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NET NEUTRALITY WITH COMPETING INTERNET platforms

Transcript of Net Neutrality WNET NEUTRALITY WITH COMPETING INTERNET platformsith Competing Internet Platforms

  • NET NEUTRALITY WITH COMPETING INTERNETPLATFORMS*

    MARC BOURREAU

    FRAGO KOURANDI

    TOMMASO VALLETTI

    We propose a two-sided model with two competing Internet platforms,and a continuum of Content Providers (CPs). We study the effect of anet neutrality regulation on capacity investments in the market forInternet access, and on innovation in the market for content. Under thealternative discriminatory regime, platforms charge a priority fee tothose CPs which are willing to deliver their content on a fast lane. Wefind that under discrimination, investments in broadband capacity andcontent innovation are both higher than under net neutrality. Totalwelfare increases, though the discriminatory regime is not always ben-eficial to the platforms as it can intensify competition for subscribers.As platforms have a unilateral incentive to switch to the discriminatoryregime, a prisoners dilemma can arise. We also consider the possibilityof sabotage, and show that it can only emerge, with adverse welfareeffects, under discrimination.

    I. INTRODUCTION

    SHOULD WE CONTINUE TO TREAT all types of Internet traffic equally, that is,with no discrimination with respect to the type of content, service orapplication and the identity of the data transmitter, or should we insteadallow Internet platforms (Internet Service Providers, ISPs) to discriminatethe traffic they carry? This question over the net neutrality has generatedhot discussions since the Federal Communications Commission (FCC)changed the classification of Internet transmissions from the category of

    *We thank Bruno Jullien, Micha Grajek, Jan Krmer, Andre Veiga, and the participantsat the Conference on the Economics of ICT (Paris, 2012), the International Conference onManagement and Economics of ICT (Munich, 2012), the Workshop on the Economics ofICTs (Oporto, 2012), CRESSE (Crete, 2012), CRETE (Milos, 2012), and EARIE (Rome,2012). We acknowledge funding from the Orange Innovation and Regulation Chair atTelecom ParisTech/Ecole Polytechnique.

    Authors affiliations: Telecom ParisTech, Department of Economics and Social Sciences,Paris, France and CREST-LEI.e-mail: marc.bourreau@telecom-paristech.fr

    Athens University of Economics and Business, Department of Economics, Athens,Greece.e-mail: kourandi@aueb.gr

    Imperial College London, London, England; University of Rome II and CEPR.e-mail: t.valletti@imperial.ac.uk

    THE JOURNAL OF INDUSTRIAL ECONOMICS 0022-1821Volume LXIII March 2015 No. 1

    2015 The Editorial Board of The Journal of Industrial Economics and John Wiley & Sons Ltd

    30

  • telecommunications services to the category of information services inthe U.S. in 2005, making ISPs no longer explicitly subject to the principleof net neutrality.

    This debate has been exacerbated by the fact that, over the last few years,the volume of Internet traffic has grown drastically, requiring ISPs toupgrade their network capacity. In 2005, AT&T, later followed by othermajor telephone and cable operators, proposed to charge content providers(CPs) premium prices for preferential access to broadband transmissionservices. Comcast, the largest cable operator in the U.S., was also accusedof interfering with users access to file-sharing services such as BitTorrent.There have been other cases reported in the popular press of ISPs blockingor degrading the quality of content. ISPs argue that these practices arenecessary to manage Internet traffic efficiently and ensure a sufficientquality of service, especially for content, services and applications that arevery sensitive to delays, such as VoIP services or video conferencing.However, even if this view seems now widely accepted, which trafficmanagement techniques will be allowed is still discussed. In particular,policy-makers argue that it is crucial to prevent ISPs from adopting dis-criminatory practices for reasons unrelated to traffic management.1

    The net neutrality issue turns out to be highly contested among policy-makers and industry players. Opponents to net neutrality argue that a netneutrality regulation would reduce ISPs incentives to invest in broadbandcapacity, and lead to less entry of CPs.2 Proponents of net neutrality, onthe other hand, contend that the Internet has been neutral since its incep-tion, and should be kept free and open to everyone. They further argue thata departure from the net neutrality regime would reduce innovation inInternet services (entry of CPs),3 and that ISPs will continue to invest inbroadband capacities whatever the traffic regime, since this is the only wayto keep their demand high. Finally, end users are concerned about thesubscription fees that they pay to ISPs, the variety of Internet content, andthe quality of their Internet connection. The aim of this paper is to proposea formal analysis of the impact of a transition from the net neutralityregime to a discriminatory regime, in a model with competing ISPs and acontinuum of heterogeneous CPs.

    It has indeed been argued that spurring competition between ISPs cansolve the net neutrality problem, making a discriminatory regime less

    1 On September 23, 2011, the FCC released an Order on Preserving the Open Internet(FCC 10-201, In the Matter of Preserving the Open Internet, Broadband Industry Practices),where it adopts three basic protections: transparency, no blocking, and no unreasonablediscrimination. This is currently challenged in courts. Some countries have adopted non-binding guidelines on net neutrality, such as Norway and Canada, while Chile was the firstcountry to address directly the principle of net neutrality in its legislation (Holland was thesecond).

    2 See, for example, Yoo [2005].3 See Van Schewick [2006].

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    2015 The Editorial Board of The Journal of Industrial Economics and John Wiley & Sons Ltd

  • threatening (in terms of blocking, sabotage, etc.) to the extent that ISPsrace against each other.4 For example, the European Commission statedthat the significance of the types of problems arising in the net-neutralitydebate is correlated to the degree of competition existing in the market.5 Inthe U.S., the FCC exempted mobile networks from most of the net neu-trality rules,6 on the grounds that they face stronger capacity constraintsthan fixed networks, and that competition warrants net neutrality or atleast mitigates the negative effects of a departure from it.7

    Despite its apparent relevance in the policy context, the competitionaspect has been overlooked by the literature, as most papers assume amonopolistic market structure at the ISP level. Though it is always benefi-cial for a monopolist ISP to depart from the net neutrality regime, since itcan extract part of the CPs revenues by charging them for priority and stillserve all end users, it is less clear that a switch to the discriminatory regimewould benefit competing ISPs. Moreover, in a monopolistic framework,consumer surplus is not affected by a departure from net neutrality if theISP can fully extract the surplus from the consumption of content and theconsumer market is fully covered. As the ISP additionally extracts part ofthe CPs profits under discrimination, a departure from net neutrality thenmechanically increases welfare when it is profitable for the ISP, as the ISPinternalizes total welfare more. An important question is whether this isstill true when there is competition between Internet platforms.

    We build a two-sided model where two horizontally differentiated Inter-net platforms compete to bring together the two sides of the Internet, theCPs and the end users. We then compare the pricing, investment andinnovation incentives under the net neutrality and the discriminatoryregimes. Innovation in services takes place when CPs enter the market andoffer advertising-supported content to end users. CPs are heterogeneouswith respect to their congestion sensitivity and may single-home, multi-home, or stay out of the market. For the most congestion-sensitive CPs (e.g.,those who offer streaming or VoIP applications) delays in data transmis-sions are harmful, since such delays make end users less likely to clickon ads, and hence, reduce advertising revenues. By contrast, the less

    4 See, e.g., Becker et al. [2010].5 Communication from the Commission to the European Parliament on 19 April 2011.6 In particular, the rules allow mobile operators to discriminate or to block specific appli-

    cations. However, mobile networks have the same obligation as fixed networks to publiclydisclose their network management practices (transparency rule). See Maxwell and Brenner[2012] for a comparison of the net neutrality rules for fixed and mobile networks in the U.S.and in Europe. Choi et al. [2013] show that net neutrality rules may be harmful when thenetwork capacity is highly limited (as on mobile broadband networks), because it hindersentry from highly congestion-sensitive CPs.

    7 In its Order, the FCC explains the different rules for fixed and mobile networks by statingin particular that most consumers have more choices for mobile broadband than for fixed(particularly fixed wireline) broadband (paragraph 95).

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    2015 The Editorial Board of The Journal of Industrial Economics and John Wiley & Sons Ltd

  • congestion-sensitive CPs (e.g., those who supply e-mail account services)are hardly affected by congestion. Under net neutrality, CPs that areconnected to the same ISP are treated equally, and experience the same levelof congestion. Under discrimination, by contrast, ISPs offer two differen-tiated traffic lanes to CPs, a priority (fast) lane and a non-priority (slow)lane. CPs have to pay a priority fee to their ISP to access the fast lane, whilethe slow lane remains free-of-charge. Finally, end userswho