net neutrality

Happy Veterans Day!!!

On Monday, President Obama made a strong statement in favor of net neutrality, maintaining that the provision of internet access should be a utility service like the provision of water and electricity.  Personally, I think this is common sensical and correct, and it’s the way we should do things if we were starting from scratch.

His statement comes a few days before the Federal Communications Commission will release its newest version of internet rules, one that will likely allow internet service providers to continue to charge extra to big services like Netflix.  Mr. Obama is now on record as opposing what the head of the FCC, Tom Wheeler, is about to do.

I can’t help thinking that the statement is more than a little disingenuous.  It comes just after the election, so voters don’t have a chance to weigh in on the issue.  It also comes less than a year after Mr. Obama appointed Mr. Wheeler, who spent his career working in and lobbying for the biggest ISPs, the cable companies, to head the FCC. (Wikipedia says Mr. Wheeler is in the cable industry Hall of Fame–wireless HOF, too.)  What did Obama expect Wheeler to do?

I don’t have a solution for the net neutrality issue, but I think know where the problem lies.

Government creates utilities when the public interest is best served by having only a small number of companies providing a capital-intensive service.  Certain firm are granted monopolies or near-monopolies in given service areas.  To prevent abuses, the firms’ business focus is restricted and profits are regulated.  Profit growth is (almost always) tied to the increases in new capacity the utility brings into service.

Consumers are charged by the amount of the service they use; utilities are chomping at the bit to provide more and better service.

Almost none of this applies to the cable companies, whose profits, in the short term anyway, can be maximized by doing the opposite–providing the worst service at the highest price (think:  Comcast or Time Warner Cable).  Yes, both the cable companies and their mobile brethren, ATT and Verizon, have the advantage of being able to build their internet presence using their monopoly cable/telephone infrastructure.  But that in itself doesn’t make their ISP services monopolies.

I don’t see any quick fix.  The orthodox economic solution in a case like this is to encourage competition–that is, prevent further consolidation among existing ISPs and provide incentives to new entrants.  Let’s see if Mr. Obama speaks out against the proposed Comcast-TWC merger, which would be his next logical step if he means what he said on Monday.

 

 

 

net neutrality: one more time

Last week the FCC issued its latest pronouncement on net neutrality, the question of who regulates the internet–and therefore, implicitly, who owns it.  You can find the FCC releases and member commentary here.

background

Two pieces of background information are necessary to understand the meaning of the FCC statement.

1.  A while ago Comcast deliberately slowed down its service to BitTorrent, a file-sharing service.  Comcast said a small number of BitTorrent users were gobbling up huge amounts of bandwidth and slowing down service on its network for everyone else.  The FCC ordered Comcast to stop doing so.

Comcast successfully sued, arguing in court that the FCC didn’t have this kind of jurisdiction over it.  The case hinged on the FCC’s classification of the internet, not as a communications service, but as an “information” service.

Reading between the lines of subsequent statements by the parties and press coverage, the FCC decided to respond by saying it now realizes the internet is indeed a communications services, like plain old telephone service.  That would remove the internal contradictions in the FCC’s behavior.  But it would also potentially open the door to taxing internet access in the same way that phone service is.

Talk about driving a stake through the heart.  However, after hearing personally from over half of the members of the House of Representatives and a third of the Senate, the FCC changed its mind.

2.  In August, in the midst of the post-Comcast court victory discussion, Google and Verizon issued an internet manifesto (see my post).

what the FCC said

Last week’s FCC statement addresses the GOOG/VZN manifesto point by point.  The highlights:

–wired internet has one set of rules.  An ISP can’t block any content or services.  It also can’t deliberately slow down, or speed up, any particular content or services.  It can, however, offer different speeds of internet access to customers at different prices.

–wireless has another.  Basically, anything is ok, because the greater number of mobile internet service providers means consumers can switch ISPs if they don’t like what their current one is doing.

So far, this is more or less what GOOG/VZN suggested.  But…

–possible new services.  As I mentioned in my August GOOG/VZN post, I think GOOG wants to use its own money to build an internet service that’s more like the information superhighway that the rest of the developed world has, rather than the rutted country lane that ISPs have created in the US.  But before it invests billions doing so, it wants assurance that its service won’t be regulated as a public utility–that is, as if the network had been created with public money.  What GGOG/VZN got in this statement was just the opposite.

As I read it, the FCC says that a GOOG service would be subject to punitive regulation if it posed any threat to existing wired internet services.  But if a new service can’t be any better than today’s services, what’s the point?

jurisdiction?

The FCC asserts in its statement that it’s in charge–a reprise of Al Haig’s famous declaration, perhaps?  But the courts have been saying something else.  Congress seems to have the agency on a very short leash, as well.  And the new Congress may well have something more definitive to say.

Stay tuned.

A big new step toward the “Internet of Things”

About a decade ago, someone in the RFID-tag community coined the “Internet of Things” phrase.  The idea is that the ultimate destiny of the Internet is to be a communication and coordination network, not primarily of people, but of devices–from appliances, to houses to cars…–talking with each other through imbedded chips.

Today, that idea is sounding less and less like science fiction.  During the June quarter, major US wireless networks reported that they hooked up more new devices (such as digital picture frames and internet-enabled TVs) than new people to their networks.  Maybe not such a surprise, given that the US is already 100% penetrated with cellphones.

Another step came last Thursday, when the FCC issued an order allowing the use of wi-fi-like devices over the “white space” frequencies that separate TV channels and are intended to prevent interference.  This is intended, in the words of the FCC press release,  to “unleash a host of new technologies” that include things like:

–home wi-fi without dead spaces,

–“super wi-fi,” that is, long-distance, wide-range wi-fi that should allow inexpensive blanket wi-fi coverage of large areas, like ports or other large distribution hubs, as well as extending wireless internet into sparsely populated locations.

This action opens the door for all sorts of “intelligent” device applications.  Devices and services–like appliances with chips in them that can coordinate their actions (adjust the heat, wake you up earlier is there’s traffic congestion…)–should in theory be available by early 2012.  IBM posted its ideas on what the Internet of Things will be on You Tube in March.

http://www.youtube.com/v/sfEbMV295Kk?fs=1&hl=en_US

There’s still a big issue to be faced , however–net neutrality.  At least some of these wi-fi networks will be built by companies.  Will these be private, or will non-affiliated service providers be entitled to offer their wares on it, even though they have not contributed to the network’s construction costs?  This is the question that GOOG and VZ raised in an oblique way in their “Legislative Framework Proposal” in early August.

To me, it sounds like GOOG and VZ are willing, even eager, to build out “super Wi-Fi” networks and offer new services on them–provided they can either deny access to other potential service providers or give them lower priority on the new systems.

This implies that the development of really revolutionary new services will depend on the FCC clarifying the ownership issue for new commercial Wi-Fi networks.

investment implications

A favorable FCC decision for GOOG and VZ on Wi-Fi network ownership would likely be a big plus for both companies.  In the absence of that, the significant winners–and the safest stock market plays, in any event–will be the chip makers that will supply demand for new-standard Wi-Fi chips.

the Google-Verizon plan unveiled yesterday

GOOG and VZN made their new internet plan public yesterday.  An explanation is available on the GOOG public policy blog, which links to the proposal’s text on Scribd.  (I searched without success to find the proposal on the VZN website.)

the plan

It has some straightforward features, followed by a couple of curve balls.  First, the plain vanilla–

fixed-line internet

The proposal has five points that deal with the fixed-line internet as it exists today.  They are:

1.  Service providers can’t prevent lawful activity, including sending and receiving content, running applications and using services, and connecting devices to the network.

By implication, service providers would be able to stop unlawful activity or actions that harm the network or users.

2.  Service providers wouldn’t be able to engage in “undue” discrimination against lawful activity in a manner that causes”meaningful” harm.

3.  Service providers would have to disclose terms of service and network management practices “in plain language” and in enough detail that users can make informed choices.

4.  Providers can do “reasonable” network management, including measures to reduce congestion, ensure security and eliminate unwanted or harmful traffic.

5. The FCC would enforce consumer protection and nondiscrimination requirements, not by general rulemaking, but by case-by-case actions against violators.

This leaves the FCC relatively toothless, but that’s basically where Congress and te courts have the agency now.

the eyebrow-raising ideas

These have generally drawn the most unfavorable comment in the blogosphere so far.

1.  Wireless would be exempted from all the fixed-line rules, except for #3, transparency in terms of service.  In other words, service providers could deny access to users if it wanted and prioritize content.  Very convenient for Android-based phones on the VZN network.

2.  “additional or differentiated services” could be offered by any service provider who also runs a broadband internet service governed by the plain-vanilla rules.  On this “differentiated” network, which could make use of internet content, the service provider would be able to prioritize traffic.  On its blog, GOOG offers the examples of online gaming/gambling, education (distance learning?), entertainment (movies, concerts?), and health care monitoring as examples of possible additional services.

my thoughts

It sounds to me like GOOG and VZN want to make very large capital investments in wireless and fixed-line internet service networks and want to setle the ownership issue before they do so.

Up until now, the cable and telephone companies that have built out multi-billion dollar internet networks have been compelled–rightly or wrongly–by their semi-monopoly status to accept the rules of “net neutrality.”  If DIS, for example, wants to offer an internet on-demand movie download service over, say, the Comcast network, in direct competition with Comcast’s own cable on-demand service, net neutrality says Comcast has no choice but to allow this to happen.  More than this, Comcast has to make every effort to ensure DIS has enough bandwidth that its service will be successful.

In some sense, then, content providers own the network just as much as the firms who built it, who are relegated to being nothing more than “dumb pipes” that deliver content to consumers.  I’m not trying to make judgments about what should or should not be the case.  I’m simply trying to describe the current state of affairs.

GOOG and VZN, it seems to me, are content (resigned?) to this being the case with capital investments made to date.  But before they commit new money to build new network infrastructure (GOOG, I think) or enhance an existing one (VZN Wireless) they want to make sure they own the network in the strongest possible sense.

Yes, if GOOG and VZN are permitted to build on their own terms, there’s a chance that the existing fixed-line internet–already a laggard in world terms–will develop more slowly than it would otherwise.  On the other hand, without some assurance that they will own the resulting network, I don’t think a non-utility like GOOG will build anything.  Also, there may be more competition in private networks than one might initially think.  Where GOOG treads can AAPL be far behind?


“search neutrality” –Google’s newest challenge? the ITA acquisition

Everybody is by now familiar with the topic of net neutrality.  This is the question of whether the owners of high-speed transmission networks for internet traffic have the right to regulate the flow of data, assigning some information to what is in effect the slow lane while allowing other content to barrel ahead in express.

This issue still hasn’t been fully dealt with.  As I posted in April, the FCC ordered Comcast to stop interfering with traffic through BitTorrent, a peer-to-peer file-sharing service that the ISP claimed was using up too much bandwidth.  Comcast sued, on grounds that the FCC didn’t have the authority to issue it such an order–and won.

The FCC responded by moving to reclassify Comcast as a public utility, like phone companies ATT or Verizon, so that it would have the regulatory authority it needed.  This opens a whole political can of worms, however, so it’s still not clear where matters stand.

GOOG’s ITA purchase

The wheel of competition has recently taken a turn in a different, but related, direction with Google’s agreement to buy ITA Software, founded by MIT scientists and now held by private equity, for $700 million.  ITA makes the airline database search software that powers the air part of travel sites for online agencies like Kayak and Orbitz, as well as for the online sales sites of Continental Air.

GOOG’s isn’t the first purchase of this type.  Two years ago, MSFT paid $115 million for the smaller private company Farecast, which is at the heart of MSFT’s Bing Travel service.  But ITA is bigger and already services significant third-party customers.

unhappy campers

Not everyone is happy with this development–especially not Barry Diller, CEO of online travel agent (and former MSFT subsidiary) Expedia.  He’s worried that if/when it acquires ITA, GOOG will promote its own services over those of EXPE.

This assumes, of course, that GOOG will follow MSFT’s lead and create a travel site similar to Bing Travel.  That may well happen.  In paid search, a prospective GOOG Travel could outbid everyone else for keywords, since this would just be transferring revenue from one GOOG pocket (travel) to another (search).  It’s not so clear that would happen in any unfair manner in unpaid search.  The reputational, and legal, risk to GOOG is too high, I think, for that to occur.

EXPE isn’t out of the woods by any means, however–in my opinion.  It’s possible that the combination of GOOG and ITA professionals will produce new travel software that’s significantly better than anything on the market today.  Maybe ITA can do this alone, with GOOG financial support.

Suppose that instead of using ITA software itself  GOOG offers it for free to any travel site that is willing to allow GOOG advertising on it. This is basically what it did with cellphone operating system software.   That would give any takers a 10%-15% cost advantage over sites which either develop their own travel software or buy it from third parties.  It would also make it easier for new firms to enter the market.  Any way you look at is, GOOG offering ITA for free would  lower the value of any database technology that a company like EXPE holds.

That’s Mr. Diller’s real problem, I think.  If so, he can’t just say this–that there’s something wrong with a new market entrant turning up with better, lower-cost technology.  Search neutrality may be the best weapon he has to fight with.

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.