5 BIG Implications from Court Signals on Net Neutrality – A Special Report

September 13, 2013

Economic rationality, competition, and broadband pricing freedom are the big winners, and common carrier-like net neutrality was the big loser, if the Appeals Court panel decides Verizon v. FCC as expected.

Monday’s intense tag-team grilling of the FCC’s lawyer by Judges Tatel and Silberman left most observers thinking the Court will decide it is illegal for the FCC to impose common-carrier-like regulation on broadband providers — regardless of what else they decide.

-(Listen to the Judges’ one-hour grilling of the FCC – here – it’s the middle half of the two-hour court recording.)

This single point of relative

clarity is a big deal with many implications, if the Court indeed decides it is illegal for the FCC to impose common carrier-like regulation on broadband providers via its Open Internet order.

Summary Tentative Conclusions:

  1. The tent-pole net neutrality assumption of the Tim Wu/Susan Crawford-Save-the-Internet movement – i.e. common-carrier-defined net neutrality for broadband — may actually be illegal, not legitimate U.S. policy as many have long assumed.
  2. Two-sided broadband markets and usage based pricing are normal legal economic practices, paving the way for commercially-negotiated broadband payments by, and usage pricing for, big cost-causing edge providers, like NetFlix and Google-YouTube.
  3. Consumers would be able to pay less, not more for broadband, if consumers no longer were forced to shoulder the full broadband cost of Internet access by subsidizing the biggest edge companies like Netflix and Google-YouTube, which consume ~half of the Internet’s peak traffic per Sandvine.
  4. Over-the-top (OTT) Internet video models would no longer enjoy the current FCC entitlement of zero pricing for edge companies, like Netflix and Google-YouTube; they would have to negotiate commercial arrangements to pay for the costs their mass video streaming causes.
  5. If the FCC then tries to reclassify broadband as a Title II common carrier service, this court would likely strike it down, for the many strong reasons discussed at the end of this analysis.

I.    Common-carrier-defined net neutrality is likely illegal.

Many observers, including this one, thought the key question for this court was whether or not the FCC had the directlegal authority to do what they wanted. The big surprise was when a majority of the court signaled that the

cornerstone of the FCC Open Internet order, a non-discrimination mandate on broadband providers is likely to be found illegal. The reason for the surprise is that Judge Tatel, in his Cellco decision in the data roaming case, did not find the FCC’s policy in that order to be common carrier-like regulation. Different facts can lead to a very different conclusion.

Concerning the FCC Open Internet Order’s cornerstone anti-discrimination provision, Judges Tatel and Silberman indicated the FCC’s provision was indistinguishable from the Title II, Section 202, common carrier non-discrimination provision, which cannot legally be applied to an unregulated information service like broadband.

This potentially is a very big deal. There is virtually no broadband industry objection to freedom-defined net neutrality, i.e. a user’s unfettered freedom to access the legal content, apps and services of their choice over the Internet, subject to reasonable network management. In stark contrast, there are very strong broadband industry objections to common-carrier-defined net neutrality, which in effect could be monopoly rate regulation of prices, terms and conditions of competitive companies without market power.

This Tatel/Silberman legal interpretation could politically isolate common-carrier-defined net neutrality proponents to the political fringe even more. It forces them to advocate for the FCC to reclassify broadband as a Title II common carrier service – the extreme political equivalent of asking the FCC to use a policy weapon-of-mass-destruction on the broadband sector – to somehow save the FCC’s authority from natural obsolescence.

The competitive broadband industry has invested several hundred billion dollars in broadband Internet infrastructure based upon the FCC’s repeated precedents over the last decade that broadband is an unregulated information service not a common carrier regulated monopoly telephone service.

The FCC knows there is strong bipartisan congressional opposition and Republican FCC commissioner opposition to common-carrier-defined net neutrality. (Importantly, later in this post I will explain why an attempt by the FCC to reclassify broadband as a Title II service would likely be rejected by this court.)

II.   Two-sided broadband markets and usage based pricing are legal.

Judges Tatel and Silberman repeatedly signaled opposition to the FCC mandating zero pricing for edge providers and defining the charging of edge companies as unreasonable discrimination.

This is a very big deal. This court has finally provided some legal and economic adult supervision to the political net neutrality debate. Economics are not per se discrimination. Economics naturally dictate that those that get more value or use more pay more. That’s economics 101, whereas mandated zero-pricing – is uneconomics 101.

If the court effectively rules normal economics and commercial negotiations are not discriminatory, it will expose that much of the net neutrality debate is really motivated by uneconomics and who gets subsidized, not about freedom, free speech, censorship or discrimination.

Look no further than the writings of Professor Tim Wu (who coined the term “net neutrality” in 2003), to understand how common-carrier-definednet neutrality is all about economic subsidies; who gets to pay nothing; and who gets stuck

with their bill. See Professor Wu’s 2009 paper that was repeatedly cited in the FCC’s Open Internet order, entitled: Subsidizing Creativity through Network Design: Zero Pricing and Net Neutrality.

Net neutrality to them is really about securing economic subsidies; talking about freedom, and free speech, blocking, discrimination and censorship are basically political cover and misdirection to avoid a public discussion of subsidies of edge providers, which would not be popular because they don’t need it.

This upcoming court decision will likely help focus the net neutrality debate on hidden economic subisidy scheme behind the political net neutrality rhetoric. This shift in the debate could have big implications for consumers and for big edge companies, which I will discuss next.

III.  Consumers would pay less for broadband, not more without FCC common-carrier-like net neutrality.

The great service the incisive minds of Judges Tatel and Silberman have done here is to put laser focus on the nonsensical legal and economic impact of the FCC’s de facto mandating of zero pricing for edge providers.

Common sense tells us that if broadband consumers, residential and business, are the only ones paying for the bandwidth they use, yet “edge providers,” who consume most all of the Internet’s traffic with their bandwidth-voracious, video streaming, are entitled to zero-pricing (free bandwidth), broadband consumers are economically subsidizing the few bandwidth-hogging edge providers.

Simply consumers are paying more than they should have to pay, because the FCC effectively has mandated subsidies for “edge providers.”

Today’s FCC rules perversely force consumers to subsidize Internet streaming companies like Netflix and Google-YouTube by barring a two-sided market from naturally forming. Consumers don’t pay for the full cost of a newspaper because advertisers pay the rest.

Consumers wouldn’t have to shoulder the full cost burden of video streaming, if those companies streaming video paid for their own streaming distribution costs. Why should consumers have to subsidize NetFlix and Google’s free lunch when they consume 45% of the Internet’s peak traffic per Sandvine? In other words, how much is the implicit subsidy or FCC tax on broadband consumers because it has mandated zero pricing – free bandwidth – for edge providers?

Let me debunk the myth of net neutrality proponents that a two-sided market would mean that consumers or startups would pay more than the broadband tier of service that they pay for now. Virtually 100% of consumers and 99% of businesses would face no risk of increased costs from no more zero pricing for edge providers – they would be the ones that would benefit from the video streamers contributing their fair share of the broadband Internet infrastructures cost.

The entities that face paying more if zero-pricing subsidies are illegal are the big video streaming companies like Netflix and Google-YouTube, which I will discuss next.

IV.   OTT providers’ presumed entitlement of consumer-subsidized free video distribution is at risk.

Over the top (OTT) video streamers should be most concerned by what Judges Tatel and Silberman signaled Monday. They did not see payments from edge providers for better, more or faster bandwidth as discriminatory, but as economics and business. It is noteworthy that the judges specifically mentioned Google over a dozen times in their questions and hypothetical arguments. The only other company mentioned frequently in the oral arguments was Verizon which challenged the FCC’s order.

Why this is a big deal is that the common-carrier-definednet neutrality movement has created a conventional wisdom that on the Internet everything is or should be free, and that somehow includes and means that OTT video streamers

should have no cost obligation for the bandwidth that their video streaming business consumes in distributing their service to consumers. Apparently the Appeals Court views their business conventional wisdom as an illegal FCC mandate.

Netflix in particular has the most to worry about. They are all in that their business is entitled to a permanent subsidy of free Internet distribution when Sandvine indicates that Netflix consumes ~30% of the Internet’s peak traffic. Netflix has a nosebleed P/E of 377, over twenty times that of the overall market, based on a fast growth model where they plow most all of their ~$1 billion gross margin back into the business to maintain its ~20% growth.

Netflix’ big problem here is that a large part of their current gross margin is the implicit FCC bandwidth subsidy of the FCC’s Open Internet order. Without a video streaming free lunch subsidized by all broadband consumers, Netflix would have to pay for their own distribution like most every other company does in the economy. If they had to pay for at least some of the real costs that they currently shift to consumers via net neutrality, they would have much less cash flow to fund their fast growth.

Simply, investors don’t know it yet but Netflix, but the Appeals Court may effectively expose that Netflix is an FCC-inflated stock, much as WorldCom, Qwest, Global Crossing, and other fiber backbone companies were FCC-inflated stocks during the tech bubble over a decade ago because of the implicit CLEC subsidies the FCC bequeathed them via skewed rate regulation.

Google also has something to worry about from their FCC video distribution subsidy likely going away. Unlike Netflix, Google does not enjoy an FCC inflated P/E, and its ~$30b in gross profit margin is ample enough to cushion the additional cost of paying its fair share of bandwidth.

Nevertheless a change in a video streamers economics in the U.S. is significant because of Google’s clear dominance of Internet video distribution in the U.S.  Per ComScore, Google reaches 84% of the U.S. Internet audience. Per Neilsen, Google has 65% share of all U.S. online video streams and that is 25 times more total Internet video streams than their nearest competitor.

V.    Title II reclassification of broadband is likely illegal.

Proponents of common carrier-like net neutrality regulation will push the FCC to reclassify broadband as a Title II common carrier service. They will cite the Supreme Court Brand X decision, which decided the FCC could determine if broadband was a telecom service or information service, and the recent Arlington Supreme Court decision affirming Chevron Deference. They will imply that these combined precedents technically confer on the FCC near imperial power to decide the economic fate of the entire broadband sector at any time.

What they will conveniently ignore is everything else that has happened — before and since the FCC confirmed broadband was an unregulated information service — that would likely make a potential FCC Title II reclassification of broadband illegal and/or unconstitutional.

Facts and Merits Haven’t Changed: The FCC’s original decision to confirm broadband was an unregulated info service was consistent with decades of FCC Computer Inquiry precedents that sought to not regulate computer networks (like the Internet) in order to encourage innovation. The FCC on the facts and merits determined repeatedly that broadband networks were computer/information, router-based, packet-switched networks; they were not telephone-switched voice networks warranting monopoly telephone rate regulation. Those foundational technological, functional, and market facts and merits have not changed, if anything, they have grown more supportive of an information services classification.

Arbitrary & Capricious Whipsaw: Reclassification after all this time (for the transparent purpose of regulatory relevance) would be highly vulnerable to legal challenge as an arbitrary and capricious, unreasonable whipsaw, and 180 degree reversal of forty years of policy, precedent and evidence. The FCC would have a steep climb to factually defend and justify that most everything the FCC has thought, done and defended for ~forty years of deregulating computer/information services was somehow all wrong. It’s not reasonable for the FCC to argue, “because we say so;” the FCC has to comply with procedure, the law, due process and the Constitution.

Assume Unbounded Classification Power? If in the middle of the game, the FCC unilaterally has wide latitude to change most all of the rules of the game for some players, like broadband, via “reclassification,” the FCC logically could have wide latitude (and Chevron Deference) to reclassify other businesses, like some types of edge providers, as common carriers too.

If nothing else matters but the two Supreme Court precedents, the FCC essentially could imagine it has carte blanche or imperial power to reclassify any Internet-technology company as a common carrier to preserve the open Internet. Then those tech-entities would have to sue in court on the facts, and win, to escape the FCC’s common carrier grasp.

Simply, what is the legal limitation on the FCC from reclassifying most any information service as a common carrier service?

A Bait & Switch Taking? The FCC’s last classification decision was made when broadband was a nascent business serving a small fraction of Americans. Now it is mature business serving virtually all Americans. Since the FCC’s decisions to confirm deregulation, the broadband industry has invested several hundred billion dollars in broadband infrastructure, as a direct result of the formal classification decision and the prospect of a stable policy precedent and a competitive market of risk and reward.

Broadband companies never would have invested or operated as they have over the last decade, if there was the real potential that their networks could become monopoly telephone rate regulated networks.

If the FCC reclassified, it could be considered the biggest regulatory “bait and switch” in U.S. history, promising one thing to gain nearly a trillion dollars of private sector, risk capital infrastructure investment, only to unreasonably seize the private property of competitive companies a decade later without just compensation, based on no reasonable evidence that their economic model enjoys market power or is somehow harming the public sufficiently to justify public utility regulation.

No Justification of a Problem: FCC reclassification would run directly counter to the law and evidence. After a decade of broadband market experience, the FCC to date has found no significant evidence of any broadband problem warranting a rate regulation solution. Thus reclassification could run afoul of equal protection of the law and precedent that regulatory solutions must be reasonably proportionate to the problem they propose to address.

Communications Law Dissonance: An FCC reclassification of broadband would depend on an obsolete 1934 interpretation of the FCC’s authority as the rate regulator of a telephone monopoly, and run completely counter to Congress’ 1996 Telecom Act modern purpose: “To promote competition and reduce regulation…” and Internet policy statement: “It is the policy of the United States… to preserve the… competitive free market… Internet… unfettered by Federal or State regulation.”

The practical effect of the FCC reclassifying broadband would be an effective rewrite of the 1996 Telecom Act to favor monopoly regulation over competition, and FCC regulation over consumer choice. That is not ambiguous. That is obvious.

In short, FCC reclassification of broadband as a common carrier service would run counter to the evidence, policy, precedent, the law, Congress, and the Constitution. The FCC would be supplanting Congress’ policy, role and authority. Simply, FCC reclassification of broadband at this point is a legal, political and Constitutional non-starter that also would be enormously destructive economically.

# # # # #

FCC Open Internet Order Series

Part 1: The Many Vulnerabilities of an Open Internet [9-24-09]

Part 2: Why FCC proposed net neutrality regs unconstitutional, NPR Online Op-ed [9-24-09]

Part 3: Takeaways from FCC’s Proposed Open Internet Regs [10-22-09]

Part 4: How FCC Regulation Would Change the Internet [10-30-09]

Part 5: Is FCC Declaring ‘Open Season’ on Internet Freedom? [11-17-09]

Part 6: Critical Gaps in FCC’s Proposed Open Internet Regulations [11-30-09]

Part 7: Takeaways from the FCC’s Open Internet Further Inquiry [9-2-10]

Part 8: An FCC “Data-Driven” Double Standard? [10-27-10]

Part 9: Election Takeaways for the FCC [11-3-10]

Part 10: Irony of Little Openness in FCC Open Internet Reg-making [11-19-10]

Part 11: FCC Regulating Internet to Prevent Companies from Regulating Internet [11-22-10]

Part 12: Where is the FCC’s Legitimacy? [11-22-10]

Part 13: Will FCC Preserve or Change the Internet? [12-17-10]

Part 14: FCC Internet Price Regulation & Micro-management? [12-20-10]

Part 15: FCC Open Internet Decision Take-aways [12-21-10]

Part 16: FCC Defines Broadband Service as “BIAS”-ed [12-22-10]

Part 17: Why FCC’s Net Regs Need Administration/Congressional Regulatory Review [1-3-11]

Part 18: Welcome to the FCC-Centric Internet [1-25-11]

Part 19: FCC’s Net Regs in Conflict with President’s Pledges [1-26-11]

Part 20: Will FCC Respect President’s Call for “Least Burdensome” Regulation? [2-3-11]

Part 21: FCC’s In Search of Relevance in 706 Report [5-23-11]

Part 22: The FCC’s public wireless network blocks lawful Internet traffic [6-13-11]

Part 23: Why FCC Net Neutrality Regs Are So Vulnerable [9-8-11]

Part 24: Why Verizon Wins Appeal of FCC’s Net Regs [9-30-11]

Part 25: Supreme Court likely to leash FCC to the law [10-10-12]

Part 26: What Court Data Roaming Decision Means for FCC Open Internet Order [12-4-12]

Part 27: Oops! Crawford’s Model Broadband Nation, Korea, Opposes Net Neutrality [2-26-13]

Part 28: Little Impact on FCC Open Internet Order from SCOTUS Chevron Decision [5-21-13]

Part 29: More Legal Trouble for FCC’s Open Internet Order & Net Neutrality [6-2-13]

Part 30: U.S. Competition Beats EU Regulation in Broadband Race [6-21-13]

Part 31: Defending Google Fiber’s Reasonable Network Management [7-30-13]

Part 32: Capricious Net Neutrality Charges [8-7-13]

Part 33: Why FCC won’t pass Appeals Court’s oral exam [9-2-13]

 

 

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