Proposed Regulations Pose Threat to Internet

Before the

Federal Communications Commission

Washington, D.C. 20554

 

 

In the Matter of                                              )

                                                                        )

Preserving the Open Internet                       )           GN Docket No. 09-191

                                                                        )

Broadband Industry Practices                      )           WC Docket No. 07-52

 

 

 

Comments Of

 

Wayne Brough Chief Economist, FreedomWorks Foundation

James Gattuso, Senior Fellow in Regulatory Policy, The Heritage Foundation

Hance Haney, Senior Fellow, The Discovery Institute

Ryan Radia, Associate Director of Technology Studies, Competitive Enterprise Institute

James G. Lakely, Co-director, Center on the Digital Economy, The Heartland Institute

 

 

 

           

            In accordance with the public notice issued by the Commission on October 22, 2009, we respectfully submit these joint comments regarding the Notice of Proposed Rulemaking issued in the above dockets.   We wish to express our grave concern about these new rules, which we believe are unnecessary and threaten to harm both the Internet and consumers.   Specifically, we address four primary issues:  the critical and changing nature of network management, competition in broadband marketplace, possible harm from the proposed limits on transparency, and the lack of statutory jurisdiction for Commission action in this area.

 

 

Innovative Network Management Requires Flexibility, Not Regulation

 

As noted in the NPRM, the proposed rules for an open Internet raise “important questions” with respect to network management.  Indeed, critical decisions about the structure and development of the Internet may become encumbered with regulatory oversight should the proposed rules be codified.  As is becoming increasingly evident with the introduction of more bandwidth-intensive content and applications, scarcity does exist within the networks that provide Internet access.  With an increasing number of subscribers coming online (and the stated policy goal of accelerating this expansion), broadband providers must adapt standards and practices to address this binding constraint.  This requires the flexibility to innovate to ensure that existing resources are being used as efficiently as possible.  

 

As the Internet has become more ubiquitous, how it is being used is also changing, making concerns over network management even more important.  The shift from email to BitTorrent has put new strains on the Internet that will only increase as more users and more bandwidth-intensive applications become available.  One recent study found that BitTorrent, a peer-to-peer network application, was already responsible for more than 30 percent of Internet traffic by the end of 2004.  Overall, peer-to-peer traffic is currently responsible for more than 60 percent of Internet traffic and poses real concerns for Internet service providers, and can affect service quality for all subscribers.^[1]  Internet telephony and IPTV are a growing segment of Internet traffic and — as many have noted — the amount of data being moved across the Internet raises significant concerns over carrying capacity.

 

The transformation that has occurred on the Internet has generated new challenges.  The emails and file transfers in the early years did not create the latency and jitter (delays and problems in the data at the end of the pipe) that today’s content and applications can generate.  The shift from text files to streaming video and Internet telephony has highlighted the importance of quality of service, in both the technical and in the layman’s sense.  As one commenter wrote:

 

“As originally envisaged, the Internet was not designed for services with real time requirements…. [A]s opposed to the traditional telephone network’s use of switched circuits that are opened for the duration of a telephone conversation, the Internet uses datagrams that may have other datagrams just in front and behind that belong to different communication sources and are destined to terminate on a different host.”^[2] 

 

            Moving forward, then, two tasks are required to create the networked world of the future.  First, broadband providers must continue to invest in the fundamental infrastructure of the Internet.  Doing so requires investors to allocate billions of dollars to extend networks to reach rural and other customers. 

 

            In addition, there is also a growing need for improved network management.  Bandwidth-intensive applications and content that place new strains on the Internet threaten to diminish the benefits for everyone.  Not only is more bandwidth required, but that bandwidth must be managed more efficiently.  New technologies for traffic shaping and deep packet inspection provide new management tools for the Internet, allowing broadband providers to more efficiently allocate network resources.                The proposed rules, however, constrain the development of new mechanisms for better network management.  Instead, they propose to regulate access, something that may limit innovation.  By codifying principles of neutrality based on the “end-to-end” view of the Internet, they would effectively freeze the internet’s development at a stage that may be inappropriate for future use patterns.

 

             New net neutrality requirements would generate a typical commons problem.  That is, whenever prices are set too low, there is a predictable outcome.  Economics and history tell us that a good whose price is set below a market-clearing level will lead to a shortage in which the quantity demanded will exceed the quantity supplied.  By banning tiered pricing and packet prioritization, net neutrality rules would lead to a world of congestion.  As in any situation with an under-priced good, there is little, if any, incentive to innovate, expand, or upgrade.

 

            This is especially true when examining the emerging applications such as IPTV, gaming, telephony, distance learning, and medical technologies, all of which require more data to be moved with greater levels of effort to ensure quality of service.  And it is not as if these applications are replacing many of standard uses of the Internet, such as email and file sharing.  These activities remain popular and will actually expand as broadband deployment brings more people online.  The new applications and social networking under development are an expansion on top of the existing uses of the Internet, requiring even more data to be delivered to an expanding set of applications and increasing number of users.

 

By contrast, Christopher Yoo suggests that network differentiation, rather than network neutrality, may be the best approach to increasing consumer welfare.^[3]  Already, retailers, content providers, and applications developers are experimenting on the web, pushing technology to its limits.  Just as significantly, they are also experimenting with pricing for content and applications—much of which would be challenged by the stated principles of net neutrality.

            At the same time, a more dynamic Internet creates more opportunities for entrepreneurs.  A faster and more agile Internet paves the way for more powerful applications and a larger audience.  It must be remembered that those upgrading the Internet can only generate profits by providing a product that consumers are willing to purchase.  Investments in the future of the Internet are not made to deter consumers; rather, expanded deployment and better traffic management are efforts to bring more consumers online.  This encourages more participation by consumers and more opportunities for developers of both content and applications. 

 

Far from killing the next Google, then, a more developed and differentiated Internet offers a host of new opportunities for the next generation of entrepreneurs.  Importantly, it would allow entrepreneurs and developers to take full advantage of the latest standards to bring consumers a better online experience.  Web applications such as YouTube, BitTorrent, and IPTV require the full capabilities of high-speed broadband access.

 

Moreover, the rules being proposed would necessarily put regulators put regulators in the difficult position of having to review and adopt standards for acceptable levels of such things as latency and jitter to ensure that each broadband providers “best effort” for moving data forward is nondiscriminatory.  In effect, the new mandates would put a federal agency in the role of determining which product should be available at what price, paving the way for a long and active regulatory chapter in the development of the Internet.

 

Open Internet Regulation Could Frustrate the Goal of Universal Access to Faster Broadband

 

            By limiting how Internet service providers charge for access[4], they may also be causing harm in another way.  Broadband access is provided in a multisided market, in which distinct groups share a common platform and benefit from each other’s participation.[5]   New broadband subscribers create value for existing and future subscribers by lowering the average network cost per connected customer: “Twice as many customers connected allows costs to be spread in a way that reduces by half the cost borne by each customer,” according to Larry Darby.[6]  Value is also created for service and application providers whose business models are related to the number of subscribers, “eyeballs,” hits or other audience-related metrics.[7]  

 

Larry Darby estimates the consumer welfare gain would be $8 billion over 10 years if content providers shared 10 percent of the common costs of constructing fiber-to-the-home (FTTH) to under one million households in the first year and up to 28.3 million homes in the tenth year.[8]

 

         J. Gregory Sidak calculates savings of $3 billion to $6 billion per year if new sources of revenue allowed broadband providers to reduce access prices to the then-existing base of broadband subscribers (50.2 million households) by $5 to $10 per month. [9]  Sidak also concluded that an additional 14.3 million homes would subscribe to broadband access in response to a $5 per month price reduction, and an additional 28.6 million homes would subscribe to broadband access in response to a $10 per month price reduction.[10]

 

Innovative pricing or bundling models could help providers achieve these benefits.  Instead of charging consumers for access to advertising, for example, broadband providers might charge advertisers for enhanced access to consumers.  Broadband providers might lower the prices consumers pay for such access so more consumers sign up.  Lowering consumer prices for broadband access would benefit access, application and service providers in addition to consumers.

 

Advertising revenues support both content and delivery in other media, enabling providers to charge consumers little or nothing.  There is no reason to limit the practice on the Internet, particularly in view of the enormous investments that will be necessary to achieve universal access to fast broadband.  A non-discrimination rule will create a loss in consumer welfare by making it more difficult to spread the cost of maintaining and upgrading a rapidly growing Internet.  

 

Addressing suggestions by some that fees on content providers should be banned altogether, Alfred Kahn testified:

 

[F]ail to comprehend—or choose to ignore—that the market here is “two-sided”—providing Internet content and services to consumers and the attention of consumers to advertisers. It makes no more sense, therefore—and is clearly misguided for consumer advocates—to want to forbid the broadband access suppliers that carry those advertising messages charging the advertisers for access to the public than to require newspapers, television broadcasters or cable companies to obtain their revenues exclusively from readers, viewers or subscribers.[11]

 

Despite the fact that massive investment will be required in all segments of the Internet, and the Internet is a multisided market where all groups derive value from each other’s participation, net neutrality regulation would limit innovative pricing or bundling. If net neutrality regulation sets current revenue models into place forever, it will force broadband service providers to recover more of the cost of upgrading and maintaining the Internet from consumers.  Policymakers should be mindful of consumer welfare losses as they consider whether net neutrality regulation is in the ”public interest” or merely in the self interest of some but not all groups in a multisided market. 

 

The Broadband Market is Competitive

 

 

            While the NPRM does not rest its case for regulation on a lack of competition, it does suggest that market power is a major factor in justifying the regulation. [12]  Yet, there is competition in this market, and it is growing.   According to the FCC’s own 2009 report on high-speed services, high-speed DSL connections are available to 83 percent of the households to whom local telephone service is available, and high-speed cable modem service is available to 96 percent of households passed by cable.  Thus the vast majority of Americans have a choice of wired broadband providers.[13]

 

If not a monopoly, then is broadband a “cozy duopoly,” in which two firms share market power to the detriment of consumers?   The data, and the rivalry between the major players, suggests not.   Certainly, the market is relatively concentrated, with two leading providers holding a high market share in most markets, with a number of smaller competitors.   But this market structure is similar to that of many other industries where competition is anything but cozy.

 

            Coke and Pepsi, for instance, dominate the soft drink market but compete intensively against one another, with several smaller providers at their heels. Likewise, the supermarket industry, one of the most competitive in the economy, features two major supermarket chains in many cities, along with a number of smaller players, often with a specialized niche—such as club purchases, organic and natural foods, or gourmet fare.

 

Similarly, in broadband, telephone and cable companies compete intensely against each other for broadband customers on price and quality.[14]  Importantly, this competition is not just in the broadband market itself but also in other, related markets where the two industries are rivals. Using Internet-based telephony technology, for instance, cable firms are increasingly challenging the traditional telephone companies’ share of that market. At the same time, Verizon and AT&T are entering video markets, using their broadband networks, challenging traditional cable firms.

 

A bevy of smaller providers and technologies also keep this market in check.  New providers offer alternative avenues to consumers, with WiMax creating the potential of wireless networks covering entire towns or cities.  Other technologies under development, such as broadband over power lines (BPL), also hold promise for future deployment and new competitors. 

 

And the market share of many of these alternatives is growing: According to the Pew Internet and American Life Project, from 2007 to 2009, the percent of homes with fixed satellite or wireless broadband increased from 8 percent to 17 percent, more than a twofold increase.  In all, 43 percent of Americans report they have more than two broadband choices available to them[15].  Not all of these technologies, because of slower speeds or other limitations, are perfect substitutes for the major services. But by providing niche or specialized services, they do provide competitively significant alternatives.

 

Moreover, the wireless broadband market in the United States is characterized by intense competition in all areas, including applications, devices, and network management (including spectrum efficiency).  Over 95 percent of Americans live in census blocks with at least three wireless providers, and more than 60 percent live in census blocks with five or more providers.[16]  In addition, the number of cell phone subscribers has increased, prices are falling, and quality and offerings are expanding—hardly signs of a non-competitive market.  As the Commission itself concluded in its most recent wireless competition report:

 

U.S. consumers continue to reap significant benefits – including low prices, new technologies, improved service quality, and choice among providers – from competition in the CMRS marketplace, both terrestrial and satellite CMRS. The metrics below indicate that there is effective competition in the CMRS market and demonstrate the increasingly significant role that wireless services play in the lives of American consumers. In particular, these metrics indicate that wireless technology is increasingly being used to provide a range of mobile broadband services.[17]

 

            Both wireline and wireless markets are competitive, dynamic and expanding.  Blocking particular websites or limiting web access, common assertions of made by net neutrality advocates makes little sense in such markets.  Competition requires providing consumers with what they are seeking: the best online experience possible.  For broadband providers, then, blocking websites or limiting access does not increase broadband penetration.

 

            In addition, it must be remembered that large content and application providers may exhibit a degree of market power themselves.  For, example, if Verizon tried to block a popular site such as Amazon or Google over disagreements on pricing, consumers may abandon Verizon in favor of a broadband provider that does connect to sites that they demand, which raises an important issue.  Namely, where does the monopoly threat end?  If, in fact, Google, with more than half the market for Internet searches, does have market power, is regulation required in the name of net neutrality?[18]  Similarly, even content providers may possess market power, with a provider such as ESPN able to extract surplus rents from ISPs. 

 

            A firm in any component of the Internet can expand to provide new services, as has been witnessed by Google’s jump from applications to content with the $1.65 billion purchase of YouTube and now to hardware with the introduction of a new mobile phone.[19]  The major concern is whether a firm can leverage market power in one area into market power elsewhere.  Proponents of new open Internet regulations assert that broadband providers have monopoly power in the last mile that could be used to create market power in the content layer.  But Google’s search engine had a market share of over 82 percent in December 2009; indeed, the two top search engines had a combined market share of roughly 90 percent, but it would be difficult to demonstrate that this warrants new regulations.[20]  All of these situations can be addressed by existing antitrust laws should abuses occur.  These are phenomena that are general to any market and no legislation or special rules are necessary.   

 

Google has leveraged itself into the content market with YouTube and other services.  With respect to advertising, the search giant is clearly engaged in a two-sided market, matching advertisers to consumers using algorithms to extract as much surplus as possible.  While this may be an example of an application that is expanding into the content market, it does not seem to suggest that Google is abusing market power.  Similarly with broadband providers, in the absence of evidence of abuse, new regulations are not required.  The existing antitrust laws are more than ample to address any such concerns. 

 

As the online world emerges and evolves, questions of market power may arise that cut across all market participants.  Net neutrality has, to date, focused primarily on the physical infrastructure.  Yet the diversity of potential sources of market power suggests that the existing antitrust laws embody a degree of flexibility that makes them more aptly suited to addressing any problems than would an ex ante, proscriptive “open Internet” regulatory regime.

 

Need For Mandated Transparency Not So Clear

 

The Commission has proposed a transparency rule that would require broadband Internet providers to disclose information about their network management practices. The NPRM notes that various broadband Internet service providers currently offer a range of information about their network management practices (and about other service aspects such as bandwidth and usage limitations).[21] Some providers only explain their network management practices in broad strokes and do not provide many specifics. Other providers make available details about how they manage applications and network congestion. The Commission regards the lack of consistent network management transparency as problematic.

 

Yet the absence of universal disclosure is hardly unusual in a competitive market setting characterized by differentiated service offerings. Internet service providers compete with each other not only based on speed, reliability, and price, but also on network management practices. To the extent that consumers prefer providers that disclose their network management practices, consumers can weigh network management transparency against other aspects of service in deciding which broadband provider to patronize.

 

In proposing a network management transparency principle, the Commission fails to appreciate the extent to which proprietary product elements can be legitimate, and sometimes crucial, features of a competitive marketplace. Particularly in high-tech industries, it is commonplace for competing firms to offer services to consumers that “just work” without making public intricate details about these services’ underlying functionality. Google, for instance, does not disclose its search algorithm – known as Google’s “secret sauce” – which is used to determine page rankings on its search engine.[22] While some consumers would probably better equipped to select among competing search engines were all search algorithms open to the public, and many content providers could undoubtedly attract larger audiences were search results easier to “game,”[23] no search engine in widespread use currently discloses its search ranking algorithm. One major reason for this secrecy is that search businesses overwhelmingly prefer to maintain trade secrets that enable them to acquire and maintain economic advantage over competitors.[24] The ability to develop non-public algorithms that deliver superior results is a competitive weapon, incentivizing firms to invest heavily in building better tools for indexing the Web.

 

Broadband providers’ network bandwidth is generally a scarce resource, and providers cannot always fulfill all data transfer requests instantaneously. Determining how to allocate scarce network resources is a complex business decision, and providers are constantly experimenting with a range of approaches toward managing network congestion. While certain network management practices have been deemed by the Commission to violate the non-discrimination principle, the proposed transparency principle would likely require the disclosure of all network management practices, discriminatory or otherwise.

 

While the NPRM expounds at great length on the innovation that is continuously occurring in the content sphere that sits atop the Internet,[25] there is scarcely any mention of innovation in the network operations sphere, which includes network management techniques. Just as forcing search engines to disclose their algorithms would likely discourage future innovation in online search, mandating network management disclosure might stifle the development of novel approaches to network management.

 

The NPRM identifies a number of potential benefits that would purportedly arise from greater disclosure by Internet service providers of their network management practices. However, the Notice fails to account for potential market distortions that might result from a transparency principle. The Commission observes that “a large number of commentators on open Internet principles in our Broadband Industry Practices proceeding…believe that broadband Internet access service providers should be required to disclose more information about their network management practices than they currently disclose.”[26]

 

Despite the abundance of support among commentators for greater network management transparency, however, the Commission must consider the possibility that these “information asymmetries” in broadband might be better understood as efficient asymmetries that reflect that a competitive and innovative marketplace.

 

In analyzing the costs and benefits of implementing a transparency principle, the Commission must carefully consider various reasons why some providers might prefer not to disclose their network management practices. The Commission acknowledges that imposing onerous disclosure mandates runs the risk causing consumer confusion and saddling Internet service providers with undue burdens.[27] However, the Commission must also take into account the competitive reasons and other reasons why mandatory network management disclosure might be undesirable in the broadband market.

 

The NPRM states that “access to information plays a vital role in maintaining a well-functioning marketplace that encourages competition, innovation, low prices, and high-quality services.”[28] Mandating access to such information, however, is squarely at odds with the Commission’s goal promoting ubiquitous, affordable broadband service.

 

To the extent that the market for last-mile broadband Internet service in some areas suffers from inadequate competition, mandating network management transparency as a means of addressing perceived “market failure” will only compound consumers’ woes. Especially in sparsely populated areas, the cost of entering the broadband market can be quite substantial.[29] Imposing federal regulations that constrain the flexibility of broadband providers to develop economically viable services would give would-be market entrants one more reason not to invest in bringing wireless or wireline service to underserved areas.

 

The NPRM also omits mention of the myriad network management information sources available to consumers other than service providers themselves. In fact, the complaint that the Commission received in November 2007 regarding Comcast’s network management practices was based on network management data initially obtained by an individual Comcast subscriber and subsequently verified by the Associated Press and the Electronic Frontier Foundation.

 

Especially since the Comcast network management controversy made headlines in 2007, an array of bloggers, news reporters, advocacy groups and others vigilantly monitor the network management practices of broadband service providers.[30] While such public scrutiny does not have the force of law, it is nevertheless a crucial element of market discipline that checks potentially anti-consumer behavior by service providers.

 

These disciplinary mechanisms inherent to competitive markets are far more flexible and fast-moving than federal regulations, and the Commission should err against regulating well-functioning markets simply because of a handful of “mistakes” have been made over the years by competing firms. As consumer preferences continue to evolve, service providers can and will amend their network management disclosure policies.

 

The Commission Has No Statutory Authority to Regulate ISPs

 

Regardless of the merits of the proposed rules, there is serious doubt as to whether the Commission has the statutory authority to adopt them.    Nowhere in the Communications Act does Congress grant authority to the FCC to regulate the Internet.  

 

The NPRM nevertheless asserts such jurisdiction, primarily using the doctrine of “ancillary jurisdiction.”[31]  This court-defined doctrine, itself to be found nowhere in the text of the Communications Act, holds that the Commission can in matters that fall within its general statutory grant of jurisdiction and are “necessary to ensure the achievement of the Commission’s statutory responsibilities.”[32]  The doctrine was originally employed to allow the Commission to regulate cable television retransmission of broadcast signals, and later used to justify a number of other actions, including pre-emption of state regulation of consumer premises equipment.

 

It is in itself a remarkable legal theory, allowing a regulatory agency to act in areas where there is no grant of authority, simply because it is related to an area in which authority has been granted.   In a very real sense, it is a “horseshoes and hand grenades” doctrine, in which close is good enough to count.

 

            Even within the framework of ancillary jurisdiction, however, the case for jurisdiction in this case is startlingly tenuous and dangerously broad. 

 

In the NPRM, the Commission asserts that the proposed regulations on Internet service providers are ancillary to responsibilities under sections 230(b) and 706(a) of the Communications Act.  Section 230(b) sets forth a number of general policy goals, including “the development of technologies which maximize user control over what information is received by individuals…who use the Internet…”  Section 706(a) requires the Commission to “encourage the deployment…of advanced telecommunications capability to all Americans…”

 

There are several problems with this, however.   First, Section 230(b) doesn’t actually confer any responsibilities for the Commission..  It is merely a set of findings preceding a grant (in part (2)) of immunity for blocking of offensive material.  And while section 706 directs the Commission to “encourage” the development of technologies, it provides for the Commission to do so through a regular Notice of Inquiry, after which it would issue a finding if technology is not being adequately deployed.   The Commission has never issued such a finding.  Moreover, as Barbara Espin of the Progress and Freedom Foundation points out, the Commission itself has held that section 706 does not provide any additional regulatory jurisdiction.[33]

 

The Commission also cites Title III of the Act as a source of its authority in this area.  But Title III, at best, only provides jurisdiction over wireless Internet providers.  Without considerable logical gymnastics, it would not support regulation of wired carriers.  

 

It should also be noted that the authority the NPRM claims stems from each of these provisions is apparently unlimited.    Their language cited provide no definable limits on what may be done to “develop technologies” or “encourage deployment.”   The Commission offers no boundaries for what may be done.   Any action – up to and including full-scale common carrier regulation of Internet Service Providers – seemingly is authorized.[34]   Such as undefined grant of power would be dangerous, if not unconstitutional, and is unlikely to have been the intent of Congress.

 

Moreover, somewhat desperate search for some clause or subsection of the Communications Act conferring jurisdiction to the Commission is in itself an indication that Congress never intended to provide such authority.   The proposed regulations, all agree, would be significant in scope and effect, and a major expansion of the Commission’s ambit to a new, and up to now relatively unregulated, sector of the economy.   It is unlikely, in fact nearly beyond belief, that Congress would confer authority to impose such regulation in an unrelated backwater of the Communications Act, requiring the skills of Sherlock Holmes to find.  

 

Congress typically does not play “hide and seek” with jurisdiction.   If it did want the Commission to be able to impose regulations on the Internet it easily could have said so.   And if the Commission decides that such regulation is needed, it should request clear authority from Congress.

 

Importantly, the lack of Commission authority to regulate ISP’s does not necessarily leave a gap in regulatory protection for consumers.   Other agencies, most notably the Federal Trade Commission, have the expertise, authority and responsibility to act to prevent market abuses by Internet service providers.   In fact, given the nearly 100 years of experience by the FTC in identifying and addressing market abuses through application of the competition laws, that agency is in fact better positioned to handle this issue than is the FCC.

 

Should the Commission not be willing to drop its assertion of authority in this area, there are several steps that still could be taken which would clarify the issue and avoid confusion.   First, it should defer a final decision until a decision is reached by the D.C. Court of Appeals in Comcast v. FCC.  In that case, an appeal from the Commission’s  2008 ruling that Comcast violated the current net neutrality principles, the question of jurisdiction has been squarely raised.   A slight delay in action in this docket would likely help avoid confusion and uncertainty.   Second, the Commission should fully and explicitly explain what limits – if any – there are on its claimed authority over Internet services.    Both steps would help reduce uncertainly, and provide a clearer basis for moving forward.   

 

 

 

                                                            Respectfully submitted,

 

 

 

 

           

Wayne Brough

Chief Economist

FreedomWorks Foundation

 

James Gattuso

Senior Fellow in Regulatory Policy

 The Heritage Foundation

 

Hance Haney

Senior Fellow

The Discovery Institute

 

Ryan Radia

Associate Director of Technology Studies

Competitive Enterprise Institute

 

James G. Lakely

Co-director, Center on the Digital Economy

The Heartland Institute