Internet commerce flourishes because of market demand not regulation

One peeve I have had with the Federal Communications Commission in past and today is its penchant to describe its role in the broadband market as a facilitator of growth and innovation.  It’s like having cousin Louie visit for a weekend, overstay his welcome, and claim that he helped to build your house.  I’ve had to ask myself if I missed something during my two decades in the regulatory game.  Where did the Commission facilitate growth in the online markets?

There are probably a number of different sources to look at.  I try to keep things simple, so I decided to take a look at what professional market watchers have seen over the past four years.  Not a formal analysis that wreaks of regression analysis and all that, but an albeit cursory review of the findings from three Morningstar reports that covered a broadband provider; an online bookseller; a media company; and an over-the-top video distributor.  Since the Commission continuously refers to the entire internet ecosystem as its unit of regulatory analysis, I figured looking at companies that play in different but connected boxes in the internet ecosystem was an allowable approach.  So here goes.

First, lets go back to a Morningstar analysis of Amazon conducted on 6 December 2010.  The analysis discusses the advantages that Amazon has over brick and mortar companies such as Barnes and Nobles and Borders.  Amazon has been able to leverage the internet to deliver books at the lowest cost point, a cost point achievable because of low overhead costs.  Amazon has also been able to leverage the internet to produce and distribute e-books which, according to Morningstar, has a compelling advantage over hardcover books.  The main reason e-books have been successful is that production and distribution costs are near, if not, zero.  This ability to keep production costs near scraping the bottom has translated into lower prices for consumers.

I read through that report looking for some acknowledgment of the Federal Communications Commission.  I saw none.  Based on this report it seems that the idea of storing books in warehouses and shipping them out to consumers as the result of receiving an order online was part of a business model developed by an engineer by the name of Jeff Bezos.  No mention of the Commission or the Communications Act.

In September 2011, Morningstar sounded kind of so-so on Netflix.  Morningstar made it clear that content owners held the upper hand with the ability to enter into shorter licensing agreements for content and repricing at a higher amount.  Morningstar also noted in 2011 that Netflix faced heightened competition from new entrants and the lack of access to higher quality content.

Fast forward three years.  Netflix has built its own house of cards where orange is the new black.  Just like the Amazon analysis, Morningstar makes no mention of how the Commission’s regulation of the internet contributed to Netflix’s business model or its decision to go outside the box and not just deliver DVDs but stream video as well.

Speaking of content, Morningstar’s July 2012 analysis of Time Warner proceeded from the premise that quality content is king and that Time Warner has been able to take a strong competitive position in content.  The quality of Time Warner’s content, according to Morningstar, increases in value because it can be consumed on multiple devices, including laptops, smartphones, and tablets in addition to televisions.

The decision to deliver it via multiple platforms via multiple devices appears to have been made by private actors with no input, appropriately, from the Commission.

And how about the broadband provider portion of the ecosystem.  The Commission, along with net neutrality advocates, has been harping on the need for robust competition in the broadband space, but according to Morningstar’s August 2012 analysis of broadband provider CenturyLink, for the company to stay competitive with cable companies it would have to invest in network enhancements that facilitate faster download and upload speeds.  Not only does CenturyLink have to compete with cable in providing broadband access, they also compete with cable to distribute video.  Their provision of fiber-to-the-tower finds them competing with not just cable companies but with other competitive local exchange carriers.  CenturyLink also competes with Amazon, Salesforce.com, and Verizon in the provision of cloud management services.

Again, nothing in Morningstar’s analysis that speaks to the Commission’s requirement or even suggestion that CenturyLink enter into these markets within the internet ecosystem.

Growth and innovation have been occurring within the internet without the Commission’s persuasion or regulation and so far the Commission has not demonstrated why applying Title II regulation could add any value to the market-driven actions taken by the firms I just discussed.

Competition. The FCC’s mythical anti-innovation policy

A reality often clouded in the free market narrative is the lack of specificity as to what free market means.  There is always a price of entry into markets.  Producers have to face the cost of getting their goods and services into markets for eventual sale.  Consumers have to invest the time researching available choices so that they can negotiate the best deal that enhances consumer welfare.  Exiting markets can be costly if the time ad effort made to enter a market does not result in purchase or sale. Buyers and sellers expect these barriers to entry and can plan for them.  What most impacts the freedom to enter markets are the barriers that government can impose.  Ironically one of those barriers is the requirement of competition.

The word, “competition”, gets thrown around ad nauseum by members of the Federal Communications Commission.  It’s never defined which allows the speaker of the word to use it with the authority of a witch doctor, conjuring up images of doing the right thing for grandma and apple pie.  Per the text books, competition is short hand for “competitive markets” which means that you have multiple firms selling a similar product at some point where the marginal cost to produce the item is equated to the price.  Firms in a competitive market, in theory at least, aren’t paying much attention to what the other guy is doing but simply responding to the price signals they receive from consumers.  In reality, this doesn’t happen in either the broadband access or internet content markets and the FCC should stop pushing a policy that says that competition should be the case.

First, the broadband access market.  There are multiple firms, wired and wireless, that are providing broadband access.  For example, Comcast and Verizon provide me with broadband access to the internet and if I wanted to really go all out I could invite AT&T into the house to provide me with DSL service.  I have choice as a consumer and my choices try to distinguish themselves everyday by advertising their service speeds and prices.  The Commission continues talking about competition for broadband access but they appear to forget how capital intensive deploying new networks can be and that the barrier of cost is probably playing the most significant role in keeping potential new carriers out of a market.

In the content/information markets, it may be a bit clearer why competition”on the edge.”  In a piece in The Economist, Peter Thiel, a co-founder of PayPal, is cited as referring to competition as an indicator of failure; that success comes from providing a unique solution and monopolies, not competitive firms, are the ones occupying a once ignored space and providing a unique service.  ”A clever startup does not try to compete directly with an incumbent.  It picks a seemingly unimportant market which it can monopolise.”  Their monopoly position, according to Mr. Thiel, drives the innovation necessary for creating a unique product.

If competition, according to Peter Theil, is a relic of history that does not drive innovation, then why does the Commission push the narrative, especially with examples that abound of online startups, i.e. Facebook, Google, Amazon, that consistently bring new services while monopolising their core services?  It is probably because it goes against the grain of over a century of precedent that says abuse of dominant power is bad and that every monopoly must be automatically assumed to do or potentially do some serious abusing.  It would be political suicide for the Commission to think that far outside the box.

To me it’s economic suicide to keep innovators on the edge so constrained by the myth that competition leads to innovation.

Value of content grows without net neutrality or Title II regulation

Pew Research Center’s Internet and American Life Project today shared some results from a survey of online adults about the benefits they receive from the information obtained via the internet.  According to Pew, 81% of online adults say that the internet and cell phones help them become better informed about products and services.  Seventy-five percent and 74% of online adults feel better informed about national news and international news respectively, while 72% feel better informed about Kim Kardashian, Paris Hilton and the rest of American pop culture via the internet and cell phones.

The vast majority of survey respondents, Pew found, believe that their use of the world wide web helps them learn new things, stay better informed about topics of personal importance, and increases their capacity to share their ideas and creations with others.

In terms of traffic generated, all this appreciation for information at the swipe of a finger or click of a mouse also means that the United States is a leader in digital traffic generation.  This is what Bret Swanson, visiting fellow at the American Enterprise Institute, described in a piece for The Wall Street Journal.  According to Mr. Swanson’s findings, the U.S. generates far more traffic per capita and per internet user than any other major nation except South Korea.  The U.S. generates 18.6 billion gigabytes of traffic per month and U.S. traffic is 2.1 times that of Japan and 2.7 times that of Western Europe.  Per capita consumption of digital goods is up 48% since 2007.  With only four percent of the world’s population, the U.S. consumes 32% of consumer internet traffic.

All this consumption and growth in the digital content marketplace happened without Title II or net neutrality regulation.  I have yet to hear an argument that says Title II increases consumer demand for data or even increases the delivery of additional infrastructure.  .

The liberty to choose content based on value is what civil rights groups should rally on

The civil rights perspective regarding broadband access is severely misplaced.  The narrative in general has been that access to information exchanged over a medium based on internet protocol is a civil right; an enforceable right or privilege guaranteed by the U.S. Constitution which when interfered with by another gives rise to am action for an injury. Civil rights belong to an individual by virtue of citizenship, especially the fundamental freedoms and privileges guaranteed by the 13th and 14th amendments.

The last time I checked the U.S. Constitution, there was no language in there that expressly supports my access to a communications medium powered by internet protocol.  The Constitution didn’t even guarantee U.S. citizens access to communications networks powered by smoke signals, the telegraph, or even the telephone.  One could argue that in today’s modern telecommunications world that the Communications Act of 1934′s mandate that the Federal Communications Commission ensure the a nationwide communications network universally accessible by all Americans creates that right.  I would argue that it doesn’t and that the Act’s supporters in Congress got lucky in that the universal accessibility requirement of the Act was not challenged.

In some ways I’m surprised that Free Press or Public Knowledge have not turned the NAACP or the National Urban League’s “broadband is a civil right” argument into a “right to access a common carrier” argument thus buttressing their incorrect argument that broadband should be regulated as a Title II common carrier or public utility.  Ironically some civil rights groups like ColorofChange.org and the National Hispanic Media Coalition support public utility-like regulation of broadband and could likely add fuel to Free Press or Public Knowledge’s positions.  Unfortunately for Free Press and Public Knowledge their accusations that legacy civil rights groups are nothing but money-taking hacks for phone and cable companies has provided enough of a taint that most civil rights groups, no matter their position on net neutrality, would prefer stand closer to a spraying skunk that ally with Free Press or Public Knowledge.

Rather than risk getting to close to the edge of inadvertently pushing broadband into a common carrier box, civil rights should push a purer market-based consumer welfare argument when it comes to broadband in general and net neutrality in particular.  Their policy statement should be that federal and state government should not interfere with a consumer’s choice to have certain content delivered to their broadband-enabled devices and recognize that the consumer can enter agreements with internet access providers and content providers based on the value the consumer recognizes in particular content.

Rather than push a civil rights argument that has consumers asking for the government to define access rights, civil rights advocates should take the position that the liberty of consumer choice is a given and that public policy should recognize and respect that.

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Wheeler’s speech to venture capitalists should leave them a bit concerned

Posted November 6th, 2014 in Broadband, digital divide, economy, Federal Communications Commission and tagged by Alton Drew

“Competition, competition, competition”, chanted Federal Communications Commission chairman Tom Wheeler during remarks before the Mid-Atlantic Venture Association, a trade group of venture capitalists.  Mr. Wheeler stuck to the usual theme of competition in broadband access, an open internet, and the availability of spectrum.

Mr. Wheeler, a former venture capitalist, reminded the audience that as the chief executive officer of the federal government’s “network agency”, he was also responsible for optimizing the public’s interest in public safety, competition, and consumer choice.  What would have been more helpful is if Mr. Wheeler adequately fleshed out how the FCC intended to create a competitive market place for broadband access networks.

Just based on the definition of competition I don’t see how the FCC can introduce more competition in either market short of literally determining which and how many players can participate as producers and how many citizens can participate as consumers.  In addition, given the dynamism of the broadband access market, I don’t see why the FCC should be concerned about intervening in markets in order to bring about competition in the first place.

Michelle Connolly and James E. Prieger analyzed broadband market data from the FCC and determined that for the period 2005-2008 there was a tremendous amount of simultaneous entry into and exit out of the broadband markets.  On the national level, broadband market entry rates were between 14% and 19%, rates that are greater than many other industries.  When you account for exit rates at the national level, net rate of entry was determined as approximately 3.1% per year.

When the broadband access market is shrunk down to local levels including zip codes, entry rates increase.  Another dynamic, according to the findings of Connolly and Prieger, is the size of new entrants and firms that survive market entry.  They tend to be the larger firms on average and enter new markets via different tiers or packages of service.  The authors also found that entry and exit activity lessened with the maturity of a market.

When I consider barriers to market entry faced by broadband access providers, I’m not surprised that larger firms contribute significantly to entrance into and viability in a market.   Progressive proponents of competition tend to delete from the discussion economic and regulatory impediments to market entry.  New entrants have to consider sizes of local markets and average income in an area.  Education and age profile also impact broadband access service penetration, according to Connolly and Prieger.  Population density and topography impact deployment of services in rural areas.  Also, in my experience, franchising requirements, such as rights-of-way fees or access channel requirements for broadband operators that provide cable create a barrier to entry for smaller, less financially able companies.

There is also research that describes how competition can be delayed where potential entrants into a vacant market may think twice about entry if they have determined that the market will become contestable due to potential of growing demand.  In other words, according to analysis by Mo Xiao and Peter Orazem, a potential entrant may look for a market where demand is not as high, creating a monopoly or entering an oligopoly that keeps out other entrants.  It may not be worth the expenditure of profits to fight off new entrants into a vacant, high demand market first the first few market entrants.

What kind of policies should the FCC create to increase the number of broadband access provider entrants into a market where smaller companies may not have the scale or financial wherewithal to stay in a market?  Will the FCC continue to subsidize these firms?  If so, what type of support will the FCC give to the consumer?  Demand has to want supply.

And where potential entrants are thinking twice about dipping their toes into a contestable market because of the fear of profit erosion in a relatively near future, will the FCC pursue a policy of subsidizing potential lost profit resulting from the very competition the “network agency” espouses?

Only by honestly grasping the reality that having three or four competitors in a market is not a bad thing will the FCC be able to get off of the competition rant and focus on more important issues such as spectrum allocation and ensuring that section 706 is the only basis for any regulation of broadband access.