Critical to this model, however, is the requirement that the firm
be a monopolist in the tying market.
Applied here, proponents of net neutrality typically suggest that the
local access market is not competitively supplied and that as a result
there is a threat that the access provider could foreclose the
complementary content market.
But although access providers have
some power to set price (that is, some market power), there is clear
evidence from marketplace that access providers lack significant power
over prices (that is, substantial market power or monopoly power).
Consider, for example, that the price of DSL service from Verizon has
decreased from $49.95 per month for 768 kbps download speed in
to $19.99 per month for the same download speed in 2007.
price of cable modem service, adjusted on a per Mbps basis, also has
declined significantly over the same time period.
With such substantial
price declines, it is not reasonable to conclude that access providers have
significant power to control access prices. Accordingly, a hypothetical
claim involving an access provider’s discriminatory pricing of QoS
would not likely withstand antitrust scrutiny.
Another indicator of substantial market power or monopoly power
is the ability to exclude rivals. But evidence of entry makes clear that this
market power test also fails. According to the latest broadband report
issued by the Federal Communications Commission (“FCC”), cable
modem providers, the most popular form of broadband access
79. See Dennis W. Carlton, A General Analysis of Exclusionary Conduct and Refusal to
Deal - Why Aspen and Kodak Are Misguided, 68 A
80. To explain his theory, Carlton used as an example the case of a monopoly resort
owner. Id. at 667-68. Guests at the resort, who are required to purchase all meals at the resort,
are fully exploited by the monopolist. But to the extent that the resort can hold unaffiliated
restaurants on the island below some minimum viable scale (condition 1) by requiring that
resort guests purchase all meals at the resort, those unaffiliated restaurants will be forced to
exit, and the island natives who did not demand a hotel room (condition 2) will be subjected to
a monopolist in the supply of meals. Notice how Carlton’s model requires that the firm be a
monopolist in the resort market, else the resort would not be able to hold unaffiliated
restaurants below some minimum viable scale because resort-goers who wanted to eat at those
restaurants could simply go and stay at another resort without the limitation.
81. See H.R. 5273, 109th Cong. § 2.8 (2006) (“The overwhelming majority of
residential consumers take broadband service from one of only two wireline providers,
namely, from the cable operator or the local telephone company.”).
82. Tom Spring, Verizon Joins Broadband Price Hike Parade, PCW
, May 2,
http://www22.verizon.com/ForHomeDSL/channels/dsl/packages/default.asp (last visited Feb.
84. Jim Hu, Comcast to Raise Broadband Speed, CNET N
, Jan. 16, 2005,
http://news.com.com/2100-1034_3-5537306.html. Comcast cable modem customers with
download speeds of 3 Mbps experienced an increase to 4 Mbps for no additional charge.
Comcast customers with download speeds of 4 Mbps experienced an increase to 6 Mbps for no
J. ON TELECOMM. & HIGH TECH. L.
technology, accounted for just 57.5 percent of all residential high-speed
lines in the United States as of December 2005, down from 63.2 percent
in December 2003.
Although these data are gathered at the national
level, they can be used to roughly characterize competition in a
representative or average local broadband market.
The rapid decline in
market share over a span of just two years implies that cable operators
lack the ability to exclude rivals and thereby lack substantial market
power. Cable providers lost share primarily to DSL providers, who
upgraded their networks and slashed prices. Other broadband access
methods are also growing, with satellite and wireless providers
accounting for over half-a-million broadband connections according to
the FCC’s survey.
Moreover, new access technologies, such as
Worldwide Interoperability for Microwave Access (“WiMAX”) and
broadband over powerline (“BPL”), emerged in the past few years to
challenge incumbent broadband providers. WiMax technology began to
develop in earnest in August 2006, when Sprint Nextel announced its
plans to develop and deploy the first fourth generation (“4G”) nationwide
broadband mobile network, which will use the mobile WiMAX
Working together with Intel, Motorola, and
Samsung, “Sprint Nextel will develop a nationwide network
infrastructure . . . that will support advanced wireless broadband services
for computing, portable multimedia, interactive and other consumer
“The Sprint Nextel 4G mobility network will use
the company’s extensive 2.5GHz spectrum holdings, which cover 85
percent of the households in the top 100 U.S. markets . . . .”
BPL, the FCC counted over 5,000 BPL lines as of December 2005
impressive number, considering the technology’s brief existence in the
Most importantly, proponents of net neutrality fail to grasp the
nexus that compelling content drives the demand for broadband access.
If real-time applications fail to emerge, then access providers will not be
able to sell faster and more expensive (such as fiber-to-the-home)
TATUS AS OF
31, 2005 tbl.2 (2006), available
at http://hraunfoss.fcc.gov/edocs_public/attachmatch/DOC-266596A1.pdf [hereinafter FCC
86. Of course, there are some local markets that are served by only one broadband
provider, in which case national shares are not a good measure of the degree of competition.
87. FCC High-Speed Services, supra note 85, at tbl.3.
88. Press Release, Sprint Nextel, Sprint Nextel Announces 4G Wireless Broadband
Initiative with Intel, Motorola and Samsung (Aug. 8, 2006), available at
91. FCC High-Speed Services, supra note 85, at tbl.6.
connections to end-users. And as we demonstrate below, even if access
providers were somehow convinced that their profits could be increased
through foreclosure, access providers lack the ability to induce
unaffiliated content providers to exit the industry or to operate at a less
2. Access Providers Lack the Ability to Foreclose
Unaffiliated Content Providers
Even if they wanted to, access providers cannot easily monopolize,
let alone effectively compete in, content markets. In this section, we
focus on the most likely content markets that access providers might
attempt to monopolize—namely, content markets that are currently
profitable to serve. Perhaps the most important submarket among the
profitable Internet content markets is the market for advertiser-supported
search engines. Other profitable submarkets include online payment
systems, online games, and video-sharing websites. It bears emphasis
that broadband access providers generally have not attempted to enter
any of these three Internet content submarkets. The current industry
leaders for search engines include Google, Yahoo!, Microsoft
(“MSN.com”), and IAC/Interactive (“Ask.com”). Google offers
advertisers AdWords, which places advertising links next to relevant
search results and charging for clicks and for keywords. Google also
offers AdSense, a system that places “sponsored” links on the web pages
of newspapers and other publishers that sign up to be part of Google’s
network. “AdWords and AdSense produced $6.1 billion in revenues for
Google [in 2005].”
Yahoo! entered this submarket by purchasing
Overture in 2003 for $1.6 billion.
Microsoft built adCenter, which
serves as the advertising system for searches on MSN.
As of June
2006, The Economist estimated Google’s market share in search at
roughly 50 percent.
Online search is characterized by high barriers to
entry: “[b]ut because barriers to entry in the search business are high—
the engineering talent is limited and data centres that can simultaneously
support millions of searches are expensive—most analysts think that the
four big search engines will stay ahead of the tiny ones.”
The fact that
America Online (“AOL”), once a leader in dial-up Internet access,
permanently outsourced its search technology to Google indicates that
barriers to entry in search can impede even established and well-funded
92. The Ultimate Marketing Machine, E
, July 8, 2006, at 61-62.
95. The Un-Google, E
, June 17, 2006, at 65.
J. ON TELECOMM. & HIGH TECH. L.
Likewise, Google’s stock price as of March 2007 in
excess of $450 per share (and resulting market capitalization in excess of
$140 billion) implies that the barriers to entry to search engines are not
These barriers to entry would extend to all
potential entrants in the search submarket, including access providers.
In addition to the high entry barriers in the content markets, local
access providers have no leverage over national (and in many cases,
international) content providers, further undermining the prospect of an
access provider monopolizing the content markets. At least one of the
authors has been cited for support of the proposition that Internet content
providers are vulnerable to vertical foreclosure strategies in the net
But this application of the theory of vertical
foreclosure assumes incorrectly that a content provider is offering
content that is particular to a given locality and therefore requires access
to a single broadband provider’s subscribers. The vast majority of
Internet content appeals to all U.S. residents, not just the residents of a
particular locality. Thus, the relevant geographic market for assessing
hypothetical foreclosure strategies in broadband is conservatively the
United States, and more realistically, the world. Because Comcast, the
largest broadband service provider in the United States, controls access
to only 23 percent of all broadband subscribers, Comcast lacks the ability
to induce a content provider from exiting the industry or even operating
at an inefficient scale.
The next largest providers are AT&T and
Verizon, each with roughly 14 percent of the U.S. market.
Moreover, the unique relationship between an unaffiliated Internet
content provider and an access provider is not conducive to foreclosure
97. AOL to Use Google Searches, W
, May 2, 2002, at E2.
Google,,http://finance.yahoo.com/q?s=GOOG (last visited Mar. 26, 2007).
99. See, e.g., Barbara van Schewick, Towards an Economic Framework for Network
Neutrality Regulation, 5 J.
. L. 329, 334 n.13 (2007) (citing
Daniel L. Rubinfeld & Hal J. Singer, Vertical Foreclosure in Broadband Access?, 49 J.I
TATUS AS OF
30, 2006 tbl.2 (2007) (providing total
broadband subscribers), available at http://hraunfoss.fcc.gov/edocs_public/attachmatch/DOC-
ILOTTI ET AL
(2006) (providing Comcast’s subscribers for year
101. Press Release, Verizon Investor Relations, Verizon’s 4Q 2006 Results Cap Strong
Year of Organic Growth in Wireless, Broadband and Business Markets (Jan. 29, 2007),
available at http://investor.verizon.com/news/view.aspx?NewsID=813; AT&T I
strategies. With a few exceptions (such as ESPN360), Internet content is
not acquired by access providers at a certain cost per subscriber per
month, as is the case with traditional video programming. Setting aside
the seldom used leased access rules, unaffiliated video content providers
cannot reach a video distributor’s customers unless the distributor has
acquired the content from that content provider. By contrast, unaffiliated
Internet content providers do not need to reach an agreement with a
broadband access provider to reach that access provider’s broadband
customers. Hence, access providers and unaffiliated content providers are
not likely to get into a carriage dispute arising over price or affiliation.
Although such disputes are common in the video programming industry,
and Congress has given the FCC powers to prevent discriminatory
because Internet content providers do not depend on access
providers to reach end-users in the same way that video programmers
depend on cable or DBS providers, video programming is the wrong
framework for analyzing discriminatory strategies in Internet content
markets. Even if an access provider were to refuse to supply enhanced
QoS to an unaffiliated content provider, the only content providers that
could be affected would be real-time content providers. But even here,
the refusal to supply enhanced QoS would have to be coordinated across
multiple access providers to have any meaningful foreclosure effect.
Internet content markets are inherently national in scope. Thus, a content
provider does not depend on a single local access provider to achieve
critical economies of scale. (Contrast this with localized content in
traditional video markets, such as sports programming, that depends on a
handful of downstream providers to reach critical scale.) Without such
coordination among broadband access providers, the foreclosed content
provider could still achieve its efficiencies from the customers of other
Given the barriers to entry in the Internet content market, the caliber
of the firms that currently supply Internet content (which implies that
foreclosure would be very costly), and the unique relationship between
Internet content providers and access providers, it is difficult to conceive
how an access provider could leverage its alleged power in broadband
access into the content market by imposing a surcharge on content
providers for enhanced QoS. The last time an Internet service provider
(“ISP”) with downstream market power (in this case, dial-up Internet
access) tried to build a “walled garden” to leverage its customer base into
the upstream content market it met with unmitigated disaster.
102. See 47 U.S.C. § 536 (a) (2000).
103. Wikipedia, AOL, http://en.wikipedia.org/wiki/AOL (last visited Feb. 13, 2007)
(“[AOL] has since attempted to reposition itself as a content provider similar to companies
such as Yahoo! as opposed to an Internet service provider which delivered content only to
J. ON TELECOMM. & HIGH TECH. L.
fair, AOL’s attempt to extend it power into the content market was not
helped by the ubiquitous deployment and adoption of broadband
technologies, which rendered unaffiliated ISPs less valuable.
before the advent of broadband, AOL failed to extend its considerable
market power in dial-up Internet access into content markets. There is no
reason to expect a different outcome for broadband access providers. In
summary, access providers lack the incentive and ability to foreclose
unaffiliated content providers. Tiered QoS offerings cannot be motivated
by anticompetitive reasons.
ISCRIMINATION IN THE
In this section, we provide a non-technical discussion of how
consumer welfare could be decreased by access providers’ attempt to
comply with the non-discrimination provisions of the net neutrality
proposals. A technical analysis of the welfare reduction is provided in
sections A and B. Readers who are not technically inclined can
understand the mechanism by which consumers would be harmed in
what immediately follows.
Consumers voluntarily purchase enhanced QoS because the value
created through this feature exceeds the incremental price. The difference
between a customer’s willingness to pay for a feature and its price is
called consumer surplus. Consumer welfare is the sum of the surplus
across all consumers in the market. In this section, we examine the
consumer welfare effects that would flow from an access provider’s
likely response if required to comply with the non-discrimination
provisions in the net neutrality proposals. As explained earlier, online
video games, streaming multimedia, VoIP, video teleconferencing, alarm
signaling, and safety-critical applications such as remote surgery may
require some level of QoS. For ease of exposition, we focus on the
consumer welfare effects for one of the most popular QoS-needy
applications—online gaming. The same analysis could be applied to any
other QoS-needy application.
We consider the consumer welfare effects of an access provider’s
attempts to comply with the non-discrimination provisions relating to
QoS under two scenarios. In the first scenario, access providers attempt
to comply with the non-discrimination provision by (1) withdrawing
their enhanced QoS offerings entirely and (2) relying entirely on
subscribers in what was termed a ‘walled garden.’”).
104. See, e.g., Robert W. Crandall & Hal J. Singer, Life Support for Unaffiliated ISPs?,
bandwidth to accommodate the growth in demand for Internet traffic.
This scenario assumes that an access provider could not embed the price
of some “blended” QoS in a complementary product purchased by the
content provider (the basis of the second scenario). By withdrawing
enhanced QoS from the marketplace, many QoS-needy applications
would not function properly, and thus the demand for those products
(and the consumer welfare associated with enjoying those products)
would disappear. In the extreme case, the demand for such applications
would either disappear entirely or fail to develop. As explained above,
the proposals define a broadband network provider so broadly that they
could limit QoS offerings at positive prices by non-network QoS
suppliers such as Akamai. Even if some non-network QoS suppliers were
immune from the regulation, the demand for QoS-needy applications
would still shift inwards to the extent that network suppliers can offer
some level of QoS beyond that offered by non-network suppliers or the
price of enhanced QoS would increase to monopoly levels or both.
The effect would be to largely eliminate any welfare that is currently
enjoyed by customers of QoS-needy applications.
Next, by relying entirely on an unmanaged network, the monthly
cost per subscriber would rise to levels that could not be sustained in the
marketplace. If the cost per subscriber of an unmanaged network were to
increase to $47 per month, then the monthly subscription fee would need
to increase even further, thereby inducing a significant portion of
broadband customers to disconnect from the Internet or seek less costly
alternatives. Based on estimates of the elasticity of demand for
broadband access, we attempt to estimate the percentage of existing
broadband subscribers who would disconnect their services in response
to such a price increase.
In the second scenario, we posit that access providers would attempt
to comply with the non-discrimination provisions by offering a blended,
one-size-fits-all QoS offering to all content providers. Because access
providers could not explicitly charge for QoS, they would likely provide
a blended level of QoS that came standard alongside a (slightly more
expensive) purchase of Internet access or hosting products—that is, an
access provider would embed the price of blended QoS in some
complementary product. But a uniform level of QoS—even at a lower
price—would harm QoS-needy content providers such as Sony and
Blizzard by depriving them of the QoS needed to make their applications
function properly. Even worse, a blended QoS would harm the vast
majority of content providers that have no demand for QoS but would
105. With enhanced QoS capabilities at both the access level and the backbone level,
however, an access provider could set its content distribution service apart from Akamai’s
J. ON TELECOMM. & HIGH TECH. L.
now be forced to pay for it. The theoretical underpinnings of such a
reaction (and the resulting reduction in consumer welfare) have been
recently provided by Professors Michael Katz and Benjamin E. Hermalin
of the University of California at Berkeley.
In particular, they examine
the effects of product-line restrictions in a duopoly (a market supplied by
They demonstrate that a restriction of the number of
products that each firm can offer (applied here, the levels of QoS that can
be associated with access or hosting service) may lead firms to choose
the same quality of service (high or low), or it may lead them to choose
non-overlapping products (high and low) where they would otherwise
have engaged in head-to-head competition across all product variants.
They show that the resulting loss of competition can harm both
consumers and economic efficiency,
and provide the following
[t]here are two mechanisms through which a single-product
restriction harms welfare in our duopoly model. In the unrestricted
equilibrium, both firms offer both products. In the restricted
equilibrium, the firms sometimes offer identical products and
sometimes offer vertically differentiated products. When the firms
offer identical products, the single-product restriction reduces welfare
by eliminating what would have been efficient variety. When the
firms offer vertically differentiated products the loss of direct
competition leads to inefficient reductions in consumption levels.
Consequently, both consumer and total surplus fall.
In summary, total surplus is higher when the two firms compete without
a single-product restriction than under three plausible outcomes (each
firm chooses high quality, each firm chooses low quality, or one firm
chooses high and the other choose low) with a single-product restriction.
The section concludes with a non-technical discussion of the effect
of a non-discrimination provision on a content provider’s incentive to
innovate and on an access provider’s incentive to deploy next-generation
broadband networks. We discuss the implications of such competitive
responses on our nation’s leadership in the broadband industry.
106. Benjamin E. Hermalin & Michael L. Katz, The Economics of Product-Line
Restrictions With an Application to the Network Neutrality Debate (Inst. of Bus. & Econ.
Research Competition Policy Center, Working Paper No. CPC06-059, 2006), available at
107. Id. at 24-28.
108. Id. at 28-33.
109. Id. at 33-34.
110. Id. at 35.
A. Consumer Welfare Effects: An Access Provider Would be
Forced to Withdraw or Standardize Its Tiered QoS Offerings
We posit that an access provider would attempt to comply with a
non-discrimination provision in the supply of QoS by either withdrawing
its enhanced QoS offering from the marketplace or by replacing its tiered
QoS offerings with a one-size-fits-all or “blended” QoS offering. Under
either scenario, consumer welfare associated with the purchase of
enhanced QoS would be largely eliminated. To make our analysis
concrete, we consider the demand for enhanced QoS by content
providers that supply online multiplayer video games. A similar analysis
could be performed for other content providers.
1. Consumer Losses Associated with Withdrawal of Current
Tiered QoS Offerings
The net neutrality proposals in Congress would effectively establish
a market price of zero for enhanced QoS. To the extent that QoS can be
considered a standalone product offering (that is, a complementary
offering to hosting and access), one can analyze an access provider’s
decision to offer QoS under the standard shut-down decision in
economics. According to the Markey bill, if an access provider gives
priority or offers enhanced QoS “to data of a particular type, [then it
must] prioritize or offer enhanced quality of service to all data of that
type (regardless of the origin of such data) without imposing a surcharge
or other consideration for such prioritization or quality of service.”
Content providers that did not yet contract for QoS could demand free
QoS from access providers. Although the provision would not nullify
existing contracts for QoS between access providers and content
providers, a content provider that previously contracted for QoS would
likely demand to renegotiate its terms after learning that its rivals were
getting the same QoS for free. The classic shut-down decision in
economics is to withdraw from supplying a service if the price is less
than the average variable cost of supplying that service.
above, the average variable cost of providing QoS is the opportunity cost
of carrying a given traffic stream and thus exceeds zero.
Hence, it is
111. H.R. 5273, 109th Cong. § 4(a)(7) (2006) (emphasis added).
113. These costs have been quantified. See Qiong Wang, Jon M. Peha & Marvin A.
Sirbu, Optimal Pricing for Integrated Services Networks, in I
(Joseph P. Bailey & Lee W. McKnight eds., 1997). See also Hermalin & Katz, supra note 106,
at 19 (“Some participants in the network neutrality debate have argued that increased quality is
essentially costless, at least up to some point. We doubt the empirical validity of this
J. ON TELECOMM. & HIGH TECH. L.
reasonable to assume that an access provider would withdraw its QoS
offering from the market entirely to comply with the non-discrimination
Demand for Online Game
with High QoS
With High QoS
U.S. Online Game
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