Consequences of Treating Broadband as a Public Utility

The FCC is poised to vote on reclassifying broadband services as a common carrier, innocuously referred to as net neutrality regulations. From the outset, the net neutrality rules were unnecessary, did not address any apparent market failure, and protected companies instead of encouraging competition. While advocates for these regulations promised free, open and neutral internet, it is not clear what consumers would actually get from the deal. Instead, a host of studies showed that net neutrality regulations would eventually affect consumer welfare enhancing pricing, raise network costs, discourage investment, and affect quality and service differentiation.

No Market Failure to Justify Regulations

Years ago, the FCC touted a “hands off” approach to regulation, cited unprecedented growth, innovation and investment due, and stated “we can have openness and competition by allowing this market to develop unfettered by regulation.”  That approached seems to have worked.  While the industry can be characterized as having high fixed costs and economies of scale, the market performance of the industry points to extraordinary growth, increased competition, faster speeds and lower prices.  To date, the Bureau of Labor Statistics’ Consumer Price Index for Internet Services and Electronic Information Providers indicates that prices have fallen by half in real terms since 1998.   Meanwhile, broadband speeds have increased.

Based on SEC filings covering the latest three years of operations, the top 10 network service companies have invested over $165 billion. In addition, a study by Darby, Fuhr and Pociask found that network communications companies reinvested 64% of cash flow from operations, compared to 28% for edge companies. The study also found that network companies earned 14% of their cash flow as profits, while edge companies earn 49%. In other words, the broadening and deepening capital formation underway is occurring without extraordinary profits. As we have shown in past, the profits by Internet Service Providers have been generally below the average S&P 500. In other words, there is no evidence of market failure and, therefore, no economic justification for a regulatory remedy.

While the FCC may seek to impose net neutrality regulations, it has yet to identify exactly what market failures exist that these regulations would fix, nor has there been any empirical or cost/benefit analysis to demonstrate how consumers would benefit.  However, there have been numerous studies demonstrating that net neutrality regulation would, in fact, harm consumers.  This, in fact, was the conclusion of the United States Department of Justice in their September 2007 filing to the FCC:

 The FCC should be highly skeptical of calls to substitute special economic regulation of the Internet for free and open competition enforced by the antitrust laws. Marketplace restrictions proposed by some proponents of “net neutrality” could in fact prevent, rather than promote, optimal investment and innovation in the Internet, with significant negative effects for the economy and consumers.

 Regulations Make Consumers Pay More

The FCC has proposed rules would clearly prohibit ISPs from offering differentiated prices to applications and content providers, effectively banning multi-sided pricing. Multi-sided pricing exists when a platform brings together independent groups that value each other’s participation in the market. For instance, a newspaper (as the platform) brings together readers and advertisers — collecting subscription fees from readers and selling ad space to businesses. Hahn and Wallsten observed that banning multi-sided pricing (effectively setting the ISP price for content providers at zero) would lead to consumer welfare losses.

In a comprehensive study on this issue published in Media Law & Policy, Darby and Fuhr found that a ban on multi-sided pricing would require consumers to pay for all of the upgrades to the Internet, thereby increasing consumer prices and decreasing broadband demand – both of which would reduce network investment. The study estimated the present value of lost consumer welfare to be as much as $32 billion over 10 years, or about $285 per broadband household. In a piece written in the Journal of Competition Law and Economics, Sidak later evaluated and modified Darby’s figures and re-estimated the welfare losses to be in the range of $3.44 to $7.74 billion per year. In another study, Pociask found that restrictions on multi-sided market pricing would mean that consumers lose $69 billion in potential benefits over the next 10 years. We also know that preventing sponsored data agreements (zero pricing) also prevents a Pareto Improvement in consumer welfare and guarantees that consumers are worse off.

Net neutrality could also prevent ISPs from providing enhanced quality of service to unaffiliated content providers. Litan and Singer estimated that this would lead to billions of dollars of consumer welfare losses – including a $1.5 billion decrease in consumer welfare just for foreclosing enhanced quality of service offerings to online multi-player video game providers. In other words, net neutrality would prohibit voluntary commercial agreements with unaffiliated content providers – a practice that would keep consumers from getting lower broadband prices or more bandwidth, while making consumers pay for all of the investment and upgrade costs for the next generation network.

Net Neutrality Would Make the Network “Dumb” and Costly

The FCC says it would allow reasonable network management by ISPs, but how that is defined could make all of difference of whether consumers are adversely impacted by increased congestion, unwanted spam and malicious online attacks. Even requiring ISPs to provide public details on their network management techniques could provide hackers and others the information they need to circumvent network management techniques and protect online consumers.

Rules that effectively make the Internet a dumb pipe point will have adverse consequences for consumers, according to numerous studies. Litan and Singer cite one study’s estimates that an unmanaged network would cost as much as $466 per month. In another study, Ford, Koutsky and Spiwak found that a neutral network could cost consumers $300 to $400 more in costs per month than an “intelligent” network. Yukel, Ramankrishnam, Kalyanaraman, Houle and Sadhvani showed that an undifferentiated service network could require nearly twice the provisioning (and therefore twice the network costs) as a managed network.

Net Neutrality Would Raise Prices for Low-Income Consumers

Net neutrality restrictions on price discrimination could limit the ability of Internet Service Providers to offer significantly lower priced broadband services at slower speeds and service quality. The effect of this prohibition would be to average service speeds and quality across all consumers, and, accordingly, price. That averaging would benefit high-end consumers by potentially lowering their price, but it would raise prices for lower-end consumers. This point is echoed by Greg Moore in the Asbury Park Press, executive director of the National NAACP Voter Fund:

 The effects could be disastrous for low-income and minority communities, pricing them out of the broadband market by guaranteeing a free ride to companies such as Google and eBay while shifting costs for broadband expansion back to consumers. Although net neutrality activists claim to be protecting free speech, net neutrality regulations would effectively silence many minority voices, as low-income communities drop off the online landscape because they can’t afford the price of admission.

Since broadband services are price elastic and since consumers with lower incomes are apt to be more price sensitive than other online users, any restriction on price differentiation would lead some lower income consumers to drop their online service. One study by Pociask documents that limiting price differentiation would disproportionately harm lower income consumers:

 Net Neutrality regulations would also increase the price of broadband services, because it increases the cost of the network that provides those services. Because broadband services are very price sensitive, just a $5 increase in price could lead to a 15% drop in total broadband subscribership and a 60% decline in demand for lower-income, price sensitive consumers.

The late Dr. Frank Bowe, longtime distinguished professor for the Study of Disabilities at Hofstra University, wrote that net neutrality regulations would inhibit supportive technologies that can help millions of Americans with special needs. If Internet regulations prohibit ISPs from offering tailored services to customers, some unique network-based applications would never be developed to help the elderly and infirm. Dedicating bandwidth to integrated monitoring and interventions systems for chronically ill patients could be illegal, since it would require prioritizing medical needs over less critical information – like music downloads and other entertainment content. According to a study by Litan, accelerating broadband use – just for senior citizens and those with disabilities alone – will add $620 billion in economic benefits in the next 25 years. However, Litan sees the imposition of Internet regulations as a real threat to these benefits. One endocrinologist, Max E. Stachura, M.D., correctly summarized the problem with way:

 A telehealth provider could conceive a new application for monitoring or remote management and therapy, but a network neutrality framework could preclude the broadband provider from offering the necessary bandwidth configuration. The point is that it is impossible to know today the network requirements of tomorrow’s telemedicine. Policymakers would be unwise to lock in regulations that can only limit the flexibility of the broadband Internet.

Reclassifying Internet services from an “information service” to a “common carrier service” will open up these services to a whole array of new taxes. One article details six new taxes that will be hitting broadband providers and consumers. The result will guarantee that Internet service prices will increase. The FCC was warned about these tax implications and their effects on consumers, but some have chosen to ignore it and pretend that it won’t happen, but it will.

Conclusion: Public Utility Regulations Will Be Costly for Consumers

This essay has provided many examples of how net neutrality rules would impede investment and innovation, and would push costs to consumers – particularly, lower-income, those with special needs, low-end online users and others. To summarize, net neutrality regulations would do little to protect consumers, but it would have a substantial affect in limiting service and price differentiation. Specifically, net neutrality would prohibit two-sided pricing that would reduce consumer prices; it would limit service innovation like providing “broadband-on-demand” services, it would prevent data prioritization that would benefit consumers, and it would favor “one-size fits all” services in a market of differentiated demand.

In the absence of any clear market failure, policymakers need to be cautious about promulgating rules that create more costs than benefits.