Net Neutrality: this week’s appeals court decision

the Comcast lawsuit

Three years ago, the Associated Press responded to consumer complaints by running tests that showed that Comcast was slowing down access to peer-to-peer file-sharing services like BitTorrent, which allows users to swap large files, like movies.  Comcast first denied doing anything, but later said it acted because a small number of users were hogging bandwidth and slowing down access speeds for everyone else.

The Federal Communications Commission ordered Comcast to stop this, under “net neutrality” principles it had laid down in 2005.  Comcast sued.  Earlier this week, an appeals court ruled that the FCC had no legal authority to issue the order.  So, barring another appeal, Comcast has won.

What is Net Neutrality?

First of all, one should note that the name itself is a very clever, highly political choice, sort of like the Patriot Act or the Employee Free Choice Act.  Just as no one wants to be seen as opposing free choice or patriotism, it seems unreasonable to be against neutrality.  So opponents are already on the defensive, no matter what the actual concepts are that lurk behind the names.

FCC statements on net neutrality say consumers are entitled to:

–access all lawful content

–run any applications or services

–connect to the internet with any legal, non-harmful device

–competition among service, application and content providers

–disclosure of operating principles by ISPs

–no discrimination by ISPs against any legal content or applications.

two observations

1.  This is all jockeying for economic advantage.

On the one side, cable and telephone companies have spent billions building out internet networks, with at least vague imaginings of being able to operate the kind of “walled gardens” that Apple’s iPod and iPhone now run, and AOL did in the Nineties.  They don’t want to be reduced to being “dumb pipe” conduits earning a minimal return for transporting very profitable applications run by others.   But they suffer from the weakness of any capital-intensive industry (think:  container shipping or cement plants) that their capital is already sunk in the ground and can’t easily be retrieved.  So they are almost by definition price takers.

On the other, content and application providers are radically dependent on ISPs to deliver their products to consumers.  They wonder (fear?) what would happen if an ISP owned a service that competed with theirs–like Comcast when it takes control of NBC Universal.  Would, say, competing news services find their offerings delivered at slower speed than NBC’s?  Would content/application providers that didn’t link up with Hulu find themselves shunted onto the local track while more NBC-friendly competitors stayed on the express rails?

You might say that an ISP would be foolish to do this, but outside the most densely populated areas, what recourse do consumers have?  There’s no competing internet service to switch to.

At this point, this is mostly in the realm of “what if?”.  Other than the BitTorrent instance, there’s scant evidence that ISPs are acting on what may well be their secret fantasies.

2.  Almost everything that has been said about Net Neutrality is couched in negative terms–what ISPs are not allowed to do.  The other side of the coin has been pretty much ignored.  ISPs are allowed to sell different classes of service, with minimum quality of service guarantees.  And wealthy service providers (think:  Google) can maintain cutting-edge server networks of their own to support their products.  They can also pay ISPs to colocate their equipment with the ISPs to increase service speed.

So neither side is exactly the powerless “victim” of the other that its proponents would like to portray it as.

investment implications

1.  The Roberts family, which controls Comcast, are very shrewd businessmen.  Their attempt a few years ago to acquire Disney and its current agreement to buy an interest in NBC Universal illustrate what they think of the future of the IPSs (i.e., dumb pipe).  In the BitTorrent case, they had two options:  slow down service or add capacity.  The second would mean capital spending that wouldn’t generate any more revenue.  Whether you think Comcast did the right thing or not, it’s an indicator of the maturity of the business if option #2 makes no economic sense.

2.  The wired broadband networks have by and large been built with private money.  This suggests they shouldn’t be regulated as public utilities.  Even if that were possible, and net neutrality thereby assured, I don’t think anyone wants that.  The next step, I think, would be taxation along the lines of telephone services, raising the cost of internet service for everyone.

In theory, tax increases would get parceled out among consumers, ISPs and content providers according to their economic power.  But no one really wants to find out what that allocation would be.  And everyone except the government is worse off.

3.  Content providers want security but they don’t want regulation.  What do they do?

a.  They attack the “walled garden” that Apple has established by providing/supporting the creation of equivalent devices at lower prices.  The Google phone, the Chrome netbook or the $100 iPad-equivalent that Marvell recently displayed are examples.

b.  They promote the proliferation of alternative ways of internet access–WiMax, municipal free internet services.  The more alternatives a consumer has, the less able any one ISP is to take content-unfriendly action.  Also, an ISP would certainly hesitate to take action if that meant that a whole town or county or some other political entity were affected.  Doing so would invite adverse political consequences.

4.  How to invest?

I suspect a value investor would have a field day rooting through the cable companies and the traditional media companies, since many have already acted on their belief that these firms are the ultimate losers in the internet revolution.

That’s not what I do, however.  I continue to think that the designers of new devices, and of the key components that go into them, are the best bet.

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