier post, the average wireless Lifeline customer will have a direct wholesale cost of $4.875/month to serve.  In return, the carrier receives $9.25 from the USAC.  If we estimate indirect costs at around $2.00/line (say $1.875/line), we can see that it is not out of the question for a fairly typical wireless Lifeline provider to earn around $2.50 per line served per month ($9.25-$6.75).

How Much Could the FCC Save Consumers by Fixing Wireless Cost Subsidies?

Last year there were about 14 million non-Tribal Lifeline subscribers. See LI08 appendix.    About 80% of Lifeline consumers use prepaid wireless service, which amounts to about 11.2 million wireless Lifeline subscribers.  If the FCC should be reimbursing these subscribers' carriers $6.75/month instead of $9.25/month, then the USF and its contributors would save $22.4 million/month--or $268 million/year.  

In other words, if the FCC simply finished the part of the Lifeline Reform Order that the FCC should have addressed first, the Commission could annually save consumers about 70% of the projected costs to run the entire agency.  It goes without saying that the Chairman's next budget briefing would be an easier "ask" if he could assure lawmakers that the Commission is putting most of that number right back into consumers' pockets--while still supporting the vitally important benefits provided by the Lifeline program.  

So, what is the FCC waiting for?



March 26, 2014 12:11 PM

Net Neutrality Rules: Do They Really Limit "Cattywampus" ISPs?

On Sunday, the Wall Street Journal reported that Apple was in talks with Comcast to provide a new type of streaming TV service.  The report was vague on the specific service except to note that: 1) the parties were "talking," 2) an Apple device-to-be-named-later was going to be used, 3) the service would involve a "managed" (or guaranteed bit-rate) transmission path over Comcast's ISP, and 4) would require a significant investment by Comcast.  

Predictably, the Twittosphere erupted with the swift condemnations due any speculative service that whiffs of net neutrality blasphemy.  If the speculation involves Comcast, then it wreaks of blasphemy.

The Meandering Meaning of Net Neutrality

But, what is the "dogma" of net neutrality?  Is it the FCC's 2005 Internet "Freedoms?"  Is it the Open Internet Rules that were vacated--no blocking and no unreasonable discrimination?  Public Knowledge just told the FCC that the two biggest "threats" to the Open Internet are ISP data caps and "peering"/interconnection disputes.  PK at pp. 6-10.   

If net neutrality can be said to have any consistent premise, it is best depicted metaphorically in this 14 second, Geico commercial.
 

The ISPs are like "Mr. Tickles."  The whole rest of the Internet stakeholders are represented as the man in the portrait holding Mr. Tickles.

Yet, firms like Cisco, who on Monday announced a 2 year and $1 billion commitment to cloud services, as well as competitive over the top companies like Amazon, Hulu, and yes, Apple TV, continue to want to invest in cloud services.  In other words the leading Internet infrastructure equipment maker fully expects that--even without rules--the ISP (Mr. Tickles) will continue to "hold still" and not "git all cattywampus" on them.

The Flimsy Factual Bases for "Concerns" About the Open Internet

First, let's acknowledge one point on which everyone should be able to agree.  The "open Internet" is valuable to every consumer, and every seller, that touches the Internet economy.  In fact, the rise of the Internet economy seems to be proof that the "open Internet" is so important that virtually every aspect of that "openness" is already guaranteed by existing contracts between the thousands and thousands of Internet stakeholders.  

But, those that think rules must be necessary to ensure the continued openness of the Internet must have some reasons, right?  Well, if we look closely, the concerns that have been advanced in past FCC proceedings have been largely based on theoretical predictions that haven't really materialized.

Peering Concerns

The first FCC concerns about "peering" (i.e., settlement-free Internet interconnection) vs. "transit" (i.e., "paid" interconnection) were expressed by Internet backbone competitor GTE in the MCI/WorldCom merger. See paras. 147-150.  The FCC adopted GTE's concern, which was that the combination of WorldCom's UUNet and MCI's backbone would have had no "peers."  Thus, because a combined WorldCom/MCI would have been able to require "paid peering" by any other ISP or backbone seeking to use its network, the post-merger firm could raise the costs of any new entrant.  

This disaster was averted when MCI agreed to divest its Internet backbone to Cable and Wireless.  In fact, the divestiture to C&W was considered a huge failure, and MCI's alleged bad faith failure to satisfy the concerns of the Department of Justice was a primary concern behind the DoJ's challenge to WorldCom's proposed acquisition of Sprint 2 years later.   In short, the remedy didn't work, but was apparently unwarranted, anyway. 

"Net Neutrality, Broadband Discrimination"

In 2003, Professor Tim Wu argued, in the above-titled paper, that "[c]ommunications regulators over the next decade will spend increasing time on conflicts between the private interests of broadband providers and the public's interest in a competitive innovation environment centered on the Internet."  With the exception of Comcast's protocol-specific BitTorrent throttling in 2007, these concerns have largely failed to materialize.  Notably, Prof. Wu never mentions the FCC's previous (and PK's current) concerns about peering as a cause for concern.

Broadband ISP "Incentives" to Discriminate, Circa 2010

In the Open Internet Order, the FCC largely parrots Prof. Wu's concerns that broadband ISPs have the incentive and the ability to discriminate against "over the top" providers offering services that compete with the voice and/or subscription video services sold by the ISPs.  The FCC first establishes, using the ISPs' own statements, that consumers view certain online applications as substitutes for voice and subscription TV service. Order, para 22.

Then, the FCC simply assumes from comments of groups advocating rules (and not ISPs or voice/video competitors) that, of course the ISP has incentives to discriminate against online alternatives.  Yet, the record contained no data supporting the FCC's conclusion (showing, e.g., higher profits in TV/voice than broadband Internet).  Order, paras 23-24.

Public Knowledge expressed no concerns about data caps and peering in the 2010 docket.

The Problem with Apple TV . . .

Supposedly, Apple wants Comcast to help it deliver some kind of super-cool IPTV that will actually make you want to buy video service from Comcast (vs. get it on the Internet).  As part of this service, Apple wants Comcast to offer Apple TV a guaranteed quality of Internet access, so that its video content would not be affected by general congestion issues that can otherwise cause videos to buffer.  And that higher quality access, even if not exclusive to Apple, is a problem . . .

Is The Problem With "Net Neutrality"

My fear is that "net neutrality" is no longer about just a reasonable set of minimal consumer expectations designed to keep the Internet creepy enough to hold the Interest of consumers and the NSA, while at the same time keeping it wholesome enough to prevent SkyNet from becoming self-aware by 1997 (or whatever similarly-fevered nightmares the rules protect us from). 

terminators.jpg
Skynet logo.jpg










Without a presumptive tolerance for commercially-reasonable service deviations, net neutrality becomes a fetish devoid of any utility.  If we can't limit proscribed conduct to only practices or agreements that unreasonably restrict Internet "output," then how do we know whether rules are serving consumers or requiring everyone to serve a concept that may have limited benefits?





March 21, 2014 10:07 AM

Netflix's Hastings: It's Not All About You, Brother

Yesterday, Neflix CEO Reed Hastings published this blog post, arguing that "strong" net neutrality rules would not require Netflix to pay for the costs to augment its inbound ports to Comcast's ISP gateway (it did last month).  I have no problem with Netflix buying something from Comcast, and then complaining about having to pay for it.  It kind of makes Mr. Hastings seem like every other Comcast customer, no?

Ric Flair_caption.jpgBut (to paraphrase "the Nature Boy" Ric Flair):  you may not like it, but you better learn to love it, because it's the best thing going, brother.  What I mean is this.  We're all appreciative of Netflix's success, but we would like more companies like Netflix.  This means that it's possible to imagine a day when people don't buy subscription TV service from their ISP at all.

Yesterday, I talked about the difficulties that the present system that prevents broadband-only customers from getting access on any terms to in-market streamed games (if those games are available only through an RSN).  When these problems are resolved, consumers will presumably be able to buy content from a number of sources online, in addition to the HD channels you can get over the air (which covers most local NFL, a good amount of college basketball/football, and some baseball).

In a future where the Internet is the primary video delivery media, but programming is purchased by consumers from multiple vendors, it is unrealistic for video providers--who will be getting paid by consumers to deliver the service being sold--it is unfair and unrealistic to expect that all of the ISP's users should pay for each upgrade of inbound capacity required by a limited number of subscribers.  

For example, at the end of last year, Netflix probably had about 33.5 million users (based on this article).  The total number of broadband customers at the end of last year was around 84.3 million, based on this recent report from Leichtman Research.  So, at present, Netflix would have 100% of ISP customers pay for a service that only 40% are signed up for, and an even smaller percentage use Netflix service intensively enough to require the inbound capacity upgrades.  

On its face, Netflix's request doesn't seem huge when it and YouTube may be the only really large video content providers.  However, even if only Netflix switches IP transit vendors or CDNs, every so often, the ISP will have to make the investment again because not all backbones handle Netflix traffic.  

Moreover, in a world where the traditional "cable" company is selling a much smaller amount of programming than today--and the average consumer may be buying Netflix-style, over the top video from 4-5 independent providers--it seems more unfair for the ISP to be required to charge all of its customers for service only some will use.  

The only reason Hastings' argument has a scintilla of appeal to consumer groups is because consumers pay so much for cable today.  If/when everyone will get video from their own over-the-Net service, then Netflix will better understand that if you're the one taking the people's money, then you pay for any incremental additional costs to deliver your product--and it's your responsibility to make sure traffic hits the ISP's network at a high enough speed to be useful to your customer.

The bottom line is that consumers want more "Netflix's" and less subscription TV, and the fairest way to apportion inbound capacity costs is to bill the incremental cost causer--which is the party collecting the revenues from the customers that are using the service which requires in-bound capacity upgrades.  To do otherwise, is to simply re-adopt the unfair cable price structure of the existing pay TV market (everyone pays for the people that use the most high cost--a/k/a "sports" programming).

When you're the only widely used alternative to Comcast, you get a lot of sympathy--as Netflix does, and often deserves.  But, business arguments disguised as "public policy" arguments don't work unless they work for all users.  In the past, Netflix has also shown an indifference to costs that its heavy users impose on general, lighter use Internet customers.   But these arguments are near term winners for Netflix that don't get all members of the public into a better place; understandable, but not persuasive, arguments that the government should reject.


March 20, 2014 11:02 AM

How the FCC Looks at Sports, Blackouts, and Broadband Consumers

The first day of March Madness is one of the greatest TV watching days in America, made even better by our special devotion to drinking and gambling.  Monday's article on Recode reminds us, though, that broadband-only consumers will be forced to spend this great national holiday watching TV in a bar.  

wheeler_zero_sign_2_caption.jpgThe value consumers place on sports content is as obvious as the rising prices of subscription TV.  But, sports content, and its regulation (or lack thereof) can also provide some insights into the FCC's priorities, and the relative value that the FCC places on the sports consumer (vs. the sports programming distributors).  It is also interesting to compare how the FCC views sports content distribution practices with how a court might view the same practices under the antitrust laws.

The FCC On Sports Blackouts

A good way to see just how the FCC views sports content consumers, relative to broadcasters and pay TV providers is to look at the FCC's NPRM to eliminate its sports blackout rules.  The proceeding began in November of 2011, when a group called the Sports Fan Coalition (Public Knowledge, Media Access Project, and some sports fan sounding groups) filed a petition to eliminate the rules.  

The petitioners were absolutely right and reasonable.  The FCC should have simply said, "we agree--and we're actually a little embarrassed that the rule was adopted at all, much less still on the books."

In reality, it took the FCC two more years to unanimously approve . . . a Notice of Proposed Rulemaking to ask questions about the effects of "repealing" the sports blackout rules (that it had no clear authority to adopt in the first place).  To reassure industry that the FCC hadn't found religion, Acting Chairwoman Clyburn was careful to explain that, "[e]limination of our sports blackout rules will not prevent the sports leagues, broadcasters, and cable and satellite providers from privately negotiating agreements to black out certain sports events."

Because, you know, what could go wrong with private blackout agreements between leagues, RSNs, and their MPVDs?  It's not like the agreements could be more anticompetitive than the rules themselves, right?

A Year Earlier, In a Court of Law . . .

In December 2012, a federal district court in New York issued an opinion refusing to dismiss antitrust complaints filed by TV and Internet consumers against Major League Baseball, the National Hockey League, Comcast, DirecTV, and other affiliated RSNs.  (Yes, the defendants are the same parties the FCC "will not prevent" from entering into private blackout agreements.)  The Southern District of New York ruled that the complaints presented a "plausible" claim that blackout agreements between the baseball and hockey leagues, and Comcast, DirecTV, and their RSNs were being used to eliminate Internet competition, require customers to purchase from MVPDs, and generally increase prices to consumers.

Here are some excerpts from the court's opinion describing how real consumers view the types of agreements the FCC "will not prevent" (internal quotes refer to the plaintiffs' complaints):

Plaintiffs challenge "defendants' . . . agreements to eliminate competition in the distribution of [baseball and hockey] games over the Internet and television [by] divid[ing] the live-game video presentation market into exclusive territories, which are protected by anticompetitive blackouts" and by "collud[ing] to sell the 'out-of-market' packages only through the League [which] exploit[s] [its] illegal monopoly by charging supra-competitive prices."  Opinion, at 2. Emphasis added.

The Complaints allege that the "regional blackout agreements," made "for the purpose of protecting the local television telecasters," are "[a]t the core of Defendants' restraint of competition." "But for these agreements," plaintiffs allege, "MVPDs would facilitate 'foreign' RSN entry and other forms of competition." Plaintiffs argue that the "MVPDs also directly benefit from the blackout of Internet streams of local games, which requires that fans obtain this programming exclusively from the MVPDs." Id. at 8.

Back at the Commission . . .

Public comments on the FCC's sports blackout NPRM were a filed a few weeks ago.  Major League Baseball does not typically blackout telecasts in response to gate sales.  But, realizing that its own private blackout agreements may soon be illegal, the MLB, predictably, argues the FCC rules are still needed--as an anticompetitive backstop to the anticompetitive agreements the FCC "will not prevent."  Of course, the MLB doesn't tell the FCC why it might not have as much access to private blackout agreements in the future.

In its comments, the Sports Fan Coalition devoted a several pages of its comments to explaining (as then Acting Chairwman Clyburn noted) that, even without the FCC's rules, anticompetitive private blackout agreements will still be available to the leagues, the RSNs, and the big cable and satellite companies.  But, the SFC is simply responding to the FCC's primary concern in the NPRM.

full fcc at meeting_caption2.jpgFCC Priorities: TV, TV, and TV

The contrast between the federal district court's skepticism and the FCC's comfort with private blackout agreements could not be clearer.  It is notable, but not terribly surprising, that there is no reference to the two year old consumer antitrust cases anywhere in the sports blackout docket; not in the original petition, the FCC's NPRM, or in any party's comments.  It's almost as if the FCC and sports consumers are in different worlds.    

If you just read the FCC's press releases, and the speeches from the Chairman and other Commissioners (and their tweets), you might think broadband Internet was a huge priority.  Yet, it's difficult to reconcile the FCC's statements with the fact that the Commission tolerates agreements by regulated TV distributors (broadcast, cable and satellite) that require sports leagues/teams to refuse to deal with broadband-only consumers on any terms for "in market" games.

The Chairman says that he will target legal restrictions on the ability of cities and towns to offer broadband service.  I'd be more impressed if he targeted restrictions in sports content distribution agreements that intentionally reduce the value of the broadband Internet to all consumers.




March 5, 2014 2:50 PM

CDN-ISP Agreements Fuel Content Delivery Competition

Last week began with news that Netflix had decided to improve its long-languishing service for customers of Comcast's ISP by directly interconnecting with Comcast, cutting out Internet transit provider Cogent Communications.  The Cogent-Comcast "peering" dispute had been a long-standing topic of media speculation.

Prior to the announcement of the direct interconnection agreement, many media sources had wished to present this dispute as just another iteration of ISPs attempting to "extort" money from sources of competing content.  Netflix's decision to solve the problem itself had pretty much eliminated the "poor Cogent" articles by the end of the week--after Dan Rayburn's detailed explanation of the deal.

Knowing what we have learned in the past week, it would seem that Netflix's "ISP Speed Index" is more likely a fairer representation of the performance of Netflix's CDN versus that of its third party transit providers.  The Netflix ISP Speed Index is obviously not attempting to measure "true" ISP speeds, because even gigabit provider Google Fiber hovered around 3.5 Mbps for most of last year.

The ISPs to which Netflix connects with its own CDN generally see speeds in the 2.3 Mbps-2.9 Mbps range.  For the customers of ISPs served by a third party transit provider, speeds are often much lower.  But how bad is too bad? 

The "Mendoza Line" for Poor Streaming Transit Performance  

Within the past day, Verizon's CEO has said that their FiOS ISP is close to a direct interconnection agreement with Netflix.  Recall, that Cogent also had issues with refusing to augment inbound capacity to Verizon.   

In fairness to Cogent, it does not claim to offer CDN service.  Still, you have to wonder, where is Netflix likely to switch away from "plain old transit" service next? 

Luckily, Netflix kind of tells us (and its transit/CDN vendors) the levels of service deterioration at which they can expect the "Never mind, I'll do it my damn self" call from Reid Hastings.  Here is the performance of several ISPs who offer broadband access at speeds well above 5 Mbps for the last 4 months, as reported by Netflix's ISP Speed Index.
Netflix CDN Chart-2.jpg

I looked at the Netflix ISP Speed Index for the last 12 months, and, traffic delivery at anywhere between 2-3 Mbps seems to be acceptable.  If you're reading about customer service complaints, it's safe to assume that speeds have dropped below 2 Mbps for the ISP in question. 

For both Comcast and Verizon customers, Netflix's transit/CDN vendor(s) performed well for most of the year--only deteriorating significantly over the last several months.  Like in baseball, though, there is a Mendoza Line for competent transit service, and it seems to be around 2 Mbps.  So . . . if you're a Mediacom customer, you probably don't have much longer to wait.

Netflix's traffic is certainly growing very quickly.  But, asymmetric, end-user-destined video traffic is growing very quickly for all ISPs, everywhere.  Sandvine's second half 2013 traffic report shows that for the largest Internet consumers (North America and Asia) peak hour video consumption may be as high as 70% for the average North American user, and 75% for the average Asian consumer (I got that by adding the "real time entertainment" and "P2P" categories for both continents).  You'd think this would be a good thing for a content delivery network, no?

Is "Peering" Net Neutrality Redux?

Level 3 explains in this recent ex parte, that all is not rosy in the world of the CDN--despite Level 3's own recognized success in the market--because of the nettlesome costs that some ISPs believe should be paid by the party getting paid to carry the traffic to the ISP (namely, Level 3).  BTW, this is completely the same issue as the Netflix carrier-v.-every-ISP-in-the-graph issue.

But, Level 3 characterizes what some would call the costs of providing CDN service, as "tolls" that unfairly target large CDNs distributing disproportionately-downstream, bandwidth-intensive traffic.  Level 3 tells the FCC, "ISP tolls that facially apply equally to all traffic are effectively tolls on the most bandwidth-intensive services - video services that compete with the ISP's own video services." (ex parte at 8/8).  

What types of Level 3 traffic are ISPs targeting?  Well, sometimes it looks like this:

IMAG0015.jpg

You see, HBO Go is an online service that HBO (not the subscription TV provider) offers its customers that already buy HBO's premium subscription TV channel.  Since HBO, like almost every any other provider of streaming video service, lacks the demand to justify the hassle/cost of direct interconnection with the ISP, it uses the highly-competitive CDN market to deliver its service. 

Level 3 is one of HBO Go's CDN partners, for certain Apple devices.  As Level 3 notes, the end-user is often buying a TV service from their ISP.  But, poor quality delivery from the TV channel's online content devalues the TV product the ISP is selling.  Thus, it isn't clear why the ISP has an incentive to degrade Level 3's traffic, when the ISP knows that some significant portion of Level 3's traffic is a complement to the ISP's subscription TV service.  

The CDN business is focused on how to efficiently deliver asymmetric, bandwidth-intensive traffic to the customers of the ISP.  If the ISP had to pay for/build incoming capacity from every CDN to the ISP, then it's good for the CDN, but the ISP can only limit its costs if they CDN traffic stays put.
 
So, why would Level 3 want the FCC to impose regulations that give an ISP any kind of interest in which CDN provider a content owner would choose?  Maybe, because sometimes those CDN customers decide to build their own CDN, as soon-to-be-former Level 3 customer Apple is reportedly doing.  New CDNs equal new competition for small content owners, and that's not always a great thing . . . for CDN incumbents.  Now I get it.




October 29, 2013 2:14 PM

Lifeline Part 4. The Solution: It Ain't That Deep

One day several years ago, when I was still at COMPTEL, a friend of mine at one of our member companies was trying to convince me (for probably like the thousandth time) not to keep banging my head against a wall on an issue that I can't even remember.  This time, though, he put it differently, and I still remember his advice.  He said, "Why do you have to play the Yankees every day?  Why can't you take a break sometimes. . . maybe play the Brewers every once in a while?"

Well, that is the best way to describe the advice I would like to have given the FCC if I had a chance to read their 2012 Lifeline Reform Order before they adopted it.  Because, if you had the chance to change anything about the Lifeline program, wouldn't you at least want to get all the parties on your side?  

Administering a huge, and growing, program like Lifeline is hard enough.  Not questioning a prevailing retail price of $0/month leaves the FCC wrestling the "invisible hand" of the market--a Sisyphean proposition. Wouldn't you want to do everything you could to align the incentives of all the program participants with yours?  

The Wireless Lifeline Business

The curious thing about the Lifeline Reform Order is that while prepaid wireless service is generally understood to be the primary cause of the fund's rapid growth--which precipitated the Lifeline NPRM--there is no evidence at all in the order that the FCC even tried to understand the prepaid wireless business.  So, let's try to see if we can figure it out.  

The typical prepaid wireless Lifeline "offer" goes something like this: the customer is promised 250 "free" minutes per month, as well as a "free" handset.  If the customer wishes to use more than 250 minutes, they can purchase additional minutes at a fair, but profitable, price.

From a cost perspective, this 2009 Fierce Wireless article references wholesale voice prices available to some MVNOs that are below 3 cents/minute.  Four years later, it is probably a very safe, even conservative, assumption that most Lifeline MVNOs can get at least a 3.25 cents/minute wholesale rate.

So, if the prepaid wireless carrier is spending $8.125/month (250 mins * $0.0325/min) and only receiving $9.25 from the fund, how are they making money?  Even at 3 cents/minute, the possibility of profit would still seem fairly remote ($9.25 - $7.50 = $1.75), because we are only looking at the direct costs of providing service (the amount owed to the wholesale carrier).  Adding on an indirect cost (employees, cost of sales, overhead, etc.) of say $2/line (just a guesstimate) would still leave a carrier in the negative.

In reality, the typical customer will actually use something less than the 250 minutes.  For purposes of our illustration, let's assume the average customer uses about 150 minutes.  We can safely make this assumption, because the prepaid wireless Lifeline business--like every flat-rated pricing plan--is based on "breakage."  This means that the average customer consumes less than they pay for.  In the case of wireless Lifeline service, the "they" that is paying is you and I.  Remember this point, because we'll come back to it.

Assuming a price of 3.25 cents/minute and an average use of 150 minutes/month, the average customer will have a direct wholesale cost of $4.875/month to serve.  In return, the carrier receives $9.25 from the USAC.  If we estimate indirect costs at around $2.00/line (say $1.875/line), we can see that it is not out of the question for a fairly typical wireless Lifeline provider to earn ($9.25-$6.75) around $2.50 per line served per month.

Reimbursement vs. Reward

Remember the part about the flat-rated plans relying on "underachievers" for carrier profitability?  That's great for the carrier and the few "overachievers", but "we" are the ultimate consumer--the whole "buy" side of the market, if you will.  And, we--under the law--are only allowed to "reimburse" prepaid wireless carriers, i.e., cover their $6.75/month in costs.

The relevant statutory provision that deals with Lifeline provider reimbursement is 47 U.S.C. Section 214(e), which says,

A carrier that receives such support shall use that support only for the provision, maintenance, and upgrading of facilities and services for which the support is intended. Any such support should be explicit and sufficient to achieve the purposes of this section.
(emphasis added).  The plain language of the statute certainly seems to indicate that Congress didn't want the FCC to be deliberately spending more than was necessary for the provision of the relevant facilities/services.  

How to Get Real Lifeline Savings?

Let's say there are 16 million Lifeline subscribers (close enough) and 80% use prepaid wireless service, then there are about 12.8 million wireless Lifeline subscribers.  If the FCC should be reimbursing these subscribers' carriers $6.75/month instead of $9.25/month, then the fund could be paying $32 million less per month--for an annual savings of $384 million/year.  Now, that beats the heck out of sweating USAC and the carriers to try to squeeze the limited savings that we might get from the existing "reform" rules, no?

But the savings don't stop here.  Prepaid wireless Lifeline service adds a wonderful choice for low income consumers, and it's silly to think that if the FCC got the subsidy right, the service would go away.  It wouldn't; but the wireless carriers would have to start charging a small positive monthly fee in order to stay profitable.  

A minimal fee (say $5-$7/month) would not only give the service providers more money, which would not only allow them to offer more data, but it would also remove the incentive for "inefficient consumption" (to use a euphemism) that today's $0 price creates.  Thus, if customer carelessness or dishonesty were responsible for any significant amount of program waste, the FCC could correct this more easily by realigning customer incentives than by placing more administrative burdens on carriers.

How Hard Is It?

In the Lifeline Reform Order, the Commission comes up with all sorts of excuses for why it couldn't do what we just did here.  I won't rebut each one, though none of the excuses would stand up to any scrutiny.  The most damning fact, though, is that the FCC could have quickly gotten an accurate subsidy amount simply by looking at average wholesale billing information from no more than 4 carriers. In fact, they could have gotten the whole story just from Sprint, who has a large wholesale and retail role in the Lifeline program.  

If it's that easy--and it is (no OMB approval needed)--then what's the excuse for not just going to the source?   The benefits of significant annual savings, ensuring customer cooperation, and sparing the vast majority of good customers the demeaning, uncivil debate currently raging seem like a prize worth a casual inquiry, don't they?  

October 25, 2013 2:07 PM

Part 3. Lifeline Reform: How'sThat Working Out for You?

In the last post, we talked about the generally uncivil and unproductive tenor of current arguments over the Lifeline program.  I've already mentioned that I would have liked the FCC to have taken a more holistic "once and for all" approach to modernizing the Lifeline program.  The Commission's decision was a mistake for at least two reasons.  

First, by deciding to ignore some of the seismic changes in the telecommunications market since the original Lifeline rules were adopted, including the shift from monopoly to competition and consumers' enthusiasm for wireless, the Commission left itself with very few options for "reform" and "modernization." In fact, by failing to undertake any reforms based on the structure of the modern telecommunications market, the Commission pretty much forfeited any claim to Lifeline "modernization."

The second reason the FCC made a mistake by not taking a comprehensive evaluation of the Lifeline program when crafting program reforms is that the FCC left itself with fewer chances to succeed.  In other words, by focusing exclusively on reforming carrier and consumer practices in order to prevent duplicate and ineligible disbursements, the FCC "doubled down" on its theory that waste and fraud were the primary cause of the $1.3 billion increase in the Lifeline program between 2007-2012. Here at p. 2

So, did the FCC win the bet?  Well, the Lifeline Reforms have been in effect for almost a year and a half, and yet the political acrimony over the size and administration of the fund has only escalated. What do you think?

The Lifeline Reform Rules

As we noted, the primary focus of the new Lifeline rules is to eliminate waste, fraud and duplication in the program.  Unfortunately, this burden was transferred squarely to service providers.  As a result of the new rules, carriers now have the responsibility to confirm eligibility of applicants, keep better records to help eliminate intra-company duplicates, and to educate applicants about the consumers' duties under the program. In other words, carriers got a lot more risk and no more resources to manage that risk.

One big change on the near horizon that could result in some measurable efficiency improvements to the fund is the duplicates database.  As we saw with the NALs recently announced by the FCC, data entry and record-keeping errors can always result in some (relatively small) number of duplicate claims within the same company.  However, the largest amount of duplicates result from the same customer getting service from multiple providers.  

For example, let's say the customer has been receiving wireline Lifeline service for a long time from one carrier, then perhaps another member of the subscriber's household signs up for wireless Lifeline service from a different carrier.  The error could be inadvertent, but today it doesn't get caught unless or until USAC goes through a study area with a lot of in-depth validation (IDV) audits and then compares subscriber lists between carriers.

When the database gets up and running, all of these duplicates will get identified and eliminated in every study area before they result in duplicate recovery from the fund--and without a lot of intensive audit work by USAC.  This will reduce the size of the fund.  But, what about the other reforms?

Dr Phil.jpg 

The most significant reform so far, in terms of controlling fund size, has been the requirement that Lifeline providers re-certify their entire customer bases each year.  For 2012 the Lifeline fund disbursed $2,190 million.  For 2013, the fund is expected to disburse $1,812.  See here at p. 25. So, savings over the past year resulted in around $378 million.  

Still, this year was the first year of mandatory re-certifications, and many customers had not had contact with their service provider in quite some time leading up to this year's re-certifications. It is doubtful that next year's re-certifications will remove anywhere near this number of customers from the fund.  Without this significant one-off reduction in the size of the fund, how much has the fund benefited from the new rules?

While we've said that the total amount of duplicate reimbursements received by the five carriers in the NALs was a total of $73, 250, the total amount of overpayments received by these carriers was likely much higher.  In fact, I would guess that the main reason the level of fines was so high, relative to the overpayments alleged, is because the carriers in the NALs chose not to settle.  If these carriers had settled with the EB, they would have had to pay the fund back all of the overpayments received throughout the carriers' service territory for the previous 12 months. 

If we make the wildly optimistic assumption that each firm with an NAL over-recovered $500,000--and had settled with the EB--the total amount the fund would have saved since the Lifeline Reform Rules went into effect would have been--at most--$3 million (the 5 NALs plus 2 settlements earlier this year).  To be fair to the FCC, though, I know that USAC also engages in a lot of "ordinary" recovery through its frequent audits.  However, I have not been able to find the amount of their audit recoveries.  Thus, let's be super conservative, and estimate that the Lifeline Reform Rules (through USAC audits and FCC enforcement) save the fund about $10 million/year (out of a $1,812 million fund this year).

In our final installation of this series, we'll look at what the FCC should have done in its NPRM if it wanted to comprehensively reform Lifeline.  We'll also look at the savings the fund could have reaped if the FCC had made even a tiny effort to holistically reform Lifeline.

October 21, 2013 4:02 PM

Lifeline Series, Part 2: the Sound and the Fury

In the last post we mentioned the letter from the 44 House Republicans, who with no sense of self-awareness, sent the FCC a letter during the shutdown where they referred to the Lifeline program as representing "everything wrong with Washington."  Sure, it was wildly hyperbolic, but--admittedly--not completely baseless.  

But before we get started in discussing the "state of the debate," it helps to know some history--because understanding the real facts--is necessary to fully appreciate the bedlam that characterizes the current state of the "conversation."  The best piece I can recommend--which keeps with the theme of "why are we here?"--is this entertaining and informative blog by Harold Feld, explaining the ironies of Lifeline.

Where We Are:  The "Uncivil" War

If you've paid any attention to Lifeline over the past few years, you'll also recognize that the House Republican letter is hardly the first time that the Lifeline program has been portrayed as some kind of political litmus test, implying that if you support Lifeline you are nave at best, and grossly irresponsible at worst.  For a debate in which few, if any, of the program's opponents have any experience with the Lifeline program, the level of rancor in this "debate" is truly without equal.

Even worse, some "political activists" on the "anti-Lifeline" side try to generate opposition/hostility toward the program by associating the Lifeline program with the most appalling, frequently racial, stereotypes of poor people.  For example, who can forget the "Obamaphone lady?"  More recently, there was this deceptive video that circulated over the Summer from political activist (and pseudo-journalist) James O'Keefe.   

What's notable about O'Keefe's video is that it features actors, acting out the worst stereotypes of low income people.  People viewing the videos aren't reacting to anything that is actually being depicted in the video, rather they are being manipulated by a storyline created by the narratives of actors with a political agenda.

But there wouldn't be a rancorous debate unless both sides were participating.  So, as dishonest and deplorable as the "kill Lifeline" side is, the advocacy of the "save Lifeline" side is as insipid as it is unpersuasive.  The "save Lifeline" crowd has a website called Lifelineconnects.org.  On the website, you can look through their news clippings on their advocacy activities.  The group has done some advocacy at the Commission, and they have had advocates for the program testify before Congress.  Do you know what their message is?  Lifeline is good.  Beyond anecdotes of how Lifeline is helping a few deserving people, there is very little of substance on the web site.  

How We Got Here

The one uncontroverted fact about the state of the Lifeline program is that it has become wildly controversial over the last several years.  But, how did it get to this?  It didn't start that way; Lifeline started as a reasonable, bipartisan program to ensure that all Americans had access to basic communications services.  The addition of wireless service to the program in 2005 was merely an evolution of the program's founding principle.

So, when it became necessary to update the program--only a few years ago--it was clear that the program needed changes.  Starting in 2009--which, it should be noted, was a very bad year for the U.S. economy--the USF's low income fund began to grow dramatically.  

In early March of 2011, the FCC released its Lifeline/Link Up NPRM to discuss changes to the Lifeline program that would help modernize the program and put it on a more stable foundation for the future.  The NPRM identified the dramatic growth in the low income fund as the primary factor leading to the conclusion that the Lifeline rules needed to be revised.  

While the growth in the fund was the real issue that needed to be addressed, rather than to try to understand the basis of this phenomenon and to deal with the larger implications of the growing low-income fund in a holistic way--addressing USF contribution reform along with reforms to the Lifeline program--the Commission took a short cut and assumed that most of the problem was the result of the influx of prepaid wireless "Lifeline-only" service providers, who must have been running amok. New rules on service providers, the Commission said, would surely solve the problem.

This one lazy assumption is what set the table for all of the successive, unproductive, rancorous debate over Lifeline's future.  Because, after all, when you limit the possible explanations for fund growth to one--waste--then every service provider and every consumer participating in the program becomes part of the problem. Thus, the eventual result of the Commission's approach--that the future of the Lifeline program would be the victim of an unproductive war of political values--was hardly unforeseeable at the time, as I explained in this blog.

Given where we are, in terms of the level of the conversation about the future of Lifeline, does anyone honestly think that a solution to Lifeline's real problems is going to come out of this protracted "Sumo match" of opposing political values?  Neither do I.  But, if the Commission is to rescue Lifeline, they'll have to start understanding the relevant facts.  

In the next installment in this series, we'll look at how the wireless Lifeline business works, and how the Lifeline Reform Rules are working.  Finally, in our last installment, we'll talk about realities that the Commission must recognize, and the changes that must be made in order to stabilize the Lifeline fund.  

October 18, 2013 1:24 PM

Lifeline: A Dirty Waste? I Know a Worse One . . .

Last week, I tried my hand at writing a satirical post, supporting Dr. Anna Marie Kovacs' excellent study for the Internet Innovation Alliance.  I had "so-so" success, and--with what's been going on in Washington for the past few weeks--I can't blame anyone that mistakenly interpreted my post as a serious endorsement of government-imposed inefficient investment in order to prop up the economy.  Dr. Kovacs' study deserved better, and if you'd like to see better, please read this excellent discussion of the study by Richard
Bennett.

Among the if-you-didn't-know-better-you'd-swear-it-was-made-up news from last week, a group of Republican House members--after imposing a minimum of $160 million per day in costs to U.S. taxpayers (not counting long term credit cost affects) from shutting down the government for what Sen. John McCain described as a "fool's errand" based on an inability to understand how the government works--sent a letter to the FCC complaining about a program [Lifeline] that they contend "continues to symbolize everything that is wrong with Washington."   

Did you get it?  Republican House members shut down the government--at a minimum cost of $160 million a day--because they failed to understand that the U.S. system of government requires the majority of both houses of Congress, and the approval of the President, to not only enact a law, but also to repeal a law--in this case "Obamacare."  Then, these same lovable rapscallions send a letter to the FCC (where no one is working at the time) to protest the "Obamaphone" program--because that program represents "everything that is wrong with Washington."  Pot-Kettle-Black much, gang?

One of the many, subtly-hilarious parts of the movie "Willy Wonka and the Chocolate Factory" is when Willy, played by Gene Wilder, offers a nauseous parent a "rainbow drop" candy which will allow her to "spit in 7 different colors." "Violet Beauregard", a gum-chewing, bossy little girl offers the unsolicited comment (while digging her finger up one nostril) "spitting is a dirty habit."  Willy looks at Violet, and responds, "I know a worse one."  Here, take a look for yourselves.



In this vignette, the woman getting sick is the low-income consumer, Acting Chair Clyburn is like Willy Wonka, and the House Republicans are like Violet--we'll just call her "Marsha"


Aside from the fact that these Republican House members seem to erroneously believe that every law the President is charged with enforcing must be cited with the prefix "Obama", i.e., Obama-Constitution, Obama-Bill of Rights, etc., they are clearly taking aim at any government program that could even arguably threaten them for the crown of "biggest waste of taxpayer money."  Nonetheless, even the broken clock is right twice a day, so let's consider the basis for their ill-timed concerns.

In addition to a steady cascade of (mostly-unsubstantiated) negative publicity, the FCC recently imposed notices of apparent liability (NALs) against 5 Lifeline providers for approximately $14 million for submitting inaccurate and duplicative requests for reimbursement.  It should be noted, though, that the FCC is not alleging that the providers in question defrauded the Fund by this amount.  However, we should take away the understanding that the FCC is very serious about making sure that carriers submit accurate reimbursement requests. 

The amount of the alleged overpayments by the Lifeline Fund to the carriers is relatively small, compared to the amount of "fines and penalties"--which are punishment for the violations that led to the overpayments. In total, the 5 carriers received $73,250 in overpayments, resulting from duplicative claims for reimbursement from a total of 2,753 customers (out of over 19 million enrolled in Lifeline). 

So, to be clear, these Republican House members are not outside their rights to raise questions about the Lifeline program and its administration.  They were, however, outside their rights to assume their conclusion--that the Lifeline program is not worth, or not possible to repair--before they even asked their questions.  Nonetheless, even if they weren't right about their conclusions or even most of their questions, they do seem to exhibit ever so slightly more intuition about how markets work than the Commission.  

And, while this ever so slight recognition of market incentives isn't in itself going to change the direction of the Lifeline program, it is a start to figuring out how the Commission is--if it ever is--going to get the Lifeline program firmly on the road to reform that it started over 2 years ago, that will eventually include databases to check inter-company duplicates and to be able to perform eligibility verification online as additions to its arsenal of best practices to protect program integrity.  So, be sure and check in next week to part 2 of this "very special" Telecomsense series, to hear me expound on something I am very familiar with.