The very important sleeper issue I expect we will spotlight for the CPAC audience is the imminent threat to the Internet from a China/Russia-led effort to get the United Nations’ International Telecommunications Union to regulate the Internet similar to the way they regulate telephony and postal service, via a renegotiation of the treaty that affects telecommunications in Dubai in December 2012.

UN regulation of the Internet would kill the proverbial goose that laid the golden egg, by locking in the past and making innovation difficult in the future.

This is a not so subtle effort to undermine and slow America’s high tech innovation leadership in the world by miring U.S. Internet companies in the ITU regulatory swamp.

UN regulation of the Internet is a big, under-appreciated, looming threat to freedom and economic growth.

•    Ironically the FCC is asking Congress to give it spectrum auction authority to not auction spectrum.
•    In other words, the FCC is asking to be unilaterally empowered to decide not to auction some spectrum so it can deem it “unlicensed spectrum,” like that used for WiFi and garage door openers.

There are huge fiscal problems with the FCC’s position, given our nation’s severe fiscal situation: a trillion dollar Federal budget deficit and a ballooning multi-trillion dollar public debt.

First, the real world effect of the FCC’s gambit here is to try and get revenue-raising legislation to not raise many billions of dollars.

•    Article I Section 7 of the U.S. Constitution empowers only the House of Representatives to originate revenue-raising bills.
•    Given that the FCC apparently does not want to auction a major portion of this TV broadcast spectrum, the FCC is essentially asking that the FCC, not Congress, decide whether or not the nation raises billions of dollars for the taxpayer to improve our nation’s dire fiscal situation.
•    If the FCC believes the nation should not auction some of this spectrum, the FCC and the Administration should formally request that Congress affirmatively authorize in law the forgoing of billions of dollars in revenues.

Second, forgoing billions of Federal revenues is de facto spending billions of dollars of the taxpayers’ money in an off-the-books scheme, outside of the checks and balances of the Constitutional Federal appropriations process.

•    In effect fiscally, the FCC is asking Congress to authorize a shadow Federal spending program, where the FCC alone would decide how to spend multi-billion dollars of forgone Federal revenues without any of the normal appropriations accountability or oversight.
•    This is not a trivial fiscal matter given the FCC’s abysmal track record in fiscally mishandling spectrum auctions e.g. the extraordinarily high default rate of PCS auction licensees; the NextWave fiasco; the “D” Block fiasco for public safety; and the “C” block auction with open conditions that shortchanged the taxpayer of ~$7b by my estimate.

Third, in effect the FCC is angling for a fiscal spectrum earmark, so it could reward special interests with essentially billions of dollars in unauthorized Federal subsidies, outside of the normal public spending authorization and appropriations processes.

•    With many tens of billions in cash reserves, the tech interests behind the push for unlicensed spectrum in particular have more than enough financial wherewithal to pay top dollar for the taxpayers’ spectrum and then they could make it openly available to the public to spur the open innovation they envision and seek.
•    Open market auctions without economic regulatory conditions are the fairest and most effective mechanism for allocating spectrum, and the least prone to manipulation or abuse.

Fourth, the FCC has not explained who would pay the necessary financial incentive to TV broadcasters for them to allow auction of their prime spectrum.

•    It would seem logical that if the TV broadcasters need a financial incentive to auction their spectrum, and the FCC apparently would like to make some of that TV spectrum unlicensed and free of any cost or revenue raising, someone has to pay the broadcasters to vacate their licensed spectrum.
•    Does the FCC envision the taxpayer would somehow pay the incentive, or would the FCC or tech interests pushing for it pay for it?
•    And how would the Government account for, or not account for, the incentive payment, and forgone revenues in the Federal budget and appropriations processes?

In sum, the debate over fiscal matters needs to be decided in a fiscal context.

If there are good arguments for not auctioning spectrum, the FCC and those that agree with the FCC’s position should make them publicly to Congress. When one cuts through all the rhetoric on this, it really comes down to the simple question of: to auction or not to auction wireless spectrum?

Simply this is not the competitive truce that critics claim. It is cable choosing to not become a fifth facilities-based 4G LTE national wireless infrastructure, but to become a new and substantial wireless reseller of Verizon wholesale in the cable bundle long term. And it is Verizon choosing to continue doing what it has always done – not building green-field wire-line broadband infrastructure outside of its original geography, but doing something new in reselling cable services in a wireless bundle where it currently cannot offer that type of competitive offering. The competitive imperative of Verizon FIOS and cable competing head-to-head where they currently compete will continue unabated because of the reality of huge fixed/sunk cost facility economics and ongoing DBS competitive pressure.

Silo-Vision is Obsolete

Looking backward ninety-nine years, the AT&T Kingsbury Agreement declared telephone service a monopoly; however the 1996 Telecom Act made telecom competition the new law/policy and now the once highly-profitable long distance business is a dying feature of other communications services and the once local phone monopoly incumbents have lost half of their local phone customers to competitors.

Looking backward almost thirty years, the government declared wireless a duopoly; however twenty years ago Congress embraced free market competition for wireless, (and market auctions as the mechanism to best allocate spectrum to its highest economic use and best reward the taxpayer), which has resulted in the U.S. having the most robustly competitive wireless market in the world save for Hong Kong.

Looking backward twenty years, the 1992 Cable Act effectively declared cable a monopoly; however since then competition — from DBS providers DirecTV and Dish, and from Verizon FIOS/DSL, AT&T UVerse and other telcos — has forced cable to lose ~40% of paid TV share to competitors.

If one looks backward in time through an analog lens one naturally sees less competition the farther one goes back in time. However, if one takes any point in this time period, and looks forward in time through a digital/Internet/convergence lens one sees continuous surprises in the amount, type, origin, speed, intensity, and innovativeness of new and growing communications competition.

Seeing the Metamorphosis of Communications Competition

If one looks backward, one misses the remarkable metamorphosis of communications competition where the old regulated “opoly” caterpillars have been released from their cocoons and grown into broadband communications butterflies. (See “The Metamorphosis of Communications Competition: Driven by Broadband, Internet and Cloud Computing Technologies” here.)

If one looks forward one sees that butterflies from other industries have come from most every direction to compete with the communications butterflies for users’ communications affection and business. Facebook’s historic IPO S-1 boasts that Facebook is at “the forefront of enabling faster, easier and richer communication between people” and has the astounding statistics to back it up; a eight year old company with 845 million users worldwide generating 2.7 billion communications a day! Apple’s legendary iPhone has singlehandedly transformed how users view mobile communications and tilted the competitive/economic balance of power between communications providers and handset manufacturers, in Apple’s favor. Google is building a gigabit broadband network in Kansas City, Google Android is the leading mobile operating system in the world, Google Voice may provide the most comprehensive integrated communications platform in the world, and Google unsuccessfully bid $4b for wireless spectrum. And Microsoft bought Skype’s voice and video conferencing service and has entered into an operating system – handset alliance with Nokia. This is not your father’s communications marketplace.

In sum, to understand the competitive context of the Verizon Wireless-cable agreement one has look forward through a broadband Internet and cloud computing lens to see the incredible and increasing competitive dynamism that exists in the communications market today.

At bottom this agreement does not lessen any existing competition, but increases competition in a different way than originally was anticipated sixteen years ago. This agreement eventually creates substantial new wireless competition via a wireless component of an expanded cable bundle; and elsewhere it creates additional competition from a wireless provider that did not have a cable offering to bundle.

If the review looks at the facts and not what people sixteen years ago thought should have happened, one will see an innovative cross-marketing agreement that only increases the competitive intensity of the communications market.

The main reason is that the online marketplace is economically structured around users being a commodity, data, to be aggregated and mined, not customers to be served and protected in a competitive marketplace. That’s because the overriding economic force that created the free and open commercial Internet – the predominant Silicon Valley venture capital/IPO value creation model – was and remains largely antithetical to protecting online privacy.

The Silicon Valley venture capital/IPO driven model is laser-focused on achieving Internet audience/user scale fastest in order to gain first-mover advantage and then rapid dominance of a new product or service segment. This predominant Internet economic model is predicated on a precious few investments achieving such rapid user scale that it: warrants a buy-out at an enormous premium multiple; enables fast and exceptionally-profitable liquidity (via the new secondary derivative market for private venture shares or employee options); or broad liquidity via a public IPO.

What is the essential critical element of achieving audience/user scale fastest? Free. No direct cost to the user fuels fastest, frictionless, viral adoption. This free economic model presupposes online advertising as an eventual monetization mechanism and shuns products and services directly paid for by the user because their inherent time-to-market is too slow and their upfront sunk cost of sales and customer service is too high for this predominant value creation model.

The other essential element of a fastest-adoption-possible model is user trust. User trust is created legitimately by providing the user with very valuable innovation for no monetary cost. However, user trust also is illegitimately manufactured and maintained via misrepresentation that the free service works for the user (when the real monetary value creation comes from the Silicon Valley liquidity derivative market and the online advertising market); and only has the interests of users in mind by: downplaying privacy concerns, risks or harms; implying that privacy undermines the free speech and sharing ethos of the free and open Internet; and claiming that privacy is outdated, anti-innovation, and no longer the current social norm.

Privacy policies generally meet the letter of full disclosure but seldom the spirit, by refusing to openly explain to the user in detail the purposes, amount, breadth and sensitivity of the private data being collected on a user and how that aggregated information could be used or abused by the collector, a third party or the government.

The second big reason that market forces for privacy protection are so weak is that the user is not the customer but the product. Once Internet companies’ founders, early investors, and employees have generated wealth via the Silicon Valley value creation model, their companies’ economic models shift to the full harvesting of the value of this economic model via advertising revenue growth. In the online advertising model, the user is the product and the advertiser is the customer. Importantly, the grand assumption of the online advertising model is that it assumes and depends on publicacy (the opposite of privacy), because what makes online advertising work is the unlimited business freedom to maximally leverage whatever customer data (private/personal information) a company can mine in order to most effectively and profitably micro-target users’ personal hot buttons.

The third big reason market forces for privacy protection are so weak is the glaring lack of user leverage/consumer power in the market equation. By design, the Silicon Valley venture capital/IPO model produces first-movers that can dominate their chosen Internet segment: Google-search, Facebook-social networking, eBay-online auctions and payments, Amazon-retailing, Twitter-real-time-micro-blogging, Zynga-games, etc. By design, this adoption-fastest model seeks to preclude or limit the viability of a significant competitive alternative. Thus the purveyors of this model can claim users have privacy choice, when they know their model has limited choice of alternatives and the limited choices that are available also have limited market incentives to protect privacy.

Given the Internet loophole in privacy law, where other industries operate under strict privacy laws in health care, financial services and communications, online users have no meaningful privacy rights or power in the Internet marketplace to protect their privacy. What this means is that consumers face the exact opposite market situation as they do in other markets, where consumers (buyers) have unique private knowledge of what their own wants, needs, means and budget are. However, in the online market, the seller has most all that private information on the buyer, and the buyer generally does not know that, so they have dramatically less buyer leverage or negotiating power than they do in a market where they are the customer and not the product.

Despite there being substantial value being exchanged when users use ad-based online services, there is no real market transaction for privacy in that exchange, i.e. no market choice for users to generally protect it — or to sell it if one so chooses to exploit one’s privacy for one’s own personal financial benefit. The current model assumes that the user is and always will be a data-pawn without a real economic role or say in the market transaction over their personal data.

Tellingly, Smart Money reports that Michael Fertik, CEO of Reputation.com, estimates that a user’s “personal information can be worth $50 and $5,000 per person per year to advertisers and market researchers.” If this estimate is remotely accurate, why couldn’t/shouldn’t there be a market mechanism for a user to either protect their private/personal information or sell it for their personal benefit? What’s wrong or not workable with having users have a market role in influencing the market outcomes of their personal information? It is truly remarkable that such a rich marketplace, worth literally tens of billions of dollars per year in revenues, nearly completely shuts out the user from participating openly and directly in these transactions involving their private information.

Where does this leave us? Recently, the Supreme Court ruled in U.S. vs. Jones that using a tracking device was an infringement of someone’s private property. If people’s private data is in fact a legal form of private property — that a user has some right to exercise a substantial amount of personal control over — then the online advertising model may be built on a foundation of sand and not the foundation of rock that people assume.

Moreover, there is mounting evidence that in the future users will have more power over their privacy/private information than they do today. The EU is proposing an update of their privacy rules for the first time since 1995 and they propose to give users much greater control to opt out and control what personal information an on online company has on them. The FTC favors an Internet “Do Not Track” mechanism like the FTC’s wildly popular Do Not Call List, and Do Not Track legislation has been introduced in Congress. The Department of Commerce has proposed a Privacy Bill of Rights. Google’s new centralization of private information in its new privacy policy has generated strong opposition, a bipartisan letter from lawmakers urging that Google allow users the freedom to opt out, and charges that Google is violating the FTC-Google Buzz privacy agreement. There is evidence that Facebook users continue to be concerned about oversharing with FaceBook’s new Timeline. And the FTC has sanctioned Google, Facebook, and Twitter for not adequately protecting users’ privacy.

In sum, isn’t it ironic, that in this supposed market that allegedly serves and empowers the interests of users “at the edge,” there is no real privacy innovation to protect users’ privacy the way that users want, but only innovation to more effectively invade, abuse, or monetize people’s privacy largely without their knowledge or permission?

What does all this mean? It means there is a serious market failure in protecting users’ online privacy.

Let me be crystal clear here. I have nothing against venture investing; it is a sound capital market essential to the funding of high-risk innovation. I am not saying the venture capital model is a market failure. I am also not saying that online advertising is a market failure. I have nothing against online advertising; it is a completely legitimate and useful business model and mechanism to fund free content, if purveyors of the model fairly represent the inherent privacy/financial conflicts of interest and risks to users, so that users have the accurate information to protect themselves, if they choose to do so.

The very specific market failure here is twofold. First, extremely lax enforcement of the FTC Section 5 law against deceptive business practices, created market failure here because users were systematically denied fair representation in the marketplace, which is the first and most important line of defense against consumer fraud. Without effective fair-representation law enforcement, the consumer incorrectly assumes the online businesses in question are being forthright. Second, dysfunctional Federal privacy law — that only protects privacy expectations offline and not online — creates market failure as well, because users have minimal market control over the market for their online personal data. What is needed is new privacy legislation that is a consumer-driven, technology/competition-neutral privacy framework that works online and offline.

Simply, what is needed here to correct this specific market failure, is for law enforcement to ensure online businesses fairly represent their privacy and financial conflicts of interest to consumers/users so they can better protect themselves, and for Congress to harmonize Federal privacy law to close the huge Internet loophole in privacy law so that users enjoy the same expected privacy protections online that they do offline.

Scott Cleland is President of Precursor LLC, a consultancy serving Fortune 500 clients, some of which are Google competitors; he is also author of “Search & Destroy: Why You Can’t Trust Google Inc. In addition, Cleland is Chairman of NetCompetition, a pro-competition eforum supported by broadband interests. During the George H.W. Bush Administration, Cleland served as Deputy United States Coordinator for International Communications and Information Policy.

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Note: Below is the original 1-31-12 Forbes post link. The post above is identical to the original post, save for typographical corrections that do not change the content or meaning of the post in any way.

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Why are market forces so weak in protecting users’ online privacy? To learn why and what to do about it, see my Forbes Tech Capitalist post: “Where’s the Market for Online Privacy?”

Reports that “Twitter Can Censor by Country” is a perfect example of how the world is changing the Internet. Change is a two-way street. Conventional wisdom that only assumes the Internet is changing the world risks being blind-sided by the Internet’s underappreciated exa-trend: how the world is changing the Internet.

See my Forbes Tech Capitalist post: “Twitter Realpolitik & the Sovereignization of the Internet” to learn about Twitter’s new realpolitik and how sovereign powers will increasingly be asserting themselves vis a vis the Internet.

See my Forbes Tech Capitalist post “FCC Seeks Unbounded Spectrum Auction Authority” to see why the the FCC’s lack of regulatory humility here is so stunning.