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The Worm Turns: But Will Our Worldview?

Netflix's proposition forces us to change the way we view competition on the Internet. Instead of a sprint, we are witnessing a cage match of competition, in which these companies enter each other's markets and make and break alliances among each other.
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Netflix -- which has evolved from a DVD mail service to the largest single source of throughput on the Internet -- created a minor kerfuffle following its recent proposition to co-locate its servers with various ISPs and others. Essentially, if you want to get Netflix's bandwidth-intense HD service, you have to do it through one of these partners. Even the free-market Technology Liberation Front has condemned them, claiming "Netflix's goal is to coerce ISPs into paying for a free Internet fast lane for Netflix content."

Let's put aside whether Netflix is evil or not. Netflix's proposition forces us to change the way we view competition on the Internet.

Advocates of net neutrality, common carriage, and other schemes for extensive regulation of broadband connectivity steadfastly argue that high-speed Internet is provided by a "duopoly" of cable and telecom companies. Armed with their market power, the alleged Internet Trust threatens to stifle content, limit dissemination and jack up prices. Susan Crawford goes one further in her recent book Captive Audience, arguing that cable has vanquished its telco challengers and regulation must rise to this challenge.

I -- and probably most economists -- disagree for a slew of reasons. They range from the ISPs' needs to attract evermore customers to spread the fixed costs of system construction, to the growing strength and functionality of wireless broadband connections -- which (Crawford to the contrary) may one day relegate wireline connections to a specialty product, much as workstation PCs or analog phones are similarly threatened.

But there's also this -- would critics recognize competition when they saw it? Because their claims of a "duopoly" fail to recognize who's actually competing. Critics expect broadband competition to look like the linear "sprint" between two companies that make the same, essentially undifferentiated, product -- Coke and Pepsi, Oreo and Hydrox. To those critics, cable and fiber compete with each other in one lane, iPhones and Androids in another, apps and services and social media in another.

But that's not how competition unfolds in the broadband world. As Google CEO Eric Schmidt has noted, all of these companies -- whether connectivity providers Comcast or Verizon, device manufacturers such as Apple, device enablers such as Google or Microsoft, or service providers such as Facebook or Amazon -- compete against each other to become the portal through which consumers enter the broadband world; the "platform" on which the other components of the broadband experience rest.

The reality of this competition is ever-present, if only we're willing to see it. Consider the ongoing dynamic between Apple and mobile providers such as Verizon or AT&T. When connectivity providers improve their offerings (fourth generation mobile phones), Apple and other device manufacturers immediately come up with ways to use that stronger signal in their devices' features (SIRI), and grab more of the value of the total broadband experience. That limits providers' power to raise prices while forcing them to continue to innovate and invest, just as a "conventional" competitive sprint would.

Instead of a sprint, we are witnessing a "cage match" of competition, in which these companies continually enter each other's markets and make and break alliances among each other -- much as Google has become a device manufacturer and now an experimental infrastructure provider, or Amazon a purveyor of devices and cloud services, or Facebook an (aspiring) vehicle for Internet search. Google allied with device manufacturers by licensing Android, then challenged them by acquiring Motorola. Netflix was competing with the pay-per-view businesses of the ISPs, but now is trying to force them into an alliance, albeit on its own terms. In the cage match, competition continually renews itself, often from unexpected sources.

Which brings us back to Netflix. There was a time when we were told to fear the market power of the ISPs -- if unregulated, they would force content producers to pay a heavy toll to cross the ISP bridge to the customer. But now we're told to fear the market power of the content providers, who are picking and choosing among the ISP networks that may carry their content. Which is it?

The answer is... neither. The only way to unravel this paradox is to view it through the lens of "cage match competition." Netflix is trying to become the reason you buy signal from an ISP; companies such as AT&T, Sprint, or Cox are competing to be the infrastructure that brings you Netflix. Together, along with the providers of other devices, services, and applications, both wired and wireless, they will divide the value created by the totality of the broadband experience. And as a result, consumers benefit, which is the goal of competition in the first place.

That's what neutrality regulation advocates miss when they point to a so-called "duopoly" of broadband providers. These providers face competition far more extensive and rigorous than Oreo versus Hydrox. Case in point: A player that started out as a DVD mail service has brought the players in the broadband "duopoly" to heel.