The Coming War Over Net Neutrality

By Tim Wu, The New Yorker

05 May 13

om Wheeler, Obama's nominee to run the Federal Communications Commission, surely has much he hopes to get done. Perhaps it's freeing up some more wireless spectrum or bringing cell-phone service to Mars - who knows. But chances are (assuming his confirmation goes smoothly) that he'll end up spending time on different challenges, and a chief candidate is a resurgence of the net-neutrality wars.

The outgoing chairman, Julius Genachowski, made many very good and important decisions, but he also made a rather terrible one that may darken Wheeler's term. Genachowski spent years and much political capital negotiating net-neutrality rules that everyone could live with, only to enact them in a way that is highly vulnerable to a court challenge. That challenge (brought, cynically, by Verizon after it negotiated the rules it wanted) may soon invalidate years of work and create industry chaos.

The net-neutrality rules now in place reinforce the Internet's original design principle: that all traffic is carried equally and without any special charges beyond those of transmission. Among other things, the rules are a pricing truce for the Internet; without them, we can expect a fight that will serve no one's interests and will ultimately stick consumers with Internet bills that rise with the same speed as cable television's.

Unfortunately, like American Presidents who hope to avoid the politics of the Middle East, the F.C.C. may ultimately have no choice but to get involved in this fight. But one very important thing has changed since last time. Cable operators like Time Warner and Comcast, if they think carefully, should come to understand that they now need a net-neutrality rule more than anyone.

Ask a cable operator what makes its life miserable, and the answer is immediate and obvious: programming fees. Such fees have roughly doubled over the past decade during a period of near-flat inflation and economic stagnation. Sports is the most outrageous example: what ESPN charges cable operators keeps growing, and is now approaching five dollars per customer. The actual cost of providing the entire Internet to cable customers, which is something like a few dollars a month, is less than that. It is a lose-lose situation for nearly everyone (except athletes). The real victims are consumers, especially low-income consumers, who ultimately foot all the bills but cannot control the costs.

If programming costs are the worst thing in cable, the best part of the business is selling broadband. Cable broadband, which costs almost nothing to provide once the infrastructure is built, has little real competition, and operators can charge between forty and sixty dollars for the product, yielding margins that analyst Craig Moffitt describes as "comically profitable." Margins greater than ninety per cent are a sweet business no matter what you're doing, and what cable operators have to realize is how crucial net neutrality is to making those margins possible.

An important aspect of the Internet's original design is that many prices were set at zero - what have been called zero-price rules. The price to join the network is zero. The price that users and sites pay to reach others is zero: a blogger doesn't need to pay to reach Comcast's customers. And the price that big Web sites charge broadband operators to carry their content is also zero. It's a subtle point, but these three zeros are a large part of what makes the Internet what it is. If net neutrality goes away, so does the agreement to freeze prices at zero.

What net neutrality means in practice for cable operators is that they don't have to deal with rising programming costs in broadband. Cable operators pay Disney good money to carry ABC as a cable channel. But when a cable customer watches ABC shows over the Internet, using Hulu Plus or Amazon, the operator pays nothing. When they go to the ABC Web site, they also pay nothing. Rather, the consumer deals with the content provider directly, by watching ads or paying Amazon. The result: cable doesn't have to pass on costs that it cannot control.

Back in the aughts, cable operators hated the idea of net neutrality because they hoped to charge then-rich firms like Yahoo extra cash to reach their customers (in telecom jargon, a "termination fee"). But that was when the Internet companies were far weaker. Times have changed, and firms like Google and Facebook now hold serious bargaining power. You can't expect to provide a decent Internet service that doesn't include Facebook and Google. And so, instead of being able to charge Google to reach its customers, cable operators, absent net neutrality, may have to pay programming fees to Google. In other words, Google might very well become the next ESPN, and the whole nightmare will start again.

Admittedly, it is hard to know exactly how things would work out if the zero-price rules are abandoned. Cable still has serious market power, and might, on balance, be able to charge more than it gets charged. But if you're a cable operator, why take that bet when you're already sitting on giant profit margins? Why risk the best business going? Beyond cable operators, a battle royale over Internet programming and termination fees would ultimately be terrible for consumers; the Internet would start to get both worse and more expensive.

Think of it this way: net neutrality, which sets all these prices at zero, is effectively a grand truce between the big app firms and the infrastructure providers. It eliminates an unnecessary middleman: consumers deal directly with content vendors and app firms. That's a much healthier market dynamic than one driven by hidden, passed-on costs. If cable TV isn't a good enough example, consider the dysfunction of the health-care industry, where consumers never see what they are paying for. That's what the present rule avoids.

Finally, and most importantly for the public, the net-neutrality rule continues to provide a kind of subsidy to smaller speakers and startups, from bloggers to Quora and Wikipedia. The Internet would look a lot different if these kinds of players had to pay cable before reaching their customers. It would start to look a lot more like cable TV, and few things could really be worse than that.

Wheeler and the other members of the Federal Communications Commission will be very tempted to try and avoid and ignore net neutrality during Obama's second term. If, magically, the rules aren't struck down, they will have that luxury. But if the rules are struck down, avoiding the problem may lead to a replication of the horrors of the cable-television market. There's trouble brewing; facing it is both the Commission's responsibility and its destiny.