Jan 15 2014, 8:21am CST | by Forbes
The federal appeals-court decision gutting the Federal Communications Commission’s “net neutrality” rules leaves online content providers like Netflix and Google's YouTube in the position of male patrons at an old-fashioned singles bar. In order to gain access to the network, they may have to pay a cover charge. And that opens the prospect of angry consumers and endless litigation like what has consumed the credit-card industry, as merchants battle Visa, MasterCard and American Express over who should pay for the ubiquitous charge network that everybody benefits from.
In a decision released yesterday, a three-judge panel of the U.S. District Court of Appeals for the D.C. Circuit held that the Obama administration overstepped its authority when it prohibited broadband providers from blocking or discriminating against certain types of traffic. The decision was hardly the slam-dunk victory some have ascribed to the plaintiff, Verizon: In a thoughtful post at the Volokh Conspiracy, Stuart Benjamin notes that two of the three judges found the FCC still has “virtually unlimited power to regulate the Internet,” in the words of dissenting Judge Laurence Silberman, as a means of insuring broad access and competition.
Still, the decision opens the door for what economists call a two-sided market, where the costs of a useful network fall on the parties most willing to pay for it. The classic example is the singles bar (which may or may not still exist — I’m getting old), where men paid a cover charge to get in and women walked in for free. The women got in for free because they were unwilling to pay a cover charge and the men paid because they wanted to meet the women. Without this allocation of costs, the network would break down and both sides would spend the evening watching “Three’s Company” reruns at home.
Two-sided markets abound. Women often pay more to dry clean a shirt (for them, it’s called a “blouse”) than men because men tend to be dogs who won’t take their clothes to the dry cleaner unless it’s cheap. Investors pay for the dubious value of sell-side research through higher commissions their brokers and mutual-fund managers pass through to them.
Merchants historically have paid most of the cost of the credit-card network because they get most of the benefit. Consumers spend more with credit cards than with cash or checks, and merchants don’t have to mess with fraud and the cost of running their own accounts-receivable departments.
The problem with two-sided markets is they strike many people as unfair. Merchants love the credit-card network, but they look at the 2% or more that is trimmed from their gross receipts, compare it with their 5% margins, and dream of the riches they would have if only they didn’t have to pay for credit transactions. That’s led to some of the most lucrative litigation in history, as lawyers have assembled class actions on behalf of thousands of merchants who say the credit card issuers used their monopoly control of the market to gouge them on fees.
In the latest settlement, Visa and MasterCard would refund $6 billion to merchants and get rid of rules prohibiting surcharges for credit purchases. Big retailers including Wal-Mart and Target object to the settlement, saying it lets the credit-card companies off the hook too easily and will actually cost consumers more; nevertheless a judge approved the settlement in December.
I’ve maintained the key provision of the credit-card settlements, allowing merchants to surcharge for credit purchases, is meaningless since they always had the power to offer discounts for cash. There is absolutely no difference between a discount and a surcharge, despite what plaintiff lawyers and their highly paid economic experts say. But the dispute highlights the difficulties people have in wrestling with two-sided markets. They love the network, but they hate the idea of having to pay for it. Some merchants apparently think paying for it would be more palatable if they charge the “same price” for everything, but tack on a surcharge for credit purchases. I don’t think consumers are that dumb, but who knows?
So with this decision, the D.C. Circuit may have thrown YouTube and Netflix into the singles bar. Broadband providers can go to the content providers, which consume 50% of North American downstream bandwidth, according to a recent Sandvine report, and demand fees for high-speed, reliable delivery of their content. Netflix could respond by hiking its monthly subscription charge, while Google might have to insert more ads on YouTube, or find other ways to pay to get access to consumers. Consumer advocates and net-neutrality fans worry that Comcast, say, will try to discriminate against Netflix, which is making inroads as consumers dump conventional bundled cable-TV for Internet video on demand. Others say the broadband providers can’t risk angering their customers with such tactics.
There’s nothing new about this sort of conflict and market evolution. The North American natural gas market was heavily regulated until the 1980s, including price controls on gas at the wellhead. The result was disastrous gas shortages, as drillers had little incentive to produce more, as well as inadequate pipeline capacity. Congress eliminated price controls at the wellhead in 1989 and later ordered pipeline companies to unbundle their services, providing regulated transport as one service and selling the actual gas molecules on the deregulated market. The result was a flourishing gas business, technical innovation that produced the shale-gas revolution, and now, a market where North American consumers have at least a 100-year supply of cheap gas for heating, electricity and industrial production.
The price, of course, was a couple of decades of chaos, uncertainty, and financial distress. Enron was born out of deregulation and collapsed; so was Kinder Morgan, which has been a huge success. The costs of the network, instead of being buried inside impenetrable long-term gas contracts and layers of bureaucratic rules, became transparent and fell to whoever was the most willing and able to pay. Those prices were also flexible, to inspire pipeline companies to overbuild their networks. Want the cheapest transport contract possible? Sign up for interruptible delivery, where your supply can be shoved aside for a higher-paying customer. Absolutely, positively need that gas 24 hours a day? Pay more for firm delivery, which of course also means the pipeline company has to set aside extra capacity for when your demand spikes.
The Federal Energy Regulatory Commission still maintains control over interstate pipeline rates, which some say is causing bottlenecks in markets where pipeline companies would build larger-diameter lines if they could reap higher rates on those few days a year when demand hits records. But overall, the market functions better with consumers buying their molecules from the people who produce those molecules, and paying the pipeline operators to deliver them.
The broadband market may never get to that stage. It’s hard to imagine consumers getting a variable bill each month based on how many YouTube videos they watched. Even cellphone networks seem to be transitioning to all-you-can-eat data plans, highlighting an important difference between digital content and physical molecules. But the conflict over who pays will continue to simmer in the background. And with this ruling, content providers may find themselves in line outside the bar, waiting to hear what the cover charge is to get access to all those networking possibilities inside.
Watching carefully will be the antitrust lawyers, who need only prove a broadband provider has the power to dictate prices to lodge a lawsuit challenging those fees. Market power will be elusive, of course, if the D.C. Circuit ruling inspires enough broadband providers to expand their networks.
Source: Forbes Business
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