An Abridged History of Open Internet Regulation and Its Policy Implications (w. Kendall Koning)

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On June 14, 2016, the United States Court of Appeals for the District of Columbia (D.C. Circuit) upheld the FCC’s 2015 network neutrality regulations, soundly denying myriad legal challenges brought by the telecommunications industry (U.S. Telecomm. Ass’n v. FCC 2016).  Thus, unless the Supreme Court says otherwise, Congress rewrites the rules, or INSERT TRENDING CELEBRITY NAME truly breaks the Internet, we can expect to receive our lawful content without concerns that it would be throttled or that the content provider paid a termination fee.  How did we get here?  As my colleague Kendall Koning, a telecommunications attorney and Ph.D. candidate at the Department of Media and Information at Michigan State and I lay out in this blog post outlining the history of net neutrality regulation, it has been a long road.

A short Quello Center Working Paper covering substantially the contents of this blog post is available at: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2797366

The most recent D.C. Circuit case represented the third time that FCC network neutrality rules had been before that court, the first two having been struck down on largely procedural grounds.  The FCC’s 2015 Open Internet Order remedied these flaws by formally grounding the rules in Title II of the Telecommunications Act (47 U.S.C. § 201 et. sq. 2016) while simultaneously exercising a separate forbearance authority to exempt ISPs from some of the more restrictive rules left over from the PSTN era.

The U.S. Telecommunications Association (USTelecom), a trade group representing the nation’s broadband service providers along with various other petitioners, had challenged the FCC’s Order on a number of grounds.  USTelecom’s central challenge echoed earlier arguments that ISPs don’t really offer telecommunications, i.e., the ability to communicate with third parties without ISPs altering form and content, but an integrated information service, where ISP servers exercise control over the form and content of information transmitted over the network.  As explained below, this perspective was a historical artifact from the era of America Online and dial-up ISPs, but had been used successfully at the start of the broadband era.  In a stinging rejection of ISP arguments, the D.C. Circuit not only found that the FCC’s reclassification of Internet access as telecommunications was reasonable and within the bounds of the FCC’s discretionary authority but offered a strong endorsement of this perspective (U.S. Telecomm. Ass’n v. FCC supra at 25-26):

That consumers focus on transmission to the exclusion of add-on applications is hardly controversial. Even the most limited examination of contemporary broadband usage reveals that consumers rely on the service primarily to access third-party content . . . Indeed, given the tremendous impact third-party internet content has had on our society, it would be hard to deny its dominance in the broadband experience. Over the past two decades, this content has transformed nearly every aspect of our lives, from profound actions like choosing a leader, building a career, and falling in love to more quotidian ones like hailing a cab and watching a movie. The same assuredly cannot be said for broadband providers’ own add-on applications.

The Rules, What are They Good For?

At present, the FCC states that its current Open Internet rules “protect and maintain open, uninhibited access to legal online content without broadband Internet access providers being allowed to block, impair, or establish fast/slow lanes to lawful content.”  In particular, the present rules make clear the following three conditions, each of which is subject to a reasonable network management stipulation (FCC 2015 ¶¶ 15-18):

  1. No Blocking: A person engaged in the provision of broadband Internet access service . . . shall not block lawful content, applications, services, or non-harmful devices . . . .
  2. No Throttling: A person engaged in the provision of broadband Internet access service . . . shall not impair or degrade lawful Internet traffic on the basis of Internet content . . . .
  3. No Paid Prioritization: A person engaged in the provision of broadband Internet access service . . . shall not engage in paid prioritization . . . [—the] management of a broadband provider’s network to directly or indirectly favor some traffic over other traffic . . . either (a) in exchange for consideration (monetary or otherwise) from a third party, or (b) to benefit an affiliated entity.

These rules are, to a degree, a modern version of common carrier non-discrimination rules adapted for the Internet.  47 U.S.C. §201(b) requires that “all charges, practices, classifications, and regulations for . . . communication service shall be just and reasonable.”  Whereas in the United States, these statutes date back to the Telecommunications Act of of 1934, common carrier rules more generally have quite a long history, with precursors going as far back as the Roman Empire (Noam 1994).  One of the purposes of these rules is to protect consumers from what is frequently deemed unreasonable price discrimination: if a product or service is critically important, only available from a very small number of firms, and not subject to arbitrage, suppliers may be able to charge each consumer a price closer to that consumer’s willingness to pay, rather than a single market price.

Consumers of Internet services are not only individuals but also content providers, like ESPN, Facebook, Google, Netflix, and others, who rely on the Internet to reach their customers.  As a general-purpose network platform, the Internet connects consumers and content providers via myriad competing broadband provider networks, none of which can reach every single consumer (FCC 2010 ¶ 24).  The D.C. Circuit succinctly laid it out, writing (U.S. Telecomm. Ass’n v. FCC, supra at 9):

When an end user wishes to check last night’s baseball scores on ESPN.com, his computer sends a signal to his broadband provider, which in turn transmits it across the backbone to ESPN’s broadband provider, which transmits the signal to ESPN’s computer.  Having received the signal, ESPN’s computer breaks the scores into packets of information which travel back across ESPN’s broadband provider network to the backbone and then across the end user’s broadband provider network to the end user, who will then know that the Nats won 5 to 3.

Thus, when individuals or entities at the “edge” of the Internet wish to connect to others outside their host ISP network, that ISP facilitates the connection by using its own peering and transit arrangements with other ISPs to move the content (data) from the point of origination to the point of termination.

One of the key issues in the the network neutrality debate was whether or not ISPs where traffic terminates should be allowed to offer these companies, for a fee, a way to prioritize their Internet traffic over the traffic of others when network capacity was insufficient to satisfy current demand.  Many worried that structuring Internet pricing in this way would enable price discrimination among content providers (Choi, Jeon, and Kim 2015) and might have several undesirable side effects.

First, welfare might be diminished if prioritization results in a diminished diversity of content (Economides and Hermalin 2012).  Second, because prioritization is only valuable when network demand is greater than its capacity, selling prioritization might create a perverse incentive to keep network capacity scarce (Choi and Kim 2010; Cheng, Bandyopadhyay, Guo 2011).  Third, ISPs who offer cable services or are otherwise vertically integrated into content might use both of these features to disadvantage their competitors in the content markets.  In light of the risk that ISPs pursue price discrimination to defend their vertically integrated content interests, network neutrality can be seen as an application of the essential facilities doctrine from antitrust law (Pitofsky, Patterson, and Hooks 2002) to the modern telecommunications industry.

In response, broadband ISPs have claimed that discriminatory treatment of certain traffic was necessary to mitigate congestion (FTC 2007; Lee and Wu 2009 broadly articulate this argument).[1]  ISPs also claim that regulation prohibiting discriminatory treatment of traffic would dissuade them from continued investment in reliable Internet service provision (e.g., FCC 2010 ¶ 40 and n. 128; FCC 2015 at ¶ 411 and n. 1198) and even the FCC noted that its 2015 net neutrality rules could reduce investment incentives (FCC 2015 at ¶ 410).  Nevertheless, the FCC partially justified the implementation of net neutrality by noting that it believed that any potential investment-chilling effect of its regulation was likely to be short term and would dissipate over time as the marketplace internalized its decision.  Moreover, the FCC claimed that prior time periods of robust ISP regulation coincided with upswings in broadband network investment (FCC 2015 at ¶ 414).

How the Rules Came About?

The Commission’s Open Internet rules are far from the first time that the telecommunications industry has faced similar issues.  Half a century ago, AT&T refused to allow the use of cordless phones manufactured by third parties until it was forced to do so by a federal court (Carter v. AT&T, 250 F.Supp 188, N.D. Tex. 1966). The federal courts also needed to intervene before MCI was allowed to purchase local telephone service from AT&T to complete the last leg of long-distance telephone calls (MCI v. AT&T, 496 F.2d 214, 3rd Cir. 1974).  AT&T’s refusal to provide local telephone service to it’s long-distance competitor was deemed an abuse of its monopoly in local telephone service to protect its monopoly in long-distance telephone service, and featured prominently in the breakup of AT&T in 1984 (U.S. v. AT&T, 522 F.Supp. 131, D.D.C. 1982).  Subsequent vigorous competition in the long-distance market helped drive down prices significantly.

The rules developed for computer networks throughout the FCC’s decades long Computer Inquiries were also designed to ensure third party companies had non-discriminatory access to necessary network facilities, and to facilitate competition in the emerging online services market (Cannon 2003).  For example, basic telecommunications services, like dedicated long-distance facilities, were required to be offered separately without being bundled with equipment or computer processing services.  These services were the building blocks upon which the commercial Internet was built.

The rules that came out of the Computer Inquiries were codified by Congress in the Telecommunications Act of 1996, by classifying the Computer Inquiry’s basic services as telecommunications services under the 1996 Act, the Computer Inquiry’s enhanced services as information services under the 1996 Act, and subjecting only the former to the non-discrimination requirements of Title II (FCC 2015 at ¶¶ 63, 311-313; Cannon 2003; Koning 2015).[2]  In particular, 47 U.S.C. Title II stipulates that it is unlawful for telecommunications carriers “to make or give any undue or unreasonable preference or advantage to any particular person, class of persons, or locality, or to subject any particular person, class of persons, or locality to any undue or unreasonable prejudice or disadvantage (47 U.S.C. § 202(a) 2016).”

Internet access specifically was first considered in terms of this classification in 1998.  Alaska Sen. Ted Stevens and others wanted dial-up ISPs to pay fees into the Universal Service Fund, which subsidized services for poor and rural areas.  The FCC ruled that ISPs were information services because they “alter the format of information through computer processing applications such as protocol conversion” (FCC 1998 ¶ 33).  However, to understand this classification, it is important to keep in mind that ISP services at this time were provided using dial-up modems as the PSTN.  In other words, in 1998 the Internet was an “overlay” network—one that uses a different network as the underlying connections between network points (see, e.g., Clark et al. 2006).  If consumers’ connections to their ISPs were made using dial-up telephone connections, then USF fees for the underlying telecommunications network were already being paid through consumers’ telephone bills.

In this context, applying USF fees to both ISPs and the underlying network would have effectively been double taxation.  Additionally, the service dial-up ISPs provided could reasonably be described as converting an analog telecommunications signal (from a modem) on one network (the PSTN) to a digital packet switched one (the Internet), which is precisely the sort of protocol conversion that had been treated as an enhanced service under the Computer Inquiry rules.  The same reasoning does not apply to broadband Internet access service, because it provides access to a digital packet switched network directly rather than through a separate underlying network service (Koning 2015).  However, the FCC continued to apply this classification to broadband ISPs, effectively removing broadband services from regulation under Title II.

Modern policy concerns over these issues reappeared in the early 2000s when the competitive dial-up ISP market was being replaced with the broadband duopoly of Cable and DSL providers.[3]  The concern was that if ISPs had market power, they might deviate from the end-to-end openness and design principles that characterized the early Internet (Lemley and Lessig 2001).  Early efforts focused on preserving competition in the ISP market by fighting to keep last-mile infrastructure available to third-party ISPs as had been the case in the dial-up era.  However, difficult experiences with implementing the unbundling regime of the 1996 Act, differing regulatory regimes for DSL and Cable (local loops for DSL had been subjected to the unbundling provisions of the 1996 Act, but Cable networks were not; an analysis of the consequences of doing this can be found in Hazlett and Caliskan 2008), and the existence of at least duopoly competition between these two incumbents discouraged the FCC from taking that path (FCC 2002, 2005b).  Third-party ISPs tried to argue that Cable modem connections were themselves a telecommunications service and therefore should be subject to the common-carrier provisions of Title II.  The FCC disagreed, pointing to its classification of Internet access as an information service under the 1996 Act.  This classification was ultimately upheld by the Supreme Court in NCTA v. Brand X (545 U.S. 967, 2005).

Unable to rely on the structural protection of a robustly competitive ISP market, the FCC shifted its focus towards the possibility of enforcing an Internet non-discrimination regime through regulation.  During this time period, the meaning and ramifications of “net neutrality,” a term coined in 2003 (Wu 2003), became the subject of vigorous academic debate.  Under the computer inquiries, non-discrimination rules had applied to the underlying network infrastructure, but it was also possible for non-discrimination rules to apply to Internet service itself, just as they had been to other packet-switched networks (X.25 and Frame Relay) in the past (Koning 2015).  However, there was extensive debate over the specific formulation and likely effects of any such rules, particularly among legal scholars (e.g., Cherry 2006, Sidak 2006, Sandvig 2007, Zittrain 2008, Lee and Wu 2009).  Although to that point, there had been no rulemaking proceeding specifically addressing non-discrimination on the Internet, a number of major ISPs had agreed to forego such discrimination in exchange for FCC merger approval (FCC 2015 ¶ 65) and there was still a general expectation that ISPs would not engage in egregious blocking behavior.  In one early case, the Commission fined an ISP for blocking a competitor’s VoIP telephone service (FCC 2005a).  In 2008, the FCC also ruled against Comcast’s blocking of peer-to-peer applications (FCC 2008).  However, the Comcast order was later reversed by the D.C. Circuit (Comcast v. FCC, 600 F.3d 642, D.C. Cir. 2010).

In response to this legal challenge, the FCC initiated formal rulemaking proceedings to codify its network neutrality rules.  In 2010, the FCC released its initial Open Internet Order, which applied the FCC’s Section 706 authority under the Communications Act to address net neutrality directly (FCC 2010 ¶¶ 117-123).  Among other things, the 2010 Open Internet Order adopted the following rule (FCC 2010 ¶ 68):

A person engaged in the provision of fixed broadband Internet service, insofar as such person is so engaged, shall not unreasonably discriminate in transmitting lawful network traffic over a consumer’s broadband Internet access service.  Reasonable network management shall not constitute unreasonable discrimination.

However, these rules were struck down by the D.C. Circuit in January 2014 (Verizon v. FCC, 740 F.3d 623, D.C. Cir. 2014). The root of the problem was that the Commission had continued to classify broadband Internet access as an “information service” under the 1996 Act, where its authority was severely limited.  As the court wrote: “[w]e think it obvious that the Commission would violate the Communications Act were it to regulate broadband providers as common carriers. Given the Commission’s still-binding decision to classify broadband providers not as providers of ‘telecommunications services’ but instead as providers of ‘information services,’ [] such treatment would run afoul of section [47 U.S.C §]153(51): ‘A telecommunications carrier shall be treated as a common carrier under this [Act] only to the extent that it is engaged in providing telecommunications services (Verizon v. FCC, supra at 650).’”

The FCC went back to the drawing board and issued its most recent Open Internet Order in 2015.  This time, the Commission grounded its rules in a reclassification of Internet access service as a Title II telecommunications service.  Moreover, unlike in the 2010 Order, which only subjected mobile broadband providers to a transparency and no blocking requirement (FCC 2010 ¶¶ 97-103), the Commission applied the same rules to providers of fixed and mobile broadband in the 2015 Order (FCC 2015 ¶ 14).

In contrast to information services, telecommunications services are subject to Title II common carrier non-discrimination provisions of the Act (FCC 2005b at ¶ 108 and n. 336).  As discussed above, these statutes expressly address the non-discrimination issues central to the network neutrality issue.  The reclassification permitted the Commission to exercise its Section 706 authority to implement the non-discrimination rules codified in Title II (FCC 2015 ¶¶ 306-309, 363, 365, 434).  On June 14, 2016, the D.C. Circuit upheld the FCC’s Open Internet rules as based on this and other statutes from Title II, 47 U.S.C. § 201 et. sq.

The Future of Net Neutrality

Although the Commission’s long evolving Open Internet rules appear to have found a solid legal grounding, it is important to understand that they are not without limits.  For instance, crucially, the rules stipulate what ISPs can and cannot do at termination, whereas they do not restrict the terms of interconnection and peering agreements with ISP networks (FCC 2015, ¶ 30).  Critically, in contrast to what HBO’s John Oliver might conclude from the FCC’s recent court victory, the Order does not prevent ISPs such as Comcast from requiring payment for interconnection to their networks; it merely subjects interconnection to the general rule under Title II that the prices charged must be reasonable and non-discriminatory.  Rather than making any prospective regulations on interconnection itself, the FCC’s 2015 Order leaves those issues open for future consideration on a case-by-case basis (FCC 2015, ¶ 203).

Additionally, academics are far from a consensus regarding the welfare implications of net neutrality.  When handing out judgement, the D.C. Circuit was careful to point out that its ruling was limited by a determination of whether the FCC has acted “within the limits of Congress’s delegation” (U.S. Telecomm. Ass’n v. FCC, supra note 1 at 23) of authority, and not on the economic merits or lack thereof of the FCC’s Internet regulations.[4]  In contrast to some of the aforementioned theoretical economics articles, there are a number of theoretical studies that find the type of quality of service tiering that is ruled out by the 2015 Order is likely to result in higher broadband investment and increase diversity of content (Krämer and Wiewiorra 2012; Bourreau, Kourandi, Valletti 2015), or for that matter, that under certain circumstances, it may not matter at all (Gans 2015; Gans and Katz 2016; Greenstein, Peitz, and Valletti 2016).  The empirical economic literature on net neutrality is at a very early stage and has thus far mostly focused on the consequences of other regulatory policies that might be likened to net neutrality regulation (Chang, Koski, and Majumdar 2003; Crandall, Ingraham, and Sidak 2004; Hausman and Sidak 2005; Hazlett and Caliskan 2008; Grajec and Röller 2012). To the extent that economists and other academicians reach some consensus on certain aspects of broadband regulation in the future, the FCC may be persuaded to update its rules.

Finally, the scope of the existing Open Internet rules remains under debate.  For instance, public interest group, Public Knowledge, recently rekindled the debate regarding whether zero rating (alternatively referred to as sponsored data plans) policies that exempt certain content from broadband caps imposed by certain providers constitute a violation of Open Internet principles (see Public Knowledge 2016; Comcast 2016).  Although the Commission has not ruled such policies out, in the 2015 Order, it left the door open to reassess them (FCC 2015, ¶¶ 151-153).

Signaling its concern about such policies, the FCC conditioned its recent approval of the merger between Charter Communications and Time Warner Cable on the parties consent not to impose data caps or usage-based pricing (FCC 2016 ¶ 457).  Academic research on this topic remains scarce.  Economides and Hermalin (2015) have suggested that in the presence of a sufficient number of content providers, ISPs able to set a binding cap will install more bandwidth than ones barred from doing so; to our knowledge, economists have not rigorously assessed zero rating and the FCC continues its inquiry into these policies.


[1] It should be noted that notwithstanding these claims, congestion control is already built into the TCP/IP protocol.  Further, more advanced forms of congestion management have been developed for specific applications, such as buffering and adaptive quality for streaming video, that allow these applications to adapt to network congestion.  Whereas real-time network QoS guarantees could be useful for certain applications (e.g., live teleconferencing), these applications represent a small share of overall Internet traffic.

[2] The categorizations embodied by the Computer Inquiries decisions initially stemmed from an attempt to create a legal and regulatory distinction between “pure communications” and “pure data processing,” the former of which was initially provisioned by an incumbent regulated monopoly (primarily AT&T), and the latter of which was viewed as largely competitive and needing little regulation.  The culmination of these inquiries implicitly led to a layered model of regulation, dividing communication policy into (i) a physical network layer (to which common carrier regulation might apply), (ii) a logical network layer (to which open access issues might apply), (iii) an applications and services layer, and (iv) a content layer (Cannon 2003 pp. 194-5, Koning 2015 pp. 286-7).

[3] One 1999 study found a total of 6,006 ISPs in the U.S.  See, e.g., Greenstein and Downes (1999) at 195-212.

[4] In particular, the Court wrote, “Nor do we inquire whether `some or many economists would disapprove of the [agency’s] approach’ because ‘we do not sit as a panel of referees on a professional economics journal, but as a panel of generalist judges obliged to defer to a reasonable judgement by an agency acting pursuant to congressionally delegated authority.”

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Price-Matching Advertisements and Consumer Search

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The only programs I watch on TV with any regularity are cooking competitions like Chopped and American Football, so I find it somewhat odd that I have seen the same Toys “R” Us commercial advertising the toy retailer’s price-matching guarantee as many times as I have.  Perhaps I have been watching too much Chopped Junior.  In the commercial, a creepy children’s toy informs Optimus Prime that if potential consumers find him for a lower price at a competing retailer, Toys “R” Us will match the lower listed price (see it here).  Optimus Prime is impressed not by the seemingly great deal, but by the existential realization that as a toy, he is not unique in our world.

When I first saw that commercial, my first though was, “I have a publication coming out about the practice of price-matching guarantees, AWWWESOME!!!” (this sentence is funnier after watching the commercial).  My next though was, “it would benefit consumers more if retailers competed by lowering prices than pretended to compete by using price-matching guarantees.” I explain below.

As my co-author, Brady Vaughan, and I show in our paper, “Price-Match Announcements in a Consumer Search Duopoly,” forthcoming in the Southern Economic Journal, although advertisements emphasizing retailers’ price-matching guarantees appear to be pro-competitive, price-matching guarantees actually tend to lessen firms’ incentives to lower price.  The intuition behind our main result is as follows.  Suppose that consumers vary in their propensity to shop around for price.  We might for instance think of individuals as valuing their scarce time differently, leading some to feel that their incremental cost of uncovering an additional sample price (i.e., by visiting an additional store), is higher than that of others.  In such a setup, firms face two competing forces when setting their prices: they are inclined to lower prices to attract consumers who tend to shop around for the lowest price, and to raise them in an attempt to take advantage of consumers who find the activity of price comparison too time consuming to bother with (see Varian 1980, Stahl 1989 for the mathematical details behind this outcome).  Price dispersion ensues: firms run sales of different magnitudes in an effort to maximize profits.

Now consider what happens when firms offer price-matching guarantees.  Suppose that those consumers who find it worthwhile to shop around literally go store to store in search of price (this is not the only way to explain our results, but we find it to be one that aides intuition).  Some of these consumers will end their search at a store that does not list the lowest price.  Without a price-matching guarantee, if these consumers wish to procure the good at the lowest possible price observed, they will have to go back to the store with the best offer.  But if the last store they visit offers a price-matching guarantee, they can get the lowest price there instead.  Knowing this, firms realize that they won’t be able to win over as many price conscious consumers with deep discounts, so their incentive to run sales diminishes, leading to higher average prices.

Sound like a roundabout explanation?  Brady and I are far from the first to suggest that price-matching guarantees can diminish competition and some of the earliest explanations seem downright obvious: price-matching guarantees keep firms from lowering prices because rival firms immediately match price-cuts (see Hay 1982, Salop 1986, Doyle 1988).  However, I think that Brady and I have made a fairly cogent argument that takes into consideration how consumers behave and also accounts for the myriad advertisements firms undertake to inform consumers about their policies (here is one from Walmart, another from Toys “R” Us, and one from Staples).

This result begs the question, (i) have price-matching guarantees always been found to be anti-competitive and (ii) if so, can the anti-trust authorities reasonably do anything to prevent them?  The answer to question (i) is a no.  Although the bulk of the literature lends support to our findings, there are some notable explanations suggesting the contrary.  One that I find somewhat convincing when firms are differentiated is that price-matching guarantees can be a signal that a firm generally has lower underlying costs (perhaps it has negotiated better deals with merchants or doesn’t spend as much on its service quality) and consequently sets lower prices (see Moorthy and Winter 2006, Moorthy and Zhang 2006 for the details).  That is a theoretical argument.  The empirical literature is somewhat mixed, but typically strays to answer the question, “do firms that price-match have higher prices than those that do not,” instead of “are prices in general lower or higher when price-matching guarantees are used by some firms in the market?” More empirical research is ne20160109_145051eded to settle the issue.

As for question (ii), the answer may be no as well.  The anti-trust laws, stemming from the Sherman and Clayton Acts are generally focused on restraints of competition between firms, but price-matching guarantees are effectively standing offers by firms to contract with a consumer by referencing another firm’s price (see Edlin 1997).  Contracts that reference rivals are assuredly of concern to anti-trust practitioners (Scott Morton 2013), but when the contract does not impose any restriction on any party except a commitment to lower price by the firm offering it in response to publicly available information, it would seem (without undertaking a very rigorous empirical examination of the case at hand) rather difficult to make a case that competition is being restrained.

All of this comes with a major caveat.  Although I believe that price-matching guarantees have the potential to lead to higher prices in the market as a whole, if as a consumer, you find yourself in a situation where you can use a price-matching guarantee to save money, by all means do!  Unless all consumers can coordinate with all other consumers to bring about a better situation for themselves, they should do what is in their individual best interest.  I recently visited my family for the holidays and we decided to buy a board game to spend the time.  My brother reminded me to put my research to work.  I saved 20 bucks!

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