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End of US neutrality will not save MNO model, even while it stifles innovation

FCC chairman Ajit Pai has made some creative decisions during his first 10 months at the helm, but is likely to be remembered almost entirely for overturning net neutrality in the US, despite the anger of the Internet majors which have such a huge place in the modern American economy. As the US looks set to become far less open than many of the countries which would like to challenge for that digital leadership – notably India – it may be protecting the business models of its fixed and mobile operators for a few years, but it risks putting the brakes on innovation in the wider telecoms landscape.

As he has indicated since taking over from Tom Wheeler in January, Pai proposes to reverse Title II classification for broadband providers, and replace it with some form of voluntary code of terms and conditions. That would remove the obligation for operators to be neutral towards Internet services, rather than supporting ‘fast lanes’, or giving other types of preference, to particular content or services.

The FCC will vote on the proposal at its monthly meeting on December 14 and given that the Commission has three Republican members to two Democrats, Pai is expected to prevail despite the opposition of his Democrat team-mates, Mignon Clyburn and Jessica Rosenworcel.

His predecessor Tom Wheeler reacted publicly to the proposal – officially the ‘Report and Order on Restoring Internet Freedom’ – which was circulated last week, reversing rules which were brought in, after a tortuous process and several reworkings, under Wheeler’s auspices. The former chairman said the FCC was giving into pressure from the large operators and ISPs, rather than thinking about consumer choice.

“Even for this FCC and its leadership, this proposal raises hypocrisy to new heights,” Wheeler wrote in a blog post. “The FCC has sold out to the wishes of the companies it is supposed to regulate over the consumers it is supposed to protect.”

He also criticized Pai’s plan to move the responsibility for enforcing competition and consumer rights in the Internet sector to the Federal Trade Commission (FTC) rather than the FCC.  “It is impossible to find anything pro-consumer in the expert telecommunications agency walking away from its responsibilities in favor of an agency with no telecommunications expertise or authority. Here is the secret why the big companies want this: the FTC has NO rule-making regulatory authority in this area. In the name of ‘protecting consumers’ the FCC is walking away under a smokescreen sham that the FTC can do the job.”

But Pai argued in a statement that the FTC was the best enforcer because it was “the federal government’s most experienced privacy cop”; and that the light-touch regulatory regime that he favors would encourage innovation and higher investment. He wrote: “For almost 20 years, the Internet thrived under the light-touch regulatory approach established by President Clinton and a Republican Congress. This bipartisan framework led the private sector to invest $1.5 trillion building communications networks throughout the United States. And it gave us an Internet economy that became the envy of the world.”

By contrast, he claimed, the introduction of net neutrality laws in 2015 had driven the reduce investment by operators like AT&T and Verizon since then. That argument, of course, is highly controversial. The two big telcos have reined in their capex in the past two years, but there are many factors behind that, including the near-completion of their 4G networks, and the suspension of intensive mobile build-out until 5G appears; and in AT&T’s case in particular, a sharp shift towards software-driven networks, which are less capex-intensive.

But Pai is, as FCC chiefs often do, rewriting history in the light of his own decisions. He continued the tale, writing: “But in 2015, the prior FCC bowed to pressure from President Obama. On a party line vote, it imposed heavy-handed, utility-style regulations upon the Internet. That decision was a mistake. It’s depressed investment in building and expanding broadband networks and deterred innovation.”

Meanwhile, Wheeler was offering his own interpretation in his blog post, writing: “For more than a decade, previous Republican and Democratic FCCs have tried to bring fairness and balance to the delivery of the Internet to consumers. Every one of those efforts has been opposed by the corporations that consumers rely on to deliver the internet. Now the Trump FCC has simply cut to the chase, there is no need for the big companies to sue—they’ll just be given everything they want.”

Verizon and other telcos were indeed supportive. Kathy Grillo, deputy general counsel for public policy and government affairs at Verizon, said in a statement: “At Verizon, we continue to strongly support net neutrality and the open Internet … We are also confident that the FCC will reinstate a framework that protects consumers’ access to the open Internet, without forcing them to bear the heavy costs from unnecessary regulation that chases away investment and chills innovation.”

And Jonathan Spalter, CEO of USTelecom, an association which represents large telcos, said: “The removal of antiquated, restrictive regulations will pave the way for broadband network investment, expansion and upgrades. FCC Chairman Pai’s proposal to restore the smart, common-sense, bipartisan policies that allowed the internet to flourish is a critical step toward closing the digital divide and ensuring net neutrality protections for all.”

Pai, unlike many consumer groups and content providers, argues that there is no need for heavy regulation, just for transparency so that consumers and businesses can make the best choices, and the market can penalize providers which restrict access. He claims that, under his plan, the “FCC would simply require Internet service providers to be transparent about their practices so that consumers can buy the service plan that’s best for them and entrepreneurs and other small businesses can have the technical information they need to innovate.”

His Democrat Commissioners are in deep disagreement. Clyburn took a seasonal tone in her rebuttal to the plan, just before the US Thanksgiving holiday, saying: “In just two days, many of us will join friends and family in celebrating the spirit of Thanksgiving. But as we learned today, the FCC majority is about to deliver a cornucopia full of rotten fruit, stale grains, and wilted flowers topped off with a plate full of burnt turkey. Their Destroying Internet Freedom Order would dismantle net neutrality as we know it by giving the green light to our nation’s largest broadband providers to engage in anti-consumer practices, including blocking, slowing down traffic, and paid prioritization of online applications and services.”

There are many arguments for and against various levels of neutrality. In a completely open network, with no prioritization for any one application, there are the risks of poor quality of service for high bandwidth services such as streaming video, especially on a mobile network with its limited capacity; and that a critical machine-to-machine usage such as emergency response might have to fight for space with Netflix.

The effects of severe neutrality rules on universal access were seen in India when the regulator effectively barred Facebook Basics, a stripped-down service aimed at reaching the underserved, because it involved an operator zero-rating certain applications such as the Facebook social media site.

However, the US – like most western economies – never had that strict a level of neutrality.  It was already, in reality, allowing some forms of zero-rating, and had already included flexibility for mobile operators to shape their traffic in order to improve overall QoS. And while zero-rating has remained a grey area, moves by Verizon and others vindicate the view that providers will turn those zero-rating deals effectively into Internet ‘fast lanes’. For instance, Verizon has zero-rated the data used in streaming content for Go90, its mobile-first over-the-top video service – and AT&T and Comcast have both since followed up with similar moves.

By ending net neutrality completely and trusting the ISPs to behave well, the FCC makes life far harder for smaller and alternative content or service providers, and in theory lets providers prioritize the applications which pay them most, reducing consumer choice.

The same will go for the 5G investment, which will be justified by the wide range of services the new network can support, rather than just by consumer usage. Many stakeholders in the Industrial IoT, smart cities and other business sectors – which hope 5G will enable them to become fully connected and digital – will be angry if they see operators limiting the variety of services that are available, by prioritizing just a subset of those which pay the best fees.

The way round that, of course, in 5G will be network slicing. In its fully developed form, slicing will allow the application itself to call up the connectivity and processing resources it needs and navigate its way through the virtualized network automatically. When this becomes real – by the mid-2020s – neutrality rules will be irrelevant since the service, not the operator, decides which path to take.

And it is unclear who will dominate the value chain in that virtualized, sliced environment. A few advanced telcos may succeed in adapting to a network-as-a-platform model, but that role could equally well be fulfilled by a vendor like Nokia, an emerging neutral host provider, or a webscale giant like Facebook.

One thing is clear – net neutrality reversals will be a setback for Facebook, Google and Amazon, but not a significant one. Smaller applications and cloud services providers will suffer, but the attempt to keep the telcos in a strong power position against the web giants is doomed to fail. Rising use of unlicensed spectrum, virtualization and slicing, and the market forces that Pai trusts so well, will all play against the operators in the end.

That can even be seen in the story of Facebook Basics. With that service, Facebook can succeed better in a non-neutrality world, since it can team up with operators to prioritize and zero-rate its applications, driving up usage and supporting its core business model – which relies on numbers of users, not on fees for connectivity. In the non-neutrality world, Facebook may well follow through on plans, reported last year, to bring Basics to rural USA.

The social giant was in talks with MNOs and US government officials for months, according to The Washington Post, over ways to roll out the program and be acceptable under neutrality laws. Without those to worry about, Facebook may forge ahead. That may boost the regional MNOs temporarily, but it is clear who holds the key to the consumer relationship. An operator partner might gain new traffic and customers from Facebook’s branding clout, but they are also in danger of surrendering the primary subscriber relationship to the web giant.

As telecom analyst Craig Moffett told the Post: “There’s a bigger question of opening a Pandora’s box. You’d have to be concerned that Facebook might ultimately usurp the customer relationship and, at renewal time, demand to be paid rather than just carried [by the wireless company].” Neutrality or no neutrality, that issue is going to be the critical one for the US operators in the 5G era.

Arguments against regulation are not backed up by recent history, nor by the temper of the Internet industry which the US seeks to lead. It is clear that the explosion of affordable services and creative broadband and mobile usage owes more to an open Internet ecosystem, and a disruptive set of players led by Google, than it does to the entrenched telcos. Even their recent burst of creativity in areas from mobile pricing to software-defined networking has been largely forced by a new and open competitive environment, which did not allow them to stay comfortably inside their walled gardens.

Mobile operators, backed by industry associations like the CTIA and GSMA, may be relieved about the probable reversal of Title II, but that will not be enough to save their business model. They will still need to concentrate on different ways to generate revenues from content and apps, and to manage data traffic so that the user experience is acceptable for all.

There is a deep underlying economic reason to keep the Internet open, in a market like the US where there is ongoing consolidation of operators. There are fewer and fewer of them and they are about to break cover and begin blocking services like Netflix – if allowed. Forcing Netflix to pay for connectivity was one such shift, made by Comcast, AT&T and Verizon.

What Title II did was make it safe for further operator consolidations to occur, both in the provision of fixed line and cellular broadband. This can introduce economies of scale to the underlying networks – where, in the mobile world especially, it is increasingly hard to cost-justify the build-out effort to keep pace with data usage. Operators can merge or partner, and extend their revenues with new wholesale and intelligent ‘as-a-service’ business models, without damaging consumer choice, since that will largely lie in the services – which can proliferate in an open environment and amid more robust network expansion economics.

The saga of US net neutrality:

The reversal of net neutrality by the new FCC is just the latest twist in a long and tortured tale, and is unlikely to be the last.

In June 2016, it seemed that Wheeler had got his way when the US Appeals Court in Washington DC upheld the tough net neutrality approach which he had introduced in the FCC’s Open Internet ruling the previous year. The court said the FCC was right to reclassify broadband access services under the Title II regulations which insist on open access to the Internet and that an operator cannot give priority to its own content and services, or those of partners.

There were some special conditions for mobile operators, because of the capacity constraints of their spectrum, but far fewer than they believed to be necessary. The Open Internet decision withdrew much of the ‘special treatment’ MNOs had won in the previous set of US neutrality rulings (overturned after legal challenges, thus opening the way to a new and, as it turned out, more hardline set of proposals).

At the time, Wheeler applauded the court’s decision. “Today’s ruling is a victory for consumers and innovators who deserve unfettered access to the entire web, and it ensures the internet remains a platform for unparalleled innovation, free expression, and economic growth,” he said in a statement.  “After a decade of debate and legal battles, today’s ruling affirms the Commission’s ability to enforce the strongest possible internet protections – both on fixed and mobile networks – that will ensure the internet remains open, now and in the future.”

Wheeler had originally proposed neutrality rules in 2014 which did not reclassify broadband as a regulated telecom service, but in the last months of the proceedings, he toughened his view, partly after President Obama made it clear he supported reclassification. The FCC, in a 3-2 vote, agreed in February 2015 to pass the new rules to ban providers from selectively blocking or slowing web traffic. The Commission also voted to reclassify broadband from a lightly regulated information service to a more heavily regulated telecommunications service.

Opponents like Berin Szóka, president of free market thinktank TechFreedom, “the FCC now has a blank check to regulate the Internet however it sees fit. The only way to end this madness is a legislative solution that gives the FCC clear but narrow authority over the core of its rules, but stops the FCC’s other power grabs.”

Even The Wall Street Journal criticized the decision in an editorial, suggesting that it was a breach of the 1996 Telecommunications Act, which said the Internet “shall remain unfettered by federal regulation”. The paper argued that Title II was imposed by Obama over the heads of the FCC Commissioners, and claimed that the agency could not summon a single instance of Internet discrimination.

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