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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.

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Would shifting to an internet-pipe only service get broadband providers out of the FCC’s cross-hairs?

Recently The Wall Street Journal reported on Viacom’s CBS and Time Warner’s HBO’s intent to establish a stand-alone streaming service for their content.  For cord cutters that dream of putting together their own portfolio of video content, this may seem like the a la carte approach that consumers and policymakers have been asking for.  While these moves are not indicative of a tsunami of movement by programmers from traditional cable, I have to wonder what the media world would look like if all content providers took the Netflix, over the top approach to getting programming to the consumer.  What would be the new consumer behavior?  Would net neutrality become a non-issue?

Regarding consumer behavior, consumers may feel emboldened by this increase in consumer choice, especially given the cost of cable service.  According to data from the Federal Communications Commission, as of January 1, 2013, the average price for cable service in all communities is $64.41.  Where there is effective completion, average price for cable service is $63.03, but where effective competition is non-existent, average price is $66.14.

I can see consumers combining Netflix programming at $8 per month with ESPN at $30 per month; CBS at $6 per month; and AMC at $10 per month.  I can’t pass up on “The Walking Dead.”  I agree with The Journal article’s conclusion that cord cutting may become more expensive than traditional bundling packages.  This becomes apparent when you look at the stand alone prices for internet access.

Again, according to data from the FCC, the price for stand-alone, 1-5 Mbps, internet access service is $35.  Consumers that want faster service ranging from 5-15 Mbps pay on average $44, while consumers feeling the need for more speed ranging from 15-25 Mbps pay on average $56.50.

If consumers make the decision solely on price, I don’t see much migration from current bundling options for cable.  According to an article in ArsTechnica.com, American cable subscribers receive an average of 189 cable channels but only watch 17 of them.  Assuming consumers could subscribe to 17 stand alone streaming internet channels at a price of $6 per channel, plus the broadband capacity sufficient for streaming video, consumers would still pay over $100 for service while given up 170 channels.  That may be okay for some subscribers if exercising consumer choice through a la carte service is that important to them.

If I’m paying that much to stream “Game of Thrones” strictly via the internet, I don’t want my service slowed down because my video bits have the same priority as a cat video on YouTube.  I would be willing to designate which content traffic should get higher priority to ensure that I see whether the Lannisters win the Iron Throne.  Netflix, HBO, or Viacom may not want the quality of their services degraded either due to equal treatment of their traffic and the traffic from a website showing the best way to apply lipstick.  This emerging on-demand/streaming model for video may see consumers driving the demand for paid prioritization.

Seeing how the FCC would manage the political fallout from telling consumers that consumer prioritization is a no-no would be very interesting.  Telling Viacom that it cannot meet consumer demand by entering prioritization agreements with backbone or last-mile broadband operators on the premise that such arrangements would put a cat video at a disadvantage would have content providers thinking twice about innovation in online video distribution.

As Hal Singer shared with me in a tweet, net neutrality is a Trojan Horse and Title II regulation is the end game.  I don’t see either approach advancing CBS or HBO’s new services.

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Random thoughts on consumer choice of content

Progressives have expressed concerns about consumer access to content of their choice; that decisions to access lawful content not be undermined by the end-user’s broadband access provider.   Consumer choice implies that the consumer has placed some value on the content he or she wants to receive.  One consumer may place a greater value on using their bandwidth to reading up-to-the-minute press releases on PR Newswire and business news content.  Another consumer in Florida may place greater value on gaming with his friends in Wisconsin.  Should net neutrality proponents be concerned about a consumer’s value-maximizing decision where the very small websites that net neutrality proponents claim to advocate for are not accessed as a result of consumer versus broadband provider “blocking?”

Utility or value maximization is nary mentioned by net neutrality proponents.  They have beaten around the bush by discussing it indirectly in the guise of non-discrimination or non-blocking principles.  Saying non-blocking or non-discrimination provides a false sense of speaking truth to power by putting the “bad guy” taint on broadband providers.  It also helps to embolden their status with their constituency, the consumers who believe that a handful of documented net neutrality violations is indicative of how broadband providers will behave even when millions if not billions of transactions occur every day without a net neutrality hitch.

But highlighting actual consumer choice, a consumer’s ability to place higher priority of certain websites over other content doesn’t seem to be the progressives’ cup of tea.  An enhanced analysis of the content markets should have as an issue whether consumers can make this type of choice and whether public policy should encourage it.  My bet is that progressives prefer consumer choice light versus strong, robust consumer choice.

The reason why this proper market analysis won’t be entertained by net neutrality proponents goes back to the “V” word; value.  Small content providers don’t have much in capital or time to garner the traction and eyeballs that larger, more entrenched content providers have.  It’s the economics of net neutrality.  Larger content providers have sunk millions into the marketing necessary to gain traffic.  Some are merely leveraging their legacy infrastructure.  For example, I’m a fan of The Economist.  Not only do I subscribe online, but I also get the print version so that I can read it on the plane or MARTA rail.  The Economist leverages its print reputation to attract readers online.  Online magazines that can establish pay walls and maintain loyalty with superior content will make revenues, hopefully have profits, and maintain barriers to entry.

Unfortunately for the smaller content providers progressives are so concerned about, energy is being directed toward a public policy initiative that won’t do anything for their marketing or their profit.  It’s also unfortunate that nary one of the grass roots advocacy groups pushing net neutrality have made a cogent economic argument that could give the Commission any proper guidance.

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Losing the Internet global market for the broadband access trees

The New York Stock Exchange Tech-Media-Telecom Index fell 101.46 points or 1.35%, partly on news that the European economy was worse for wear.  Equity investors ran for the debt-income hills choosing to move their stash into government bonds.

I don’t think the fall in the tech, media, telecom sector had much to do with comments made today by panelists participating in a Federal Communications Commission forum on the law and economics of net neutrality.  The takeaway from that panel for most was that no matter what net neutrality rules the FCC comes up with, whether based on Title II, section 706, or some ungodly pairing of the two, there will be blood in the form of litigation.

The other takeaway in my opinion is how so far the FCC has completely ignored the opportunity to describe how regulation, especially under a Title II regime, is supposed to help maintain optimum performance of a globally competitive interconnection of 67,000 networks when a significant portion of the globe is experiencing an inept economic performance.

If economic performance stays this sluggish worldwide, information services companies will have to really emphasize to consumers the value of their content and information products if they are to stay afloat.  But when the FCC is seriously contemplating codifying a policy that would give equal treatment of a video of a dancing cat with life-saving online medical services, it is difficult to see capital and investment moving freely to activity that brings the most value.

Morningstar notes that the FCC’s tough stand on competition and net neutrality has deflated the value of wireless Internet access platform providers, casts doubt on pending acquisitions of DirecTV and Time Warner Cable, and lessens the chances of Sprint and T-Mobile walking hand-in-hand down the mergers and acquisitions aisle.  According to Morningstar, the inability to consolidate may make Sprint and T-Mobile’s ability to garner additional spectrum or eek out a profit all the more difficult.

If the FCC wants to maintain its economic regulation focus on the providers of broadband access platforms while positively impacting the end-to-end global nature of the Internet, it may want to ease up on the “consolidation is bad” mantra and either stick to a broadband policy based on section 706 or better yet abandon rulemaking on the Open Internet altogether.

 

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Broadband, capital, and the politics of the ignorant

Broadband is capital that is used by information service providers to produce an information service.  It is the copper, fiber, cable, electronics, and software created, deployed, and used as capital inputs in the production of information services that end-users eventually consume.  By extension the Internet is also an input in the production of information services.  The cables, routers, and servers on the Internet connect over 67,000 global networks making it possible to create and sell information.

By information services, I refer to services that either generate, store, or provide end-user access to content.  This would include broadband access operators such as Verizon or Comcast; router and server providers such as Cisco; back haul providers such as L-1; Internet search engines such as Yahoo or Google; and content providers such as Netflix or Hulu. They all use broadband capacity and the Internet as inputs for the production of information services.

End users or consumers buy information services for final consumption.  They are not using fiber, cable, copper, software, or network electronics to create anything.  They have no property claim or property interest in these components.  Many end-users have no clue as to how these inputs are used much less could define them.  All they know is that they point and click on a link to get their information on current events, gossip, or the recipe for making holiday season rum cakes.

Unfortunately the noise from net neutrality proponents, specifically those pushing Title II regulation of the subset of information services providers known as broadband operators, has obscured this view of broadband as a capital input.  In addition claiming that broadband is a civil right or platform for promoting social justice is also misleading and clouds the discussion.

And the Federal Communications Commission is doing nothing to clear the air on the issue, choosing instead to fan the flames of ignorance surrounding what broadband truly is, a mere input in the production of a service.

The Commission and net neutrality/Title II proponents make this mistake easily because they fail to identify the appropriate market for analysis; the information market.  We develop, deploy, and maintain our communications networks for that sole purpose, to facilitate information exchange.  Because information is a prime component in our knowledge economy, public policy’s main focus should be on how best to promote the deployment of capital so that the exchange of information becomes easier and faster.

Net neutrality/Title II proponents may rebut this line of reasoning by saying that putting into code the principles of transparency of network management, non-discriminatory treatment of content traffic, and no blocking of access to websites of choice based on Title II is the best way to ensure information flows across 67,000 globally interconnected networks.  I beg to differ.

Title II regulation does not address the basic market components of demand and supply for information.  Demand for news, entertainment, and advice drives the supply of information.  A priori, this demand never recedes.  It continually increases.  The economy, in particular the information markets, have created a way to supply increasing demand for information by funding the development and deployment of capital inputs that make accessing and delivering information easier and more efficient.

Title II’s focus is on price regulation and transparency of agreements between network operators.  Title II’s language says nothing about the demand for information services.  Title II does not say anything about encouraging the supply of information services nor does it speak to leveraging of capital inputs to supply services.

Title II’s primary objective is to ensure that in a monopoly market for voice telecommunications that the consumer of voice communications gets a fair and reasonable rate for her voice service and the Commission is aware of all network operators involved in delivering voice services.

Title II is not a public policy tool for the 21st century.  It’s time for the Commission to diffuse the narrative that end users have the right to tell private parties how to leverage capital inputs used for providing a commercial service in a free market.  Diffusing this narrative is easier if the Commission properly describes what broadband and the Internet really are and focus on the true market for analysis: the information markets.

Once the Commission realizes that this is the market that should be promoted and that the private sector has been doing a great job in building the networks necessary for information to flow, maybe then we’ll start moving in the right policy direction.