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The FCC’s IP transition order doesn’t slow down data markets, yet

The Federal Communications Commission approved an order yesterday that provides broadband operators with requirements for how they should approach the transition from analog-based networks to 21st century internet protocol networks.  The FCC’s focus was, as expected, on the impact the transition would have on consumers.  Broadband providers are to provide consumers with three months notice of any plans to replace copper with fiber.  Broadband providers are to give interconnecting carriers six months notice of a transition from plain old copper to fiber.

FCC member Ajit Pai raised the argument in a dissent to the order that the FCC’s notice requirement would have a negative impact on the deployment of fiber facilities and investment of capital.  He says:

“First, by dragging out the copper retirement process, the FCC is adopting regulations that ‘deter rather than promote fiber deployment.’”  Mr. Pai questions the logic of requiring capital be invested in maintaining old legacy networks when the deployment of fiber could remedy issues presented by an aging copper network.

FCC member Michael O’Rielly warned edge providers in his dissent that they would be negatively impacted by the requirement that broadband providers seek permission first from the FCC before discontinuing a legacy service.  ”Every communications and edge provider better think long and hard before introducing new services because you may be locked in to providing them for a very long time.”

The irony is that by forcing broadband providers to maintain legacy networks to end users, the FCC runs the risk of creating the degradation of service it hoped to avoid when it implemented its net neutrality rules.  Take for example the FCC’s findings in its 2010 Open Internet Order.   In the order the FCC describes the “virtuous cycle of innovation” that is spawned by the openness of the Internet.[1]

“This openness promotes competition.  It also enables a self-reinforcing cycle of investment and innovation in which new uses of the network lead to increased adoption of broadband, which drives investment and improvement in the network itself, which in turn lead to further innovative uses of the network and further investment in content, application, services, and devices.  A core goal of this Order is to foster and accelerate this cycle of investment and innovation.”

The FCC went on to point out in the 2010 Order that a lack of transparency in terms of network management put edge providers at risk especially where a broadband provider’s activity led to blocking or degrading of content.  The irony is that while the FCC appears focused like a laser beam on promoting competition in the provision of broadband services by making legacy networks available for use by interconnecting and competitive carriers, it has taken its eye off of the real competition on the internet, namely between edge providers that aggregate, display, and distribute data.  These edge providers want their exchange of data to traverse high-speed networks from their location to the end-users.  While their business models may not be directly impacted in the very short run by the FCC’s IP Transition Order, in the immediate run they may find users unwilling or unable to subscribe to their services because deployment by broadband providers of last-mile high-speed facilities are being delayed by the FCC’s latest notice requirements.

1.Federal Communications Commission. Open Internet Order. 2010. https://apps.fcc.gov/edocs_public/attachmatch/FCC-10-201A1_Rcd.pdf

 

 

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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.

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Taxation, broadband adoption, and edge provider doo doo

Posted August 1st, 2014 in Broadband, capital, edge providers, Internet, taxes and tagged , , , by Alton Drew

Last week, the U.S House of Representatives gave edge providers a little love when the Republican-controlled chamber of Congress voted to make permanent a 1998 moratorium on Internet taxes.  The moratorium, scheduled to expire on 1 November 2014, prohibits states or their political subdivisions from imposing taxes on Internet access or from applying multiple or discriminatory taxes on electronic commerce.  The bill, H.R. 3086, is now in the U.S. Senate waiting for their review.

Needless to say, state and local governments have their underwear in a bunch over the bill.  According to congressional estimates, states and local governments stand to lose hundreds of millions of dollars annually should the moratorium become permanent.  For example, the Center on Budget and Policy Priorities argues that Congress has no business trying to boost the consumption of Internet access at the expense of state and local revenues.  The Internet, according to the Center, is no longer the nascent industry that needs exemption from taxation in order to grow and flourish.

States that may be particularly hit the hardest are the states who were taxing Internet transactions before the moratorium was put in place and right before the first Internet bubble popped. These states collect taxes under a grandfather clause in the moratorium and include Hawaii, New Mexico, North Dakota, Ohio, South Dakota, Texas, and Wisconsin.  In addition, Tennessee, Washington, and New Hampshire may also collect taxes but currently do not do so.

The National League of Cities argues that current tax policy advantages online retailers at the expense not only of revenue collection by localities but of main street retailers as well.  In a statement released last June, the NLC argued that “Main Street retailers are the backbone of our local communities.  These Brick and mortar shops need Congress to end the special tax status for online retailers and allow for fair competition.”

While the arguments made by the critics tug at the heartstrings, or I should say, reverberate the fiscal purse strings, they fail to take into account Congress’ responsibility to regulate commerce, the impact a failure to make permanent the moratorium will have on capital flow to edge providers, the very drivers of the Internet eco-system, the incentives presented to edge providers to move offshore that increased taxes would create, and the negative impact Internet taxes would have on broadband access adopters, the very adopters that create the derived demand necessary for a flourishing Internet eco-system.

First, Constitutional Law 101.  The Congress has the power to regulate commerce among the states.  The Internet is the conduit through which electronic commerce traverses and given the redundancy and virtual characteristics of the protocol that pushes data across some 67,000 globally connected computer networks, I think it’s safe to say that, at least inside the United States, the U.S. Congress has the option of regulating the Internet in a manner that promotes the consumption of Internet access.

Second, Economics 101.  The real backbone of any economy, whether local, regional, or national are the consumers, not the retailers.  Demand for goods and services are derived from consumer demand and more and more consumers are demanding goods and services via the Internet and at speeds that only high-quality broadband networks can provide.  Kimberlee Morrison, in a post for SocialTimes, reports that e-commerce is a $220 billion industry driven by consumers that search online for products before either entering into brick-and-mortar stores to make a purchase or just purchasing online.

Chuck Jones, in a piece for Forbes.com, wrote last fall that mobile commerce or m-commerce is expected to grow to over $100 billion in sales in 2017, up rather appreciably from the estimated $47 billion in 2013.

In a sluggish recovery where 70% of gross domestic product is driven by personal consumption, why would municipalities and states want to retard the level of consumer spending online with taxes?  And given the overindexing of people of color that use mobile broadband to access services online, is imposing a tax on Internet sales good economic policy?

According to the Pew Research Center’s Internet Project, 92% of African American adults have a cell phone and 56% of black adults have a smartphone.  Mobile broadband access is the primary mode for accessing electronic commerce as evidenced by lower adoption rates among blacks for broadband at home.  Pew reports that while 87% of white Americans make use of the Internet, 80% of blacks are traveling the information superhighway.  The gap in broadband access is wider, where 74% of whites have adopted broadband at home while the percentage of blacks who are wired at home comes in at 62%.

But Internet taxation does not only impact consumption of e-commerce or broadband adoption by people of color.  It impacts providers of services on the edge.  On one extreme is Internet information and content provider Yahoo!, a multinational corporation based in Sunnyvale, California.  Yahoo! is known primarily as a search engine, providing consumers with financial, entertainment, and cultural content.

Taxation is a threat to Yahoo!’s bottom-line according to its most recent 10-K filing.   Yahoo! notes in their 10-K that they may have exposure to additional tax liabilities which could potentially impact their income tax provision, net income, and tax flow.  Newly enacted tax law could have a materially adverse impact on the company’s cash flow.  Yahoo! cites the possibility of several jurisdictions seeking to increase government revenues by either taxing Internet advertising revenues or by increasing general business taxes.

Smaller players would not be immune from this threat according to Melbourne, Florida-based entrepreneur, web designer, and software engineer Maurice Newton.  Mr. Newton puts it succinctly and colorfully.  “The tax is a big factor.  Some companies will even go offshore to save money.  The FCC is up to their ears in edge provider doo doo and the smoke will not clear for a long time.”

The U.S. Senate needs to follow the House’s lead and listen to Internet entrepreneurs, the industries larger players, and the consumers that use broadband to access services.  A permanent moratorium on taxing Internet access will keep businesses here in the U.S. while encouraging further broadband adoption.

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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.