Results tagged “net neutrality”

May 30, 2017 11:20 AM

Correcting the [Revisionist] History of Internet Regulation

The FCC's NPRM to re-examine its Net Neutrality rules was just adopted and, with it, the Internet giants' advocacy groups have launched a misinformation campaign.  Over the past couple weeks, a number of articles have appeared that float revisionist history in an attempt  to embarrass FCC Chairman Ajit Pai--who aims  to return Internet regulation to the "light touch" approach favored since the dawn of the commercial Internet (during the Clinton administration) until 2015.

First, the Washington Post (owned by web giant Amazon) offered an "analysis" entitled "The Trump administration gets the history of Internet regulations all wrong."  Then, the website Ars Technica took the Post's "analysis" as fact to deliver an article with the even-more-smugly-insulting title, "Ajit Pai accidentally supports utility rules and open access networks."   More recently, the website TechCrunch repeated many of the same mistaken facts, but divorced from the "gotcha" rhetoric in the first two articles. 

The contortions these writers have gone through to argue that Chairman Pai inaccurately described Clinton era Internet policy could have been avoided had they gone straight to the horse's mouth.  The Clinton FCC's Office of Plans and Policy conveniently published a "Working Paper," in July of 1999, which provides great detail on the agency's approach to Internet regulation.  The paper is entitled "The FCC and the Unregulation of the Internet." (emphasis added)   

Most of the inaccurate narratives in the advocacy referenced above essentially conflate Title II of the Communications Act of 1934, the Telecommunications Act of 1996 ("Telecom Act" or "the Act"), and pre-Telecom Act FCC service classifications.  Let's try to go through some examples in context.    

"Without government oversight, phone companies could have prevented dial-up Internet service providers from even connecting to customers." (Post)

"Those [Title II] rules kept phone companies from charging dial-up Internet providers extra or blocking their connections." (Post)

Not true. In 1980 the FCC commenced a series of rulemakings (the "Computer Inquiries")  in which it decided not to regulate--at all--the new "enhanced services" being created through the combination of computer and telephone services. Telephone services would continue to be subject to the existing web of FCC, DoJ, through the MFJ  (the settlement order resulting from the AT&T antitrust case), and state regulations that already applied to these services.

This meant that a call to an "enhanced service provider," like an ISP, was treated like a call to any other end-user.  No additional charges applied because dial-up service was a call to an unregulated end-user.  Aside from having no commercial incentive to block ISP customers (in those days, customers often bought an extra line just to access the Internet), a telephone company who refused to route an end-user's call to an ISP would have been in violation of numerous federal and state laws/regulations.

"The FCC regulated phone companies under Title II of the Communications Act of 1934, which mandates that the agency ensure that services like telephone networks treat all customers equally."
 
Not exactly.  As noted, the FCC, the DoJ (through the MFJ), and state regulators all regulated some aspect of telephone companies' provision of local telephone services.  While Title II certainly applied to these services, Title II did not "require that . . . telephone networks treat all customers the same." It does, however, require that all services be available to similarly-situated customers on similar terms and conditions.  See 47 U.S.C. Sect 202(a)
 
"In 1999, the FCC used its authority under that section [Title 2] of the law to enact "line-sharing" rules that forced phone companies to let competitors offer DSL over their existing telephone networks. . . ."  (Post)  

Sort of, but needs clarification. This statement conflates the general common carrier obligations of Title II under the 1934 Act with the additional specific obligations Congress imposed on incumbent local exchange carriers ("ILECs") under the Telecommunications Act of 1996 ("the Act").  In exchange for the ability to provide long distance voice service, ILECs had to undertake additional obligations to open the local exchange market to competition.  See 47 USC Secs 251 (c) and (d).   

One of the specific, ILEC-only, obligations imposed by the Telecom Act was the duty to make available for lease, on an "unbundled" basis, certain network elements ("UNEs").  One of these UNEs, ordered by the FCC in its 1999 UNE Remand Order, was the high frequency portion of a local loop--which was already being used by another LEC to provide voice service to the customer--in order to facilitate the provision of ADSL service. This UNE was also referred to as "line-sharing," but is not synonymous with "unbundling."

"The line-sharing (or "unbundling") requirements remained in place throughout the four years of President George W. Bush's first term in the White House." Finally, in August 2005 . . .  the FCC voted to eliminate the line-sharing requirements on phone providers. Bush's FCC had previously decided not to impose line-sharing requirements on cable Internet service . . . ." (Ars Technica)

Needs clarification. This statement reflects confusion and a lack of understanding regarding two things: 1) the FCC's decision in 2002 not to classify cable modem service as a Title II service, and 2) the effect of the FCC's unanimous decision to apply that same classification to wireline broadband Internet access service in 2005. First, the Commission's 2002 cable modem classification was about whether to apply the general, 1934 Act, common carrier obligations to cable modem service. 

The FCC had no authority under the Telecom Act to impose line-sharing, or any other unbundling obligations, on cable companies.  Thus, it is incorrect to state that the FCC "had previously decided not to impose line-sharing requirements on cable Internet service."

Finally, when the FCC unanimously changed the classification of wireline broadband service in 2005 (consistent with its previous classification of cable modem service), the line-sharing UNE was no longer available by operation of law.  However, competitors providing a telecommunications service, such as voice, and DSL service could (and still can) lease the entire local loop as a UNE. 

"[the FCC's line sharing decision] gave customers a choice of broadband providers that today's users might find bizarre. A consumer guide that ran in The Washington Post's Sunday Business section in 2003 featured 18 DSL services available here."  (Post)

Misleading.  Readers will mistake the number of providers in the Post's guide with their competitive effect in the market.  If we look at the FCC's early "broadband" reports, which define "high speed" Internet access service as at least 200kbps downstream (less than 1% of the current FCC definition of broadband), we can see the relative significance of various technologies/competitors in the market.*   
 
Broadband technologies 2000-2005.jpg
The underlying data, which I didn't include in this chart, shows that the CLECs' share of ADSL services in RBOC markets was generally around 5% from December 2000 through December of 2005 (I was unable to find the FCC report with the December 1999 data).  See, e.g., Table 6 of the Report for the data as of 12/31/05.  

However, even this number dramatically overstates the CLECs' importance in the broadband market, as it was evolving.  For example, as of the end of 2005, ADSL's total share (all ILECs + CLECs) of the market for services between 2.5mbps and 10mbps in one direction was only 16%.  See Report at Table 5. Aside from the fact that this "heyday" of "broadband" competition affected very few consumers back then, it's even harder to see how advocates could seriously argue that a return to this era would help any consumers now.
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Future net neutrality advocacy pieces will, no doubt, continue to offer their own versions of the Internet giants' revisionist regulatory history.  But, as they do, they would do well to sticking with subjective interpretations of the "inconvenient truth" instead of simply making up facts that better suit their contrived narratives.  As that great Democratic Senator from NY, Daniel Patrick Moynihan once said: "Everyone is entitled to his own opinion, but not his own facts."


*Comparing CLECs with RBOCs (vs. all ADSL, or all high-speed service providers) offers a more accurate depiction of CLECs' role in the market (than CLECs/ADSL or CLECs/ADSL + Cable Modem)  because: 1) CLECs were concentrated in the urban areas served by the RBOCs, and 2) the RBOCs had to demonstrably to comply w/the FCC's unbundling rules in order to be able to enter the long distance market. 

May 16, 2017 8:16 AM

Oliver's Army

On April 27th, FCC Chairman Ajit Pai delivered a speech, describing the Commission's plan to take another look at the agency's regulatory treatment of Internet service providers.  Pai explained that his concerns with the Commission's current Internet regulatory regime--that monopoly era regulations would stifle broadband growth and service innovations--were shared by every FCC Chairman (Democrat and Republican) since the Telecommunications Act of 1996 was signed into law by President Clinton.   

Furthermore, he noted, it was only after the application of political pressure from the White House that the previous Commission adopted the more draconian "common carrier" designation (under Title II of the Communications Act of 1934), 

And what was the problem that Title II was supposed to address? We were warned that without it, the Internet would suddenly devolve into a digital dystopia of fast lanes and slow lanes....Did these fast lanes and slow lanes exist? No. The truth of the matter is that we decided to abandon successful policies solely because of hypothetical harms and hysterical prophecies of doom. It's almost as if the special interests pushing Title II weren't trying to solve a real problem....

Pai speech, p. 2.

As if on cue, the special interest groups started cranking the hysteria immediately.  A week and a half later, comedian John Oliver from HBO couldn't wait to reprise the bit that made him famous...literally.

john oliver search.png

If you missed John Oliver's segment a week ago, the gist of it was "if you disagree with me/the special interests/Internet giants, it's because you are either: 1) stupid, or  2) 'on the payroll' of the [evil] ISPs."  Chairman Pai was targeted, personally, as being both.  Predictably, the FCC's website was promptly shut down by DDOS attacks, the Commission received "comments" in the form of racial/xenophobic insults directed at Pai, and the Chairman/his family were personally threatened ...all courtesy of "Oliver's Army."

Oliver's style of argument--and that of the special interest groups he is aligned with--is known as the ad hominem fallacy, and it is used when a party is unable, or unwilling, to refute the facts, or reasoning of the opposing side.  Thus, those who question, or oppose, this view are referred to as "shills" in sympathetic publications.

The ad hominem argument is not intellectually persuasive, as it necessarily substitutes reason for venom.  However, it can be as invigorating to those who already "believe" in a cause as it is polarizing to society in general.  Perhaps Oliver thinks that since his sneering, "too-smart-for-you" condescension and contempt for anyone who thought differently worked out so well against President Trump, why not use it in every debate?  

This unproductive, and uncivil, style of discourse has infected even normally pragmatic lawmakers in this debate.  For example, in a speech to a net neutrality advocacy group about the FCC's decision to re-examine ISP regulations, Rep. Frank Pallone (D-NJ) concluded,

[i]f you're truly American, and care about the country and its democracy and the Bill of Rights and capitalism and competition, you should be on the side of Net Neutrality.

Pallone Speech at Open Technology Institute of New America Foundation (where half (5/10) of the $1million+ donors are affiliated with Google or Microsoft), see video at 25:47.  Was Pallone--like Oliver--trying to appeal to the worst instincts of the masses, as some have suggested?  I'd like to think no, but when you attack the person and not the argument, there is always the chance that someone will take the attack . . . well, personally.

The Antidote to Sneering Condescension and Vitriol

If anyone took the venom of Oliver's Army personally, it wasn't Chairman Pai.  He has consistently taken all the invective hurled at him (and it's been prodigious) with a sense of humor, a good-natured attempt to diffuse the rancor, and a commitment to listen to any reasoned concerns about net neutrality rules.  A good example is this "Mean Tweets" video he put out on Saturday (5/13). 



Perhaps Pai's good humor and generosity of spirit had some effect.  For whatever reason (perhaps due to a return of some long-lest sense of shame?), this past Sunday John Oliver put out a second, Internet-only, video asking his followers to observe some decency, as well as respect for the law.  Oliver noted, in addition to asking viewers to omit racist/vulgar comments from their invective, that the FCC's "Sunshine Act" rules prohibit advocacy on a matter in the week preceding a Commission vote on that matter. 

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In the second half of the 20th century, the city of Rio de Janeiro was home to a kind of self-described mystic, named José Datrino, but better known as the Prophet Gentileza (Kindness).  Gentileza was convinced that a return to human kindness was the only antidote for the chronic and widespread malaise/unhappiness afflicting modern society.  His most famous quote, which succinctly distilled his message, was "gentileza gera gentileza," meaning "kindness begets kindness."  Initially, of course, some people thought he was crazy, but over time he became a much-loved cultural icon. See, e.g., this video by Marisa Monte.   

Gentileza.jpg

 
The recent presidential election, and the exacerbated social polarization/incivility that have accompanied it, have only confirmed that vitriol and bile only lead to more of the same.  Perhaps there is hope that the tone set by Chairman Pai in the replay of this often-contentious economic debate will be enough to moderate the useless, angry rhetoric between Oliver's army (the Internet platform giants) and the nation's many ISP infrastructure providers.
 


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.


  

April 13, 2016 11:10 AM

Has Verizon Pulled a "Costanza?"

One of my favorite episodes of the TV comedy series "Seinfeld" is called "The Opposite," in which George Costanza reflects on his life, and realizes it is the opposite of what he hoped it would be.  At the diner, George tells his friends "that every decision I've ever made, in my entire life, has been wrong."  His best friend, Jerry, suggests "[i]f every instinct you have is wrong, then the opposite would have to be right."  (quotes from IMDB, episode 5.21)  By the end of the episode, after consistently "doing the opposite" of what he would normally do, George's life has corrected itself: he is dating a beautiful woman, has his dream job with the New York Yankees, and is able to move out of his parents' house. 


                                       Verizon Training Video

The episode starts with the universal human emotion of regret, and then humorously illustrates common logical fallacies, which are presented as both problem ("every decision I've ever made has been wrong") and solution ("the opposite would have to be right").  And, even though both problem and solution are products of fallacious reasoning . . . hijinks ensue--and problems resolve.  But, certainly, no one would actually take this seriously--especially not one of the largest companies in the country--would they?  

If its Public Policy Blog is reflective of its corporate mindset, Verizon--based on a couple of recent posts--appears to be willing to give George's zany solution a try.  But, are they really "doing the opposite," or have they just changed--as competition forces all firms to do?

A Net-Neutrality Flip?

First, on March 21st, Verizon in the context of net neutrality decides to "make clear what Verizon stands for and what kind of policies we support, regardless of the outcome of [the pending Open Internet Order appeal]."  And, as it turns out, the rules/policies that Verizon thinks "are fair, even-handed, good for consumers and essential for us and others to thrive going forward" . . . are pretty much the same rules the Commission adopted in its first Open Internet Order in 2010.  In other words, Verizon now endorses the very rules that were vacated as the result of the D.C. Circuit's decision in . . . Verizon v. FCC.    

Clearly, Verizon was seized with regret over an appeal it now realizes it could have lived with, but traded for worse rules, and is now "doing the opposite," right?  At first glance, it would seem to be the case, but, the blog is quick to explain that this is not a simple case of human regret (or any other human emotion) finding its way into Verizon's corporate offices.  

Rather, according to Verizon, it is not the same company it was five years ago, when it appealed the FCC's 2010 Open Internet Order.  In the intervening time period, Verizon notes, it has "invested billions in businesses that depend on the ability to reach customers over the networks and platforms of others."  Indeed, since 2013, Verizon has built its Digital Media, content and ad delivery, business through the acquisitions of EdgeCast, upLynk, Intel's OnCue ad delivery platform, and AOL.  

Thus, Verizon's net neutrality position is not really an example of it doing "the opposite" (though, of course, it would have saved itself and everyone else a lot of hassle and expense had it just recognized this before it appealed the 2010 Open Internet Order).  But this isn't Verizon's only, or even best, example of "doing the opposite" in the last month alone.

Verizon's Special Access "Compromise"

Last week Verizon decided to "up" the "opposite," and suggested--along with Chip Pickering, head of INCOMPAS (the rival carrier association formerly known as CompTel)--that the FCC should probably go ahead and regulate "new networks" along with the old special access circuits still subject to FCC regulation.  Verizon has long fought against any regulation of its data transmission services and has already received FCC forbearance and been selling its packet, Ethernet, and SONET optical services without regulation for almost 10 years, so this is a clear Costanza-esque flip-flop, right?

Let's take a closer look at the letter that Verizon and INCOMPAS jointly sent the FCC.  The letter asks the FCC to: 1) immediately, make all dedicated services--regardless of technology--"subject to Title II of the Communications Act, including Sections 201 and 202;" 2) seek comment on a permanent regulatory framework, which would include ex ante price regulation in "relevant markets" where competition is "insufficient."

When looking at whether Verizon is really "doing the opposite," it helps to keep in mind the "not the same Verizon" caveat.  In addition to Verizon's recent digital media investments, the company has been divesting itself of its wireline (telephone + ISP + TV) properties for years, and at an accelerating pace in the wake of the FCC's reclassification of Internet access services.  Similarly, based on Verizon's pending XO Communications acquisition, and its reported interest in Yahoo!, Verizon may well see INCOMPAS as more of a future trade association, and less of a regulatory opponent, these days.  

Until the terms "relevant market" and "insufficient competition" are defined, it's difficult to say how much of Verizon's future revenues are likely to be affected.  Given the Chairman's immediate endorsement of the "compromise," it's doubtful that Verizon is worried about having too much of its future revenues tied up by the regulation it's endorsing.  On the other hand, if you are a cable company--or a telecom carrier with some unique routes--Verizon's "compromise" seems more like the good, old-fashioned, Washington-style compromise . . . of someone else's opportunities.   

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In his more lucid, less politically-driven, first days on the job, Chairman Wheeler noted that every previous "network revolution" changed the world dramatically, and counseled that "we should not, therefore, be surprised when today's network revolution hurls new realities at us with an ever-increasing velocity."  When the velocity of new realities forces a rational economic actor to change positions as dramatically as a TV sitcom actor, it's safe to assume that the industry forcing those new realities is not subject to anything but competitive market forces.  So, why is it so hard for Chairman Wheeler to accept that the last thing a dynamically evolving "revolution" needs is more regulation?

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? 
 
May 19, 2015 12:33 PM

Who Profits from Keeping Your Favorite Content Off the Internet?

In the last post, we discussed how the broad new regulatory framework that the FCC's Net Neutrality/Broadband Reclassification Order imposes on ISPs is predicated on a few, demonstrably erroneous, presumptions about the incentives of broadband ISPs.  Contrary to the FCC's assumptions, the evidence demonstrates that broadband ISPs have a powerful economic incentive to efficiently increase output of their most profitable product--broadband Internet access.   

But, incentives--and their impact on how consumers receive content today, vs how consumers would like to receive that same content--could use some further fleshing out.  After all, if someone didn't have an incentive to keep your favorite content off the Internet--you wouldn't be paying the same company two fat bills--for TV and broadband Internet--every month, would you?

Internet Consumers Love Content, and ISPs [Don't] Love to Sell It

While consumers love the high quality content that broadband providers offer through their MVPD service, TV distribution is not a profitable service for many broadband ISPs and is not the most profitable service for any broadband ISP.  See, e.g., this recent AP article, citing SNL Kagan figures, that cable companies earn 60% cash flow margins on broadband service vs. 17% on video service.   

But, even though most wireline ISPs would rather not be in the pay-TV business, there is a strong correlation between consumers that purchase pay-TV service and those that purchase broadband Internet service.  In the AP article cited above, Comcast says that about 70% of its video customers also purchase broadband Internet service.  For non-incumbent cable companies, the correlation may be much higher.  See, e.g., Randall Stephenson, Statement to House Judiciary Committee, June 24 2014, at 3 (More than 97% of AT&T's video customers also purchase another AT&T service.)  The fact is that broadband ISPs believe they must offer pay-TV service in order to compete for the best broadband Internet customers. 

Big Content Loves Consumers' $$ . . . Just Not Consumers

As noted in the last post, the big content companies do not seem to be as responsive to consumer demand as broadband ISPs.  In fact, companies like CBS, Comcast, Disney, Fox, Time Warner, Viacom, and various cable/satellite-owned regional sports networks generally don't make their "linear" (sports, news, and primetime) programming available online at any price, unless the customer is also a TV subscriber.  

And, it's not cheap to be a TV subscriber.  In its most recent Video Competition Report the FCC notes that, in 2012-2013, the price of the most popular tier of channels increased at a rate 3x the rate of inflation for the same year. 16th Annual Video Competition Report, table 5.  (5.1% vs. 1.7% inflation)  Comcast recently disclosed that its programming costs increased by almost 7.8% in the past year--almost 10x the inflation rate!  According to Nielsen, consumers now purchase an average of 189 channels per month, but watch only 17.

The FCC [Still] Doesn't Understand that Incentives = Profit

It's clear that, despite the evidence, the FCC still believes that, for most ISPs, it's more profitable to distribute programming for "Big Content" than it is to produce and deliver their own broadband Internet access service.  That's the only explanation for why Chairman Wheeler would offer this counsel to ISP/MVPDs at NCTA's recent INTX show:  

History proves that absent competition a predominant position in the market such as yours creates economic incentives to use that market power to protect your traditional business in a way that is ultimately harmful to consumers. . . . Your challenge will be to overcome the temptation to use your predominant position in broadband to protect your traditional cable business.
Remarks of Chairman Tom Wheeler, NCTA-INTX 2015, (as prepared) at 6. 

Chairman Wheeler points out that MVPD's spent $26 billion on programming in 2013, but he doesn't mention that as this number grows, MVPD profit declines.  Wheeler Speech at 3.  According to data relied on by the FCC, programming costs (as a percentage of revenue) were the highest in 2013 that this expense had ever been. 16th Annual Video Competition Report, at ¶ 89.   Meanwhile, also in 2013, the same companies invested even more in the means of production for broadband Internet service ($28 billion (according to U.S. Telecom data) vs. >$26 billion (which includes non-ISP DBS firms' spending on content).

If Profit = Incentive, Who Profits from Keeping Content Off the Internet?

Chairman Wheeler is correct in his (implicit) premise--that the parties that benefit most from the status quo do not tend to willingly embrace disruption of the status quo.  But, the Chairman is mistaken about who benefits from maintaining the inefficient, and artificial, separation of the function of content delivery into the "MVPD" business and the "broadband Internet."  If the FCC ever thought to ask itself why these two businesses were still separate businesses at all, the Commission might want to "follow the money."

Profit Margins ISPs v Big Content3.jpgThe table above compares profit margins (income/sales) of the largest ISPs and the largest providers of MVPD content over the past 4 years.  Looking at the relative profitability of content distribution, versus broadband Internet/MVPD--and recognizing, as noted earlier, that the ISPs would be more profitable without their MVPD businesses--then there's really no question that the group which benefits most from the "traditional cable business" is not the ISPs/MVPDs, but rather, Big Content.  

But, even though Chairman Wheeler's assumptions about ISP's incentives are mistaken, he correctly observes that,

      The Internet will disrupt your existing business model. It does that to everyone.

Wheeler Speech at 6.  But, if you're a big content guy, at least he wasn't talking to you--you still get to distribute your content through the free-from-Internet-competition biosphere of the federally regulated MVPD model.  It could be worse, look at Netflix's profit margins . . .
Netflix Profit Margins 3.jpg
The graph above was part of a Seeking Alpha article by Amit Ghate.  Of course, the Big Content companies would probably expect to earn much better profit margins than Netflix, because they have more--and better--content.  But, still, how much better? 

Until now, the Big Content companies have been lucky that the FCC thinks their content needs to be protected from the ISPs.  At some point, though, its always possible that the FCC--or Congress--could start questioning whether parts of the existing pay-TV regulatory scheme are insulating content from the disruptive forces of the Internet.  If I was a content company, though, I would only get worried when they stop inviting me to secret meetings about MVPD mergers. 




May 11, 2015 11:25 AM

Does the FCC Understand ISP Incentives?

In its recent Net Neutrality/Broadband Reclassification Order, the FCC justifies the need for the Order's pervasive regulations in essentially one statement, "broadband providers (including mobile broadband providers) have the economic incentives and technical ability to engage in practices that . . . harm[] other network providers, edge providers, and end users."  Order ¶ 78.  The Commission's discussion of the ISPs' incentives/ability to harm consumers and other market participants is almost as conclusory.

The FCC appeared focused on a result that required it to presume an uncompetitive broadband market.  Supporting its premise, the FCC relies on citations from its 2010 Order, and some gerrymandered market shares, in which it defines "markets" by arbitrary selections of speed vs. consumer demand substitution.  See, e.g., Order, n. 134.  By ignoring broadband market performance, the Commission not only failed to understand that ISPs were unlikely to be the problem, but the FCC also missed a chance to conduct a more circumspect analysis of whether consumers could truly access the content of their choice online.

The FCC Didn't Consider Broadband Market Performance

The FCC states that, "[b]roadband providers may seek to gain economic advantages by favoring their own or affiliated content over other third-party sources." Order ¶ 82.  The Commission offers less than a handful of specific examples ISPs "act[ing] to harm the open Internet." Order, n. 123.  

Only in the Madison River example, was the ISP clearly seeking to favor its own service (long distance voice termination).  It is worth noting, though, that the reason Madison River had an incentive to favor its circuit switched voice was because--as a rural ILEC--the FCC set Madison River's rates well in excess of cost; so its incentive was created by one FCC regulation and then preempted by another (later) FCC regulation.  

Nonetheless, the best indicator of a market is performing competitively is whether it is responding to consumer demand by adding capacity, or whether it simply raises prices and takes more profits.  Broadband speeds have consistently moved higher, actually following  the Moore's Law trajectory.  And, the Commission notes, broadband capital investment reached levels in 2013 that had previously only been seen during the telecom bubble.  Order ¶ 2.  Moreover, connected devices, bandwidth speeds, and user adoption of streaming services has soared.  Order ¶ 9.    

The FCC Didn't Consider the Evidence on ISP Incentives

The Commission recognizes that, "the growth of online streaming video services has spurred further evolution of the Internet."  Order at ¶ 9.  But, untethered by evidence to the contrary, the FCC leaps to the [wrong] conclusion that, "these video services directly confront the video businesses of the very companies that supply them broadband access to their customers." Id.

Almost a year ago, AT&T Chairman Randall Stephenson, explained why this theory didn't make sense for most ISPs.  In his prepared testimony for the House and Senate Judiciary Committees about the AT&T's proposed acquisition of DirecTV, Stephenson states its motivation to acquire DirecTV is about trying to earn any profit on TV,

Today, 60 cents of every video dollar we earn goes straight to programmers, before we spend a penny to market our service, install a set top box, send a bill, or answer a customer's call. As a result, our video product is, on its own, unprofitable.  
Statement of Randall Stephenson, CEO and President, AT&T Inc., before the House Judiciary Committee, June 24th 2014 at p. 3 (emphasis added).  Thus, the FCC's theory--that ISPs have an incentive to prevent consumers from accessing video content online, because the ISP would prefer to sell them the same content at a loss to the ISP--is simply untenable.

Even if the ISP does earn a profit on video, it would still not have any incentive to discourage their broadband customers from accessing online video content, unless it earns a greater profit from its  video service than from its broadband service.  This is not the case for Comcast, whose broadband revenues and company profits continue to boom, despite continued losses of video subscribers.     

So, if the FCC's theory doesn't even make sense for the Prince of Darkness, then ISPs are unlikely to be the problem.  But, why don't consumers have access to more content over the Internet?

Traditional Linear Content Owners Don't Have the Same Incentives As ISPs

Even though the three largest streaming video providers (Amazon, Hulu, and Netflix) have expanded their content through original programming, and consumers have embraced online streaming video, the fact is that consumers still don't have access to that many more online programming choices than they did in 2010.  If you compare the most popular streaming sites in 2011, with what's available today, the only significant new entrants are Sling TV and HBO Now.  Unfortunately, cord-cutting is more of a media headline than a consumer phenomenon.

At times, the FCC has seemed to (sort of) recognize the problem. A little over a year ago, Chairman Wheeler was telling broadcasters that he was looking out for them with strong net neutrality protections, and that they should embrace Internet distribution of their programming.  Except for the few broadcast channels that are part of the Sling TV package, the Chairman's speech fell on deaf ears.  Chairman Wheeler didn't seem to appreciate that--because the FCC ensures the broadcasters fat margins on retransmission fees (much like Madison River's terminating access margins)--they have no incentive to expand output!  

Similarly, Chairman Wheeler understood that the linear content market had failed last summer, when he asked the CEO of TWC to resolve disputes between TWC's regional sports network (RSN), which carries the Los Angeles Dodgers, and other MVPDs serving the Dodger's home television market.  Because of pricing disputes, when Chairman Wheeler wrote to TWC, a large majority of Dodgers' fans--4 months into the 2014 baseball season--could still not watch the team on TV.

Chairman Wheeler probably thought he understood TWC's incentives pretty well--the company had a merger with Comcast pending before the Commission--when he asked TWC to respond in a competitive manner to consumer demand.  But, RSNs have powerful economic incentives to restrict output.  Thus, Chairman Wheeler was, again, mistaken about incentives.  TWC's merger with Comcast has come and gone, but 70% of the Los Angeles viewing market still cannot watch the Dodgers on TV or online.   
 
A Question of Incentives

As of Friday, Chairman Wheeler was [still] telling cable ISPs they should "overcome their temptations" to favor their TV businesses over their broadband Internet services.   Meanwhile, in an L.A. Times article yesterday, broadcast programmers candidly noted that, despite using public spectrum to distribute their content, they plan to favor even more of their own content over third party sources.  Perhaps the Chairman was talking to the wrong group?    

By now, you probably understand that I think the FCC would have been wise to spend some time thinking about whether the industries it regulates have incentives that are aligned with consumer welfare.  Had the FCC thought about it, they probably didn't need to impose such pervasive regulations on ISPs.  Likewise, if the FCC's rules are distorting the incentives of traditional TV programmers, then the FCC should eliminate these rules, also. 

On the other hand, what if traditional linear programmers simply like their FCC incentives more than those of the competitive broadband Internet, and are simply in "harvest" mode (restricting output/raising prices in the face of a slow decline in demand)?  Broadcasters aren't (usually) ISPs, so who will police them? 

Certainly not the FCC.  But, to be fair, neither have the DoJ or the FTC looked into the matter.  However, some parties are looking out for consumers . . . and the answer may surprise you.  We'll discuss further in the next post. 






 

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 19, 2014 12:22 PM

The Netflix/Comcast Dispute Pt. 2: Was Netflix Surprised?

As we mentioned yesterday, Section 5 of the FTC Act prohibits companies from engaging in "unfair or deceptive acts or practices."  A lot of the FTC's inquiry focuses how a reasonable consumer would expect to be treated.  Today we'll look at Netflix's contention that, as an OVD, Comcast has an incentive to discriminate against it.  We'll also look at whether Netflix, when it changed its manner of distribution to customers of large ISPs (i.e., most U.S. customers) in 2013, observed ordinary distribution practices for providers of video streaming service.  

If Netflix seems to be the victim of a discriminatory refusal by Comcast to continue to provide uncompensated inbound capacity to Netflix's transit providers (notwithstanding the parties agreed-upon limits of settlement-free capacity), then it couldn't have expected congestion would affect its service. Similarly, if Netflix used normal industry practices for distributing streaming video service, then it could not have foreseen that its service would fail to meet reasonable consumer expectations--and could not have been expected to disclose to these consumers that their grade of service would be below "normal."  

Does Comcast Have an Incentive to Discriminate Against Netflix?

Demonstrating the "incentive/ability to discriminate/exclude" is an essential allegation for any complainant to establish as part of a credible theory of unilateral harm to competition by a dominant firm.  In its Petition to Deny the Comcast-TWC Merger, Netflix attempts to satisfy this element by reciting general statements by the DoJ and FCC to justify settlement conditions in prior mergers.  Netflix recites theoretical statements that an integrated MVPD/ISP (i.e., Comcast) "may" have the incentive discriminate against an OVD.  Netflix seems to be hoping the Commission will assume that it is that hypothetical OVD/discrimination target; and, given that Comcast ("Satan's ISP®") is involved, it's doubtful the FCC will question Netflix's implied victimization.
 
Netflix Service Is a Complement to MVPD Service.  Netflix never directly says that it has been the target of discrimination by Comcast.  Even if we assume that Comcast would--irrationally, according to this GigaOm analysis--favor its lower margin service over its higher margin service (to which Netflix is critical), there is no evidence that Netflix's streaming video service is a substitute for Comcast's subscription video service. 

Instead, all available evidence suggests the contrary--that Netflix offers a complementary service.  Netflix's CEO has said as much, as have the cable companies and satellite companies that want to make Netflix accessible on their set-top boxes, and the large ISPs that offer "free" Netflix service as a marketing tool to attract new customers to their higher tiered services. 

Thus, it is unlikely that Comcast would intentionally degrade such an important complementary service as Netflix, because any devaluation of a complementary service damages the value of the other complementary component (Comcast).  Moreover, if Netflix believed that it was the target of anticompetitive tactics by Comcast, it would not have waited for a merger before complaining to--or filing a complaint with--the FCC or the DoJ. 

Did Netflix Use Reasonable Methods to Deliver Streaming Videos?

Since various parts of the FTC's unfair or deceptive analysis focus on practices that a "reasonable" person might consider unfair or misleading, let's try to get an idea of how other online streaming content is delivered--as the quality of other similar services informs consumers' reasonable expectations regarding online streaming video quality.  Since Netflix's customers noticed that Netflix's congestion-affected service was below their expectations, let's look at how other providers of online streaming video distribute the quality consumers expect of "streaming video service" generally.     

WWE Network.  The same week that Netflix announced its direct interconnection agreement with Comcast, the WWE (World Wrestling Entertainment) launched the WWE Network--a 24/7 online channel broadcast in 720 HD.  Moreover, because the WWE was, for many years, the largest consistent source of MVPD pay-per-view revenues, it would seem that the cable companies would not want to see this content successfully migrate from the MPVD platform to the Internet.

The WWE Network has received generally good reviews with respect to its streaming performance; and no complaints of ISP discrimination have surfaced.  The WWE Network is delivered through a partnership with MLB Advanced Media.  MLBAM, in turn, uses the Akamai and Level 3 CDNs. 

Free Porn.  As the Tony award winning musical, Avenue Q, reminds us (and the FCC is well aware), "[t]he Internet is for porn."   When you stop smirking, consider that many estimate that the volume of adult site traffic is comparable to Netflix's share of Internet traffic. See here, and here.  Moreover, like the WWE Network, the migration of adult videos to the Internet has hurt cable companies' PPV revenues.     
 
Mind Geek is the largest of all streaming adult video providers; its CTO says the company is one of the top 5 consumers of Internet bandwidth in the world.  Mind Geek uses "two of the largest CDNs in the world" to carry its traffic--not that much different from the way Netflix distributed videos (when it cared about congestion).

The "Next Netflix." Every smaller streaming site that I looked at, and which discussed their Internet transit partners, used more transit networks than Netflix.  Many providers that focus on hosting video streaming also offer multiple "CDN-style" server sites at multiple points within major ISP service territories.  See, e.g., Rackspace (9 transit networks & 219 edge locations) and AdultHost.com, which "ensure[s] congestion free" content delivery by: 1) sending packets over the "least congested" route (vs. shortest, like BGP), 2) uses at least 7 different Internet transit networks.    

So, it seems unlikely that Comcast tried to degrade Netflix's traffic by deliberately allowing its transit providers' interconnection points to congest.  Similarly, it doesn't seem like Netflix even used the same standards of distribution that a free porn monopoly provides viewers.  Thus, it was plausible that Netflix knew its customers in Comcast's territory were in for a prolonged period of substandard service.  In the next post, we'll look at the possible implications under the FTC Act. 


***Relevant Facts***

Here is a brief recitation of the relevant facts for purposes of our discussion.  Unless otherwise cited, the facts are taken from the Declaration of Ken Florance http://apps.fcc.gov/ecfs/document/view?id=7521825167 , Netflix's Vice President of Content Delivery, submitted in support of Netflix's Petition to Deny the Comcast-TWC Merger (FCC Docket No. 14-57).

For most of the history of Netflix's streaming video delivery service, Netflix believes that Comcast has required Netflix's third party vendors to pay an additional fee to cover some (or all) of the cost of Netflix-specific capacity augmentation at interconnection points.  Netflix describes 3 instances between 2009 and 2010 where it believes CDNs needed to purchase additional capacity to alleviate congestion issues. Florance Declaration ¶¶ 29-41.

Netflix acknowledges that the volume of its traffic does increase demand for ISP-bound capacity at its vendors' points of interconnection with Comcast.  Moreover, these costs are incremental and specific to the particular point of exchange between Netflix's Internet transit vendor and the ISP.  Florance Declaration at ¶ 46. 

When its traffic was carried on third party CDN networks, Netflix was aware of the costs being incurred on its behalf, but "in the short term Netflix was insulated from a sudden price increase." Florance Declaration at ¶ 39.  While Netflix was using CDNs, its performance over cable systems seemed uniformly better than even on the most advanced telco systems.  http://techblog.netflix.com/2011/01/netflix-performance-on-top-isp-networks.html

While its service was good using 3rd party CDNs, Netflix explains that, "[a]fter the Akamai, Limelight, and Level 3 CDN congestion episodes [2009-2010], Netflix began transitioning its traffic from CDNs (all of whom, we believed, were paying Comcast's new terminating access fee) to transit providers in our continued effort to avoid terminating access fees."  Florance Declaration at ¶ 40.  (dates in brackets added).  Thus, in February, 2012, Netflix signed an agreement with Cogent for Internet transit service.  Cogent began transitioning traffic to Netflix in August 2012.  Florance Declaration ¶ 41.

Based on customer complaints about service quality, Netflix's service deteriorated immediately upon switching to Cogent transit and progressively deteriorated over the next year. Florance, at ¶ 51.  However, beginning in October 2013, Netflix reports a very high level of customer dissatisfaction and cancellations, due to "Netflix's inability to do anything to change the situation."  Florance ¶ 52 (emphasis added).


 
Continue reading The Netflix/Comcast Dispute Pt. 2: Was Netflix Surprised?
December 18, 2014 4:31 PM

The Netflix/Comcast Dispute: Interconnection "Principles" vs. Consumer Rights?

[Note: This is the first post, in a series, in which we'll look at the Netflix/Cogent/Comcast congestion episode from earlier this year.  The focus will be on understanding this event from a different perspective than most of us may have thought about it before.  This series looks further into the question I raised in my last post which is: are existing laws--adequately enforced--sufficient to protect consumers?  For purposes of readability, the full citation of relevant facts has been placed at the end of this post.]

In my last post, I started to look at whether the protracted congestion--and associated consumer service disruptions--caused by the recent Netflix/Cogent/Comcast interconnection dispute indicated that the traditional voluntary agreement structure of the Internet was broken, or whether existing laws might not be enough to prevent protracted consumer disruption.  In a recent article, Prof. Susan Crawford, an advocate for all things Net Neutrality, also highlights the frustrations of customers caught in the middle of the Netflix/Cogent/Comcast dispute,

No federal, state, or local government exercises any oversight over this handful of interconnection points. No Better Business Bureau watches over how your requests for data are being treated.
Prof. Crawford is right to question why consumers got stuck with the short end of this wholesale dispute.  But, I disagree with Prof. Crawford's assumption that new laws--specific to the issue Netflix and Cogent blame for the protracted congestion--are needed. 

As noted in the last post, more specific contracts, and quicker enforcement by wholesale partners are one way to prevent extended periods of consumer frustration.  Similarly, there are also existing laws designed to protect consumers from intentional, or knowing, actions of third parties that prevent consumers from receiving services they believe they are purchasing.

The FTC has expressed concern that it will lose jurisdiction over Net Neutrality-related matters if the FCC decides to reclassify broadband as a Title II service (the FTC Act specifically exempts "common carriers").  Even though I was aware the FTC had asserted jurisdiction to handle Net Neutrality complaints, I didn't really think about the how important the FTC could be. . . until I started looking really closely at the Netflix/Cogent/Comcast congestion episode from earlier this year.   

"It's About the Principle"

When Netflix filed its Petition to Deny the Comcast-TWC merger  in August, I was interested in learning the circumstances that led to Netflix's direct interconnection agreement with Comcast.  I expected to see a pretty basic recitation of how Comcast kept unreasonably increasing interconnection prices, thereby forcing Netflix into lower quality interconnection arrangements.  

Instead, though, the brief spends a lot of time establishing that Netflix's principle--of not paying the ISP any portion of the costs of delivering its content to its customers--was the exclusive factor it relied upon in choosing vendors to deliver its customers' traffic.  The absence of any comparison of various input prices/vendor alternatives available to Netflix seemed odd.  The notion that Netflix was defending a not-purely-economic principle seemed odder still. 

The antitrust analytical framework (which was the ostensible basis for Netflix's opposition to the Comcast-TWC merger) recognizes economic efficiency, and not any unique firm-specific view of how an industry should work.  Yet, Netflix has never indicated that its decisions were based on immediate cost/price effects.  It has even clarified that the costs being imposed by the ISPs are not significant, nor has it raised prices for customers served by the offending ISPs.  See, e.g., this blog post.  Level 3 made the same argument in 2010--that it's not the cost, it's the principle. See this Ars Technica article.   

Prof. Susan Crawford, in the article mentioned above, also observes:

The FCC will find that the money amounts involved in these deals are low at the moment. It's the naked threat posed to the future that is the problem. . . .
The "naked threat posed to the future" may or may not be cause for concern, but--if this threat does not limit the immediate ability of a firm to deliver service--can a firm's reaction to such a threat excuse its performance under its customer contracts?  

It's possible that, for many months at least, Comcast customers (and those of certain other ISPs) were paying for service that Netflix knew to be substandard.  If Netflix failed to take any action to provide the grade of service for which its customers were paying, or to let prospective customers know they would be receiving degraded service for an indeterminate period, then it's possible that enforcement of existing laws might prevent future consumer abuses.    

The Federal Trade Commission Act

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

The standards for unfairness and deception are independent of each other. While a specific act or practice may be both unfair and deceptive, the FTC may find a violation of Section 5 if the act or practice is either unfair or deceptive.

In the next post, we'll look at what happened and whether Netflix's 2013 change in the way it delivered content to the country's largest ISPs seemed reasonably calculated to efficiently deliver content to customers, or, if not, whether it seemed designed to promote another goal.  


***Relevant Facts***

Here is a brief recitation of the relevant facts for purposes of our discussion.  Unless otherwise cited, the facts are taken from the Declaration of Ken Florance  , Netflix's Vice President of Content Delivery, submitted in support of Netflix's Petition to Deny the Comcast-TWC Merger (FCC Docket No. 14-57).

For most of the history of Netflix's streaming video delivery service, Netflix believes that Comcast has required Netflix's third party vendors to pay an additional fee to cover some (or all) of the cost of Netflix-specific capacity augmentation at interconnection points.  Netflix describes 3 instances between 2009 and 2010 where it believes CDNs needed to purchase additional capacity to alleviate congestion issues. Florance Declaration ¶¶ 29-41.

Netflix acknowledges that the volume of its traffic does increase demand for ISP-bound capacity at its vendors' points of interconnection with Comcast.  Moreover, these costs are incremental and specific to the particular point of exchange between Netflix's Internet transit vendor and the ISP.  Florance Declaration at ¶ 46.  

When its traffic was carried on third party CDN networks, Netflix was aware of the costs being incurred on its behalf, but "in the short term Netflix was insulated from a sudden price increase." Florance Declaration at ¶ 39.  While Netflix was using CDNs, its performance over cable systems seemed uniformly better than even on the most advanced telco systems. 

While its service was good using 3rd party CDNs, Netflix explains that, "[a]fter the Akamai, Limelight, and Level 3 CDN congestion episodes [2009-2010], Netflix began transitioning its traffic from CDNs (all of whom, we believed, were paying Comcast's new terminating access fee) to transit providers in our continued effort to avoid terminating access fees."  Florance Declaration at ¶ 40.  (dates in brackets added).  Thus, in February, 2012, Netflix signed an agreement with Cogent for Internet transit service.  Cogent began transitioning traffic to Netflix in August 2012.  Florance Declaration ¶ 41.

Based on customer complaints about service quality, Netflix's service deteriorated immediately upon switching to Cogent transit and progressively deteriorated over the next year. Florance, at ¶ 51.  However, beginning in October 2013, Netflix reports a very high level of customer dissatisfaction and cancellations, due to "Netflix's inability to do anything to change the situation."  Florance ¶ 52 (emphasis added).    



Continue reading The Netflix/Comcast Dispute: Interconnection "Principles" vs. Consumer Rights?
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 16, 2014 9:00 AM

Chairman Wheeler's Broadband Competition Observations: Title II Implications

On September 4th, in a speech to the startup-focused group, 1776, Chairman Wheeler gave a speech where he discussed consumer broadband deployment and competition.  The Chairman seemed to be of two minds about the state of broadband competition.    

On the one hand, the Chairman praised the valuable benefits that competition has yielded, in terms of spurring ISPs to deploy new, and upgrade old, networks in order to increase the speed and availability of broadband Internet to more Americans.  The White House has previously recognized broadband competition as producing better networks and faster speeds.  

However, after recognizing the value of these new last mile networks, Chairman Wheeler also concludes that the present state of competition is simply not adequate to ensure that consumers can realize all the benefits of these networks,  

Looking across the broadband landscape, we can only conclude that, while competition has driven broadband deployment, it has not yet done so in a way that necessarily provides competitive choices for most Americans.

Speech at 5 (emphasis added). 

The Consumer Broadband Continuum
 
Chairman Wheeler began by introducing the graphic below.  The chart shows, by percentage of households, the number of providers offering service at not only the FCC's currently-defined "broadband" speed (4Mbps down/1Mbps up), but also 3 additional, speed-defined, categories--10Mbps, 25Mbps, and 50Mbps.
Broadband table from Wheeler speech_4.png 

The Chairman explained that 10Mbps was the minimum speed that a household would need to stream one HD movie, and allow for simultaneous Internet use from other devices.  Wheeler also proposes changing the definition of "broadband" to 10Mbps downstream for purposes of participation in the Connect America fund.

The Chairman further argued for changing the definition of broadband, because "only wussies use less than 10Mbps/month, and the United States will not subsidize wussy Internet usage." [citation needed]  The 25Mbps and 50Mbps levels of service, Wheeler predicts, will quickly become the standards, as households continue their inexorable march toward dedicated, fully redundant, OCn SONET service. 

Competition

Wheeler observes that, at the 4Mbps and 10Mbps tiers, most Americans have a choice of no more than 2 service providers.  Moreover, the situation only deteriorates at higher speeds, "[a]t 25 Mbps, there is simply no competitive choice for most Americans."  Speech at 4 (emphasis added).

The poor picture of broadband competition that the Chairman paints has created situations where "public policy" (read: FCC regulation) must intervene to protect consumers and "innovators" from firms with "unrestrained last mile market power."  In these situations, he says, "rules of the road can provide guidance to all players and, by restraining future actions that would harm the public interest, incent more investment and more innovation." Speech at 5.

Title II Just Got Trickier

As most are aware, the FCC is currently evaluating public comments on its "rules-of-the road-for-broadband-ISPs" NPRM, in which the Commission is also considering whether to reclassify broadband Internet service as a "telecommunications service" under Title II.  Supporters of reclassification often contend that it would not compel the FCC to impose any obligations on ISPs, beyond the general statutory duties of fair dealing imposed under Sections 201 and 202 of the Act.

Title II Is Different for Dominant Carriers.  The obligations of any specific common carrier under Title II, however, depend on that carrier's classification within Title II for the relevant telecommunications service.  Consistent with what Title II proponents argue, "non-dominant" carriers have few, if any, company-specific obligations.

On the other hand, carriers classified as "dominant" have to abide by additional obligations that stem from both the statute, as well as a more specific application of the general terms of the statute, because the FCC cannot assume compliance with its general statutory obligations for the dominant carrier service. 

Thus, dominant carriers' rates can be regulated by the Commission, and they must file tariffs, subject to FCC review, describing their terms of service.  Moreover, dominant carriers have longer review times and more stringent standards for initiating new, and retiring old, service offerings. 

Finally, once imposed, dominant carrier regulations are all but impossible to get out from under.  At the end of 2012, U.S. Telecom filed a Petition with the FCC, seeking to have its members (holding less than a 50% market share in a declining segment) declared "non-dominant" for voice service. The FCC has still not acted on U.S. Telecom's Petition.

Implications for Cable ISP's Higher Speed Services

The one thing that Chairman Wheeler could not have expressed more clearly is his belief that cable is the only alternative for broadband service at or above 25Mbps.  Thus, if the Commission were to reclassify broadband Internet service as a telecommunications service, it would be difficult for the Chairman to explain why the incumbent cable providers are not dominant in the provision of higher speeds of consumer broadband service.

The specific Title II provisions, and Commission rules (such as the Computer Inquiry rules), that would apply to the cable companies' dominant telecommunications services would depend in large part on how the Commission chose to reverse the Cable Modem Order.   Although, with respect to the Computer Inquiry rules, in particular, it seems highly unlikely that the Commission would revisit its earlier unwillingness to "in essence create an open access regime for cable Internet service applicable only to some operators." Order at � 46 (emphasis added).

Whither the Dominant Carrier ISP?
 
If we pause for even a second to consider the Commission's reasoning in refusing to apply Computer II to broadband over cable, it becomes very clear why Title II regulation is not the answer.  The easiest way to avoid the incremental hassles that come with being "the firstest with the mostest" is don't be that guy.

What's that, dear broadband network?  You could offer the fastest broadband on the market, but because some additional regulation intended to "simulate" competition means you'll earn less than you would on the "slower" speeds?  Well, the easy answer would be: don't offer the higher speeds! 

This almost seems like that classic case where rent control regulations have the paradoxical effect of creating artificial shortages for the regulated service, limiting access for the very people the laws were supposed to help.  But, I'm sure that could never happen here...

 



September 8, 2014 1:59 PM

Free Press's Misleading Theories on Title II and CapEx (Pt. 2)

In its Net Neutrality Comments, Free Press combines a limited number of less-than-ideal data points with a faulty methodology and a misleading narrative to claim that has "proven" its' reckless accusation that ISPs are lying when they express concerns that Title II reclassification/regulation may distort their incentives to invest in network improvements.  

In the previous post, we discussed some of the problems with the methodology, reasoning, and data Free Press uses to reach its conclusion.  Today, we'll correct Free Press's misleading narrative "interpreting" the data with some relevant facts that you wouldn't know if you only read their comments.  

Ironically, Free Press concludes its misleading presentation of capex "facts" (Comments III.B and III.C) by stating, "[w]e hope that the Commission and other policymakers learn and understand this history, for this debate cannot be a legitimate one if basic historical facts are replaced by incorrect beliefs."  Comments at 111 (emphasis added).  This statement would be OK (but still too preachy), if it didn't just present the FCC with a version of history so tailored for advocacy that it exists only in Free Press's comments.  But, it's easy to forget . . .   

Excessive Investment=Excess Capacity=Loss of Investment + Jobs

Free Press speaks of the period before the Cable Modem Order (in 2002) with a level of nostalgia that would seem more appropriate to a former WorldCom executive than a group claiming "historical facts."  Free Press confidently asserts,

[common carriage], in conjunction with policies that opened up communications markets to greater competition, also was responsible for the largest period of telecommunications industry investment in U.S. history.
Comments at 90.   The only hint from Free Press that this period may not have been an unqualified success is when Free Press allows that, "[m]uch of this investment . . . was a bubble ...." Comments at 111. 

ebbers_nacchio_quote.jpg

Perceived Bandwidth Demand Drove CapEx.  Internet traffic grew at incredibly high rates in the second half of the 1990s, but the Internet was new to most people, and the subject of a lot of hype.  Thus, perceived Internet traffic growth not only outpaced actual Internet traffic growth, but it was also disproportionately affecting perceptions of total bandwidth demand.  But, where would people get these ideas?

Well, in a March 2000 report to Congress, then-FCC Chairman William Kennard stated,

Internet traffic is doubling every 100 days. The FCC's 'hands-off' policy towards the Internet has helped fuel this tremendous growth. 
(emphasis added).  Kennard's predecessor, Reed Hundt, would have none of this foolishness, and wanted people to know that "[i]n 1999 data traffic was doubling every 90 days." (emphasis added) ( Quote is from Hundt's self-congratulatory book, "You Say You Want a Revolution"at 224.)

Kennard_Hundt.jpg
The Reality.  Not everyone at the FCC was buying (or selling?) the hype.  A senior economist at the Commission, Douglas Galbi, published a paper the same year (2000), warning that total bandwidth demand was not as high as everyone seemed to think.

Growth of bandwidth in use for Internet traffic has been dramatic since 1995, but Internet bandwidth is only a small part of total bandwidth in use. . . .
(emphasis added).  Meanwhile, massive fiber deployments and innovations in optical transmission equipment meant that capacity was about to explode.  

The Reckoning. Only a year after Kennard's report to Congress, CNET reported that the U.S. was in the midst of a bandwidth glut, and that prices would likely decline much further.  
By summer 2001, the equipment companies issued clear warnings that the unraveling was well underway.  A few months later, the Enron scandal would break.  

Over the next year, what followed was the largest dislocation, in terms of job loss (500,000) and wealth destruction ($2 trillion) the telecom industry has ever seen.  See, e.g., this BusinessWeek article.  Law professor Dale Oesterle writes that the telecommunications industry in 2002 may have been the largest, most scandal-ridden, industrial meltdown in U.S. history.  Here at 1.

The Aftermath. After the telecom bubble burst, depressed Internet transport prices would continue well into the middle of the decade.  If you're wondering how low  

In 2006, Level 3 needed additional transatlantic capacity, so it purchased 600Gbps of lit capacity on another carrier's transatlantic fiber.  At the time of this purchase, though, Level 3 was carrying 480Gbps of traffic on its own transatlantic subsea cable system; a system that was scalable to 1.28Tbps.  In other words, Level 3 already owned unlit transatlantic capacity, but using its own fiber didn't make sense because wholesale prices had dropped below operational and replacement costs!

The Biggest Lie About Capital Investment

The central deception of Free Press's entire misleading capex narrative is, of course, the notion that the 2002 Cable Modem Order was the defining event for broadband Internet capital investment.  As explained above, the telecom bubble had little to do with Title II, and neither did the bust.  Moreover, broadband Internet services, in particular, benefited more from the bust (post Title I classification), than they did from the boom.

The cheap [below-cost] Internet bandwidth of the early/mid-2000s led to a lot of web application experimentation and new Internet companies.  Consumers responded quickly, and favorably, to the new, high bandwidth Internet applications, like Myspace. Xbox, and Youtube.    

This led to strong consumer broadband Internet adoption, which could not have been possible if the broadband ISPs had under-invested in their networks.  The FCC data show broadband Internet services increased by a factor of about 4.5 between 2002 and 2008; from 17 million customers in 2002 (see Table 3) vs. around 75 million telco and cable broadband customers in 2008 (see Table 1). 

Indeed, this 400-500% increase in demand for broadband Internet service compares favorably with total bandwidth demand growth of around 300% during last half of the 1990s. See Galbi at Table 2.  In fact, the success of the broadband Internet economy (Internet companies, backbones, metro fiber providers, and broadband ISPs) from 2002-2008 would finally end the bandwidth glut, and bring back demand for new "Title II" Internet transport capacity, including transatlantic capacity.

Free Press tries to prove that broadband ISPs are lying about their concerns with potential new, and undefined, rules under a Title II reclassification.  But, if the FCC is tempted to change its regime based on erroneous cause-effect propositions that ignore historical facts, then it would seem the broadband ISPs have every reason to fear the unintended effects that will accompany a new regulatory classification.













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 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.