Network Neutrality and Innovation

1. Network Neutrality and Innovation Johannes M. Bauer Quello Center, Michigan State University 3rd Transatlantic Forum, Montpellier, France November 14, 2007

2. Plan of presentation • Background • A simplified model • Comparative analysis • Implications

3. NGN value system • High investment costs of network upgrades in combination with new value system of NGN • Elimination of broadband unbundling and common carriage obligations (2003-2005) • Partisan claims by all stakeholders (incumbents, new competitors, advocacy groups) • Few cases of concern (Intertainer, Madison River, Comcast) • Continuing policy initiatives (FCC Openness Principles, pending legislation)

4. FCC Policy Statement “To encourage broadband deployment and preserve and promote the open and interconnected nature of the public Internet, consumers are entitled to • access the lawful Internet content of their choice • run applications and use services of their choice, subject to the needs of law enforcement • connect their choice of legal devices that do not harm the network • competition among network providers, application and service providers, and content providers.” FCC Policy Statement, August 5, 2005

5. Legislative actions (as of 11/12/07)

6. Core problem • Investment and innovation in vertically related markets • Platforms, applications/services, content • Entry barriers, concentration at each layer • Asymmetric conditions to vertically integrate • How will alternative governance arrangements affect performance? • Static and dynamic efficiency • Other goals (e.g., freedom of speech)

7. Governance arrangements • No specific net neutrality rules (private contracts, ex post and ex ante antitrust supervision) • Non-discrimination rules, e.g. • Most-favored nation obligation (e.g. for transit) • Obligation to offer same/similar services to all requesting third parties • Structural or functional separation • Detailed regulation of prices and conditions

8. P, CA, and Adv maximize π Cons maximize U Multiple, dynamic interdependencies Network neutrality rules interact with this dynamic system Simplified revenue streams Adv Content, Applications scs fc TR TR ap ac fp Platforms sa Cons sps sa ... subscriber access prices to P sps ... subscriber service price to P scs ... subscriber service price to C/A fc, fp … advertising fees to C/A, P ap, ac .. platform/content access price TR … transaction costs

9. IP, ICA Opportunities (+) Appropriability Concentration (+) Contestability (-) Firm capabilities (+) Interdependencies P  CA, CA  P Complementarity (+) Transaction costs (-) Adaptation costs (-) Innovation processes A CA scs fc - + TR, A θ, φ ap ac fp P sa C + - sps Simplified innovation system TR …Transaction costs A … Adaptation costs θ, φ … Complementarity coefficients

10. Innovation incentives • Innovation activity at platform layer • Innovation opportunities (+) • Appropriability conditions (+) • Innovation rate at content/application layer (+) • Transaction costs (─) • Innovation rate at content/application layer • Innovation opportunities (+) • Appropriability conditions (+) • Innovation rate at platform layer (+) • Transaction costs (─)

11. No neutrality rules • Platform monopoly • Complements: monopolist will cooperate with CA but will try to appropriate CA innovation rents ex post • Substitutes: monopolist will have strong incentive to compete aggressively • Both strategies will increase innovation at P, but lower innovation at CA layer • Platform rivalry • Ability of Pi to appropriate CA rents reduced: platform innovation ↓, content/application innovation ↑ • Transaction costs (contract, enforcement) will likely increase, reducing innovation incentives at both levels

12. Non-discrimination rules • Compared to no regulation scenario • Complements • Set of possible actions available to P to appropriate innovation rents of CA is constrained (ICA↑, IP ↓) • Transaction costs of CA are lowered (ICA↑) • If rules allow tiering, access-dependent forms of innovation at CA may be facilitated but access-independent forms of innovation may be weakened • Substitutes • P has incentive to compete aggressively (ICA↓, IP ↑) • P may have an incentive to sabotage if/where it cannot compete aggressively • Many overall outcomes possible

13. Concluding points • Alternative specification of neutrality regimes result in different overall innovation dynamic • Most proponents and opponents in the current debate describe special cases • Many trade-offs and feedbacks shed doubt on whether an “optimal” set of network neutrality rules could be identified ex ante • Competition at the platform level eases some but not all of the possible problems • Additional institutional diversity is desirable • Cautious policy approach best course forward

14. Contact Johannes M. Bauer Professor, Telecommunication, Information Studies, and Media Co-Director, Quello Center for Telecommunication Management and Law Michigan State University East Lansing, Michigan 48824, USA bauerj@msu.edu, +1-517-432-8003

15. Value system of NGN Content, Applications Future locus of value-added? Past locus of value-added Physical Sources: Clark 2002 and National Academy of Sciences 1994

16. Arguments against neutrality • Contributions from content and applications providers needed to recover investment cost • Differentiated service/price tiers will • allow content and application service providers to configure higher-quality services • help manage congestion caused by bandwidth-intensive applications (e.g., BitTorrent) • Differentiation is a precondition of innovation • Net neutrality requirements will inevitably lead to intrusive and detailed, old style regulation

17. Arguments for neutrality • Network layer discrimination slows innovation at the application/content layer and in the economy • A non-neutral network could • lead to tipping in favor of inferior applications • lock in existing and delay migration to new usages • Vertically integrated platform owners have incentives to disadvantage competitors • Neutrality continues end-to-end design principles that have enabled the Internet • Free speech and democracy require neutrality

18. Historical experience • Dial-up Internet • Developed faster and is more diverse in countries with more open platforms • Incremental infrastructure investment needs • Challenge of finding sustainable business models for content and applications • Mobile Internet • Most successful examples i-mode®, Nate® • Proprietary, differentiated platforms • Voluntary collaboration with complementors • Europe, US collaboration relatively limited