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The FCC is still opaque on commercially unreasonable standards

Recently Federal Communications Commission general counsel Jon Sallet introduced the concept of “jurisprudence of innovation” at a Federal Communications Bar Association function.  Jurisprudence and innovation doesn’t come off at first glance as two concepts that should mix.  Jurisprudence is defined as the philosophy or science of law while innovation is defined as the process of introducing new devices or methods.

I hear jurisprudence and I think of intellectual meandering locked within a mental ward.  When I hear innovation, I think of entrepreneurial freedom meeting the needs of an expansion of consumer welfare.  Bottom line, Mr. Sallet’s remarks were an attempt to put fresh paint on a regulatory prison cell the FCC seems so desperately eager to keep building with entrepreneurs as unwilling guests.

Here is the framework laid out by Mr. Sallet for jurisprudence of innovation.  The mandate for a jurisprudence of innovation framework is that entrepreneurship, competition, innovation, and consumer benefits are to be maximized with the goal of permitting the creation of new markets while subjecting old markets to the challenge of creative destruction.  Public policy tools for achieving this social policy include the certainty emanating from balancing potential public interest benefits against potential public interest harms; development of flexible standards for assessing the public interest; and access to resources.

The problem with Mr. Sallet’s model is that it still assumes that the FCC has a crystal ball that it can use to determine what innovation will look like in the future and whether this future will be disturbed by an acquisition applicant’s actions today.

Yes, the markets thrive on certainty, flexibility, and access to resources because these are the ingredients that entrepreneurs need to succeed.  The consensus held by entrepreneurs and producers is that they need clear rules of the regulatory road so that they can do business and best gauge the flexibility they have in developing and deploying new products and services.  The model Mr. Sallet presents adds no clarity as to how far the FCC would intervene on the front end of the innovative process.

Either the FCC will wait for a substantiated complaint to be filed (versus one based on a consumer’s feelings) so that it can weigh actual facts before crafting a resolution or it will step in along certain points or milestones during the innovation, marketing, and deployment process and hinder the very innovation it professes to want.

If the latter course is the one the FCC plans to take, I have a hard time seeing why an investor would be confident in leveraging capital in the broadband or Internet space.

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John Thune will need some help in November for his telecom initiative

The Hill reported last week on U.S. Senator John Thune’s desire to update the Communications Act of 1934, making it a 21st century law for a 21st century world.  While we have 86 and half years left in this century, Mr. Thune, Republican of South Dakota, only has four and a half months to set the stage for a 2015 re-write.  The Republicans will have to hold the House while trying to capture the Senate.

The House Energy and Commerce Committee, under the leadership of U.S. Representative Fred Upton, Republican of Michigan, has already started addressing an update of the Communications Act by issuing a series of white papers, seeking public comment on the white papers’ issues, and holding a number of hearings.

“The only way to provide the certainly that [Internet service providers], edge providers, content publishers and end users need and want is for Congress to legislate,” Mr. Thune said. “My colleagues and I need to roll up our sleeves and figure out how best to promote an open, competitive and free Internet.”

Mr. Thune and his colleagues on the left and the right of the aisle may have to work on the art of compromise if anything close to a re-write is to be accomplished by 2015.  I expect U.S. Senator Al Franken, Democrat of Minnesota, to lead a charge against any language in a re-write that attempts to negate net neutrality rules.  Mr. Franken has been making the media rounds arguing for an open Internet, expressing his fear that broadband access providers will only seek to block access to content or discriminate against certain content producers by favoring their content over a non-affiliate’s content.

In the immediate term I don’t see any new regulatory threats to edge providers.  I believe Congress’ initiatives will move slower than the innovations we see coming from edge providers.  The only way Congress can catch up to the broadband and Internet industries is to put a moratorium on innovation and that will never happen.

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Good content and capital’s search for returns will slay the net neutrality dragon

No amount of net neutrality regulation is going to slow down the convergence we are seeing in broadband and media.  That’s my takeaway from remarks made by Federal Communications Commission member Michael O’Rielly’s speech made before the Media Institute last Thursday.  Mr. O’Rielly argued that content is king and that given the proliferation of multi-video distribution and online video platforms coupled with edge providers such as Google, Amazon, and Netflix, innovators who can provide relevant content will continue to drive the market place for ideas, experience, and products.

To set themselves apart, content providers will focus on delivering high-quality content, said Mr. O’Rielly, citing shows such as Netflix’s “House of Cards” and HBO’s “Game of Thrones.”  (I just started watching “Game of Thrones” myself and I’m hooked.)  The future success of content, Mr. O’Rielly observed, will be tied to high-quality and cable, satellite, phone, and online companies are increasingly becoming both distributors and producers of content.

Nielsen, the television ratings company, provides some backup to Mr. O’Rielly’s argument.  Last May, Nielsen released a report finding that in 2013 out of an average of 189 cable channels available to cable subscribers for viewing, the average channels viewed totaled 17.5.  In 2008, the average number of channels available to subscribers was 129 with the average number of channels actually viewed totaling 17.3.  Nielsen summarized their findings by saying:

“This data is significant in that it substantiates the notion that more content does not necessarily equate to more channel consumption. And that means quality is imperative—for both content creators and advertisers. So the best way to reach consumers in a world with myriad options is to be the best option.”

I think it’s safe to apply the cable video distribution model to what’s happening online.  Cisco reported two weeks ago that in 2013, video traffic would account for 66% of all traffic on the Internet and by 2018 video traffic would account for 79% of all Internet traffic.

Netflix accounts for 34% of all North American Internet traffic during the busiest hours of the day.  They have built their “house of cards” on quality content and show no signs of moving away from this model.   Google, a company that wants to be at the hub of the “Internet of Things” has over 60% of Internet end devices/users sending traffic to its servers.

Internet traffic is flowing to and from the big players on the Internet and no amount of FCC ex-ante net neutrality regulation is going to slow down this traffic juggernaut.  Capital will flow to where it finds the highest returns and on the Internet it’s about video content flowing from trusted sources.  When content producers spend millions on high-quality productions, they want their product moving quickly to the consumers driving demand for it.

If the FCC really wants to impress markets with its knowledge of the Internet, then pursuing rules that negate a broadband provider’s good judgment in managing their networks, including providing content providers with alternative methods for high-speed access to their subscribers, is not the way to transmit confidence to the markets that government acknowledges the private sector as fully capable of stimulating innovation.

 

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Investors should support the current section 706 framework for spurring broadband investment

Investors, private equity firms, and venture capital firms concerned about the impact of public policy on broadband investment should support advocacy for the Telecommunications Act of 1996′s current Section 706 regime versus the imposition of additional net neutrality rules that run the risk of needlessly expanding the Federal Communications Commission’s jurisdiction and its penchant for ex-ante regulation into the edge provider space.

John Mayo raises a couple good arguments for why I believe that investors should stay off of the net neutrality bad wagon.  Regulation should be output centric.  According to Professor Mayo, Section 706 places policy emphasis on output and policies that emphasize output ensures competitive behavior.

How so?  look at the opposite of competitive behavior; monopolistic or collusive behavior.  Increased pricing on the part of monopolies and oligopolies are the result of reduction in output.  This is counter to our social policy of increased deployment of broadband access to all American households.  According to Professor Mayo, Section 706 aligns an economic policy rationale for Internet governance with traditional, policy proven anti-trust tools that focus on the output altering effects of firm behavior.

On the other hand, argues, Professor Mayo, Title II public utility style regulation takes an ex-ante approach that risks squelching novel, output enhancing innovation.  And where would this innovation and increased output occur?  On the edge.

I recently argued that the FCC should take into consideration the impact regulation has on an edge provider’s ability to enter markets.  Professor Mayo argues that an example of increasing output is the ability of edge provider’s to expand investment.  If an ISP’s behavior discourages edge provider investment, then yes, the FCC could make a call that Section 706 was violated because output has been restricted resulting in less content distribution choice and probably higher prices for subscribers to such services.

Investors should not let what appears as equivocation on the part of edge providers like Netflix confuse them.  A net neutrality regime further enhanced by additional rules does nothing for increase in output or entry by more viable edge providers.  Further regulations amount to additional barriers to entry manifested in greater costs of compliance, costs that impact that bottom line.

 

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Broadband: Why would an edge provider let FCC see its business model

Technocrat’s Anne L. Kim blogged on comments Consumer Electronics Association CEO and president Gary Shapiro made at a recent Brookings Institution event.  Here is an excerpt from her post:

On net neutrality, Shapiro wants more of a hands-off approach from the government. He wants to see government allow industry and nongovernmental organizations establish principals. “And if the principals are violated, then act,” he said.

“I personally am fearful of all of a sudden sending those companies into a new area of regulation like utilities,” referring to the FCC considering using Title II of the 1996 Communications Act to rewrite net neutrality rules.

He said he likes things the “way they are” and that he’s rather not see them changed, adding that “good intentions scare me.”

Take a look at Title II, something more edge providers need to do, and you can appreciate some of Mr. Shapiro’s fear.  For example, section 211 of the Communications Act requires that common carriers (a classification that net neutrality advocates want applied to broadband providers) file copies of all contracts that they have with other common carriers.  So, if Google, a broadband wannabe, has peering or transit contracts with Comcast, Google will have to file its contracts with the Federal Communications Commission, and probably with state public utility commissions as well.  If these contracts contain information regarding traffic from certain edge providers a la Netflix, Netflix wouldn’t be happy that some aspect of its business model may be on public display with the FCC.

This type of transparency may bring joy to net neutrality proponents but not to the edge providers they purportedly are so concerned about.  In my opinion, letting the government have a copy of a contract entered into autonomously is the same as the government regulating your free speech.  Unless there is a dispute to be resolved between two parties to a contract, I see no reason to let the government have access to its contents.  If edge providers want to see a slippery slope created that takes regulation right to their doorsteps, Title II will lay the bricks for that driveway.

My walk down the Yellow Brick Road of regulation gets scarier when I take a look at section 215.  Section 215 allows the FCC to examine transactions involving the furnishing of services, supplies, equipment, personnel, etc., to a carrier.  Also, the FCC, pursuant to this section, may examine transactions that impact charges a common carrier assesses for provision of wire or wireless services.  Section 215 also allows the FCC to determine how reasonable these charges are.  Also, the FCC may report its recommendations to Congress as to whether charges are invalid and should be modified and prohibited.

Now, not to knock on Google, but since they are the Internet flavor of the week given the disclosure of their perceived wretched diversity in hiring practices, disclosing matters regarding personnel much less on their services should make the company and its investors think twice about supporting net neutrality brought to you via Title II classification.

All of Title II should be scary to venture capitalists, private equity, and their investor clients, but section 218 should bring great pause. This section allows the FCC to inquire into the management of all common carriers.  The FCC may obtain management information not just from the carriers, but from entities that directly or indirectly control them.  That, in my mind, includes private equity firms or venture capitalists that may have a controlling interest in some little regional or rural broadband provider.  With the SEC stepping up its scrutiny of private equity via the Dodd Frank Act, does private equity want another alphabet soup agency knocking on its door?

Here is one more, especially for the app developers.  Section 231 speaks to app developers, or more definitively access software providers.  This section prohibits the use of the World Wide Web to transmit material harmful to minors.  I wonder how many apps fall under this category.

When you look behind the curtain of good open network intentions, you can find some scary stuff.