Strong versus Weak Net Neutrality

Yesterday, Netflix’s Reed Hastings came out strongly in favour of ‘strong’ net neutrality in a blog post:

The essence of net neutrality is that ISPs such as AT&T and Comcast don’t restrict, influence or otherwise meddle with the choices consumers make. The traditional form of net neutrality which was recently overturned by a Verizon lawsuit is important, but insufficient.

This weak net neutrality isn’t enough to protect an open, competitive Internet; a stronger form of net neutrality is required. Strong net neutrality additionally prevents ISPs from charging a toll for interconnection to services like Netflix, YouTube, or Skype, or intermediaries such as Cogent, Akamai or Level 3, to deliver the services and data requested by ISP residential subscribers. Instead, they must provide sufficient access to their network without charge.

Of course, this distinction between strong and weak net neutrality is precisely the same as the distinction I made in my post (and paper) the other week. My model demonstrated that weak net neutrality does not actually achieve anything compared with no regulation at all because there are enough free prices for an ISP with market power (and maybe one without market power) to adjust and manipulate behaviour to extract rents. Strong net neutrality takes away those free prices and, in the process, shifts rents from ISPs to content creators (like Netflix). I have no idea if Hastings read my previous post but the notions of strong and weak net neutrality are identical and I agree with his conclusions.

But there is another aspect to this issue hanging out there and that is download caps. Download caps are restrictions on the amount of internet usage a consumer can have over, say, a month. For much of its history the US has been free of such caps and, indeed, was free of them until 2010 or so for mobile broadband as well. But now those caps have appeared, especially on mobile.

The rationale for download caps is the management of bandwidth. But, in reality, bandwidth constraints exist on a time of day basis whereas download caps are pricing monthly usage. If consumers’ most valuable usage is in peak times, download caps can actually exacerbate network congestion rather than alleviate it. Thus, that rationale does not really stack up as a clear motive.

What is clearer is that download caps are a form of price discrimination (charging more to those who use the internet more intensely). A good example of such users are Netflix subscribers. The effect of this has been outlined in a recent paper by Economides and Hermalin.

In the absence of a download cap, consumers can choose content freely thinking just about the price of subscribing to that content (if any). A cap makes them trade off seemingly unrelated content for one another and so content providers are substitutes in the eyes of consumers. So there is now competition between otherwise unrelated content providers meaning that they either lower prices or have to invest more to attract consumers. From this perspective, there is an upside to consumers from download caps but is an ISP has market power, that upside can be captured by them in the form of higher fees. Basically, a cap means that profits are transferred from content providers to ISPs.

Of course, ISPs can effect this transfer another way — namely, by charging content providers directly. This is cleaner and simpler than a cap and, Economides and Hermalin show, probably more profitable as well. Alternatively, a content provider could do a deal with an ISP for data to be ‘under the cap.’ This is what AT&T suggested recently in the form of ‘sponsored data.’ However, this is just another rent transfer mechanism and, moreover, it is made easier to ‘sell’ when the ISPs have download caps on their consumers.

All this interacts with net neutrality rules. Download caps make strong net neutrality less of an issue for ISPs but, conversely, having strong net neutrality makes download caps a more attractive mechanism for price discrimination. Thus, from the perspective of Netflix, it is not just strong net neutrality that they want but also download caps that are based on competitive rather than market power outcomes.

To this end, recently, Wikipedia has come to some arrangements with mobile carriers in Africa and Asia for Wikipedia Zero (that is, free data access to Wikipedia). While this isn’t sponsored data, I would be remiss to point out that this is a violation of strong net neutrality. Just because it happens to come from a content provider that has laudable social goals doesn’t make it any less so.