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Five Reasons Chairman Pai Says Gutting Net Neutrality Helps Startups and Why They’re All Nonsense

Engine is the voice of startups in government, and we’re telling Members of Congress to stop the FCC’s December 14th Net Neutrality vote. Add your startup’s voice to our petition delivery here.

FCC Chairman Ajit Pai says his plan to gut net neutrality protections will help startups. But actual startups, the people who invest in them, and basic facts disagree.

Of all the logical errors and outright falsehoods in the FCC’s plan to eliminate existing net neutrality rules (and there are many), perhaps the most bizarre and ill-considered is the claim that allowing ISPs to charge startups for better access to their users is somehow good for innovation. Existing FCC rules ban ISPs from creating “paid prioritization” schemes whereby companies that pay special tolls can receive faster connections with end users, slowing down all other non-prioritized traffic in the process. Pai wants to eliminate the ban on paid prioritization and thinks that startups are eager to compete with massive Internet companies for the privilege to pay ISPs for better access to end users.

You might be thinking: “That seems like obviously counterintuitive bullshit. Why would anyone believe that tiny startups can afford to outbid the world’s largest companies for priority access? Surely the FCC must have compelling empirical evidence supporting their seemingly nonsensical position.”

Well, I have some disappointing if entirely predictable news for you…

To begin with, Pai ignores the simple economic reality that startups will not be able to afford priority access. According to survey data, the average startup raises somewhere between $70,000 and $350,000 in in initial capital for all its operating expenses. Compare that to an established incumbent like Facebook, which has a market cap of more than $500 billion. If priority access to consumers is indeed a valuable way for a company to “differentiate” itself from competitors, incumbents like Facebook will set the going price for priority access. And since packet switching is a zero-sum game — that is, if some Internet traffic is prioritized, all other traffic is necessarily de-prioritized — startups will be left in the slow lane.

According to ISPs’ own statements, prioritization is likely to be massively expensive, well beyond the reach of startups. They have argued that the 2015 net neutrality rules will curtail their investments by as much as $40 billion, and since those rules only prohibit them from blocking content or charging websites for priority access to end users, this means that they expect to recoup around $40 billion in access and priority fees if the rules are eliminated. To earn those kinds of profits, ISPs would need to price priority access far higher than any startup could afford.

But according to Pai, cash-strapped startups want the freedom to “differentiate” their services by entering into bidding wars with Internet behemoths like Google and Amazon for better access to users:

“Paid prioritization could allow small and new edge providers to compete on a more even playing field against large edge providers.”

Since the massive difference in financial resources between startups and large companies itself creates the uneven playing field, it’s unclear why allowing large companies to leverage their financial might to further cement their dominant positions will even things up.

Despite Pai’s frequent boasts about how economically rigorous his commission is, he doesn’t bother citing any empirical studies to justify his position — he can’t even point to the type of bogus analysis he routinely uses to support his emphatically anti-competition policies. Instead, the FCC accepts as fact the unsupported assertions from telecom companies and think tanks that allowing ISPs to leverage their gatekeeper power to extract priority access fees from websites will somehow benefit small websites.

The proposed rule ignores the thousands of startups and investors that have told the Commission in no uncertain terms that allowing paid prioritization would severely curtail startup activity. In Pai’s world, ISPs and other big companies know more about startup innovation than actual startups.

So what compelling arguments have these telecom behemoths brought forth to overcome this simple economic reality? Let’s have a look:

Argument #1: “Prioritization Is Commonplace and Pro-Consumer”

One common theme in the “support” Pai musters for his reversal of the FCC’s ban on net neutrality is a reliance on inapt analogies to other markets to show how other “prioritization” schemes have worked out fine for consumers. Not surprisingly these analogies are wildly inapposite and have almost nothing to do with the types of prioritization schemes that net neutrality rules are concerned with.

The Internet is Like a Grocery Store

In a ten page report by the Free State Foundation that the proposed order repeatedly cites to support its reversal of paid prioritization rules, the author argues that paid prioritization is just like “slotting” policies at grocery stores whereby food producers can pay for premium shelf placement.

This type of prioritization shares some trivial similarities with paid prioritization of Internet traffic, but the analogy falls apart under the slightest scrutiny. Most obviously, the market for grocery stores is competitive, while the market for broadband access is not. Most consumers have multiple choices when deciding where to purchase groceries, limiting the bargaining power any individual store or chain has in relation to food producers. With Internet access on the other hand, most Americans have one or zero options for high-speed broadband. If you don’t like how your ISP is prioritizing traffic, there’s really nothing you can do. This gives ISPs enormous power to extract rents from websites in a way that distorts competition, giving a huge advantage to incumbents that can pay the most for priority access.

The Internet is Like a Priority Lane on the Highway

Similarly, the paper argues that paid prioritization is pro-consumer because in some cities, governments have built special priority lanes on highways that drivers must pay to access. According to this view, restricting paid prioritization unduly limits user choice by preventing consumers from voluntarily paying for better access. In reality, the existing ban on paid prioritization does not bar an ISP from charging end users for different types of service.

Unlike setting tiered pricing for users to pick access speeds, ISPs charging online services for better access to users distorts the market by giving a major competitive advantage to the richest incumbents while harming the companies that can’t afford to compete against those incumbents, like startups. The Free State Foundation’s analogy to highway priority lanes would only be relevant if governments were charging car manufacturers to allow their cars in the fast lane. If cities created special fast lanes for Hondas only, you can bet that Honda sales would spike and other car companies would suffer. This is quintessential market distorting behavior that has no positive impact on car innovation.

Argument #2: “Some Prioritization Might Be Good, So We Should Allow All Prioritization”

Anti-net neutrality advocates frequently argue that because new latency-sensitive Internet services may require the type of guaranteed performance that can only be provided through priority service, all paid prioritization schemes should be presumptively allowed. According to this view, it’s better to challenge competition-distorting prioritization after the fact to prevent the preemptive blocking of theoretically pro-consumer prioritization schemes.

According to Pai’s order, companies that are harmed by anti-competitive paid prioritization schemes can just challenge those schemes under existing antitrust laws. But the kinds of companies most likely to be harmed by anti-competitive paid prioritization schemes are those that can’t afford to compete with major companies for better access to end users to begin with, and they certainly can’t afford the time- and cost-intensive legal battle that comes with antitrust complaints. Realistically, a startup harmed by a paid prioritization scheme won’t survive long enough to file a complaint, much less litigate it to a judgment.

It’s also plainly false to claim that the existing ban on paid prioritization means that ISPs can never prioritize traffic in any circumstance. The 2015 order created a formal mechanism for ISPs and websites to petition for a waiver from the ban on paid prioritization. So, if the Internet ecosystem develops in such a way that prioritizing autonomous vehicle data ahead of, say, email traffic is necessary for those vehicles to function properly, there’s an easy way to address that problem without allowing large companies to pay to degrade access to competitor services. Since the types of content that Pai believes warrant prioritization represent a tiny fraction of Internet traffic, we shouldn’t be crafting rules around edge cases.

Argument #3: “Websites That Generate A Lot Of Traffic Should Internalize The Costs Of That Traffic”

This one doesn’t require much debunking. Pai is basically arguing that popular websites should also have to pay for Internet traffic that consumers are already paying for. ISPs just want to be able to double-dip to collect money from both the customers they already charge and the websites that those customers access. This argument rests on a specious claim: that certain popular websites are generating so much traffic that they’re causing congestion on ISP networks. Of course, since websites can only “cause traffic” when ISP customers access those websites, what this really means, of course, is that consumers are generating so much traffic that they’re causing congestion.

Even assuming this congestion claim is legit (hint: it isn’t), the way to solve the problem without distorting competition is to charge users more if they consume congestion-creating amounts of data. The proposed rules try to sidestep this obvious point by asserting — without any support whatsoever — that “ISPs cannot always set prices targeted at the relevant end users.” What? You really think we’re going to believe that ISPs can identify which websites receive the most traffic but can’t figure out which customers are causing the most traffic?

Argument #4: “Allowing Paid Prioritization Will Increase Competition Because ISPs Will Reinvest In Their Networks”

Pai apparently thinks that allowing ISPs to extract monopoly rents from websites will give them the extra cash they so desperately need to build new networks. But ISPs are already making obscene amounts of money — AT&T had $40 billion in revenue in Q2 2017 alone, and Comcast earned $21 billion in Q3; why would additional revenues from paid prioritization suddenly prompt them to build new networks and compete with each other? These are massive companies that face almost no competition. How much more money do they need before they start competing?

Argument #5: “ISPs Will Pass Paid Prioritization Revenues To Consumers”

Yes, you read that right. Pai is claiming that ISPs will give the money they earn from paid prioritization schemes back to consumers out of the kindness of their hearts:

“Eliminating the ban on paid prioritization arrangements could lead to lower prices for consumers for broadband Internet access service, as ISPs may be able to recoup some of their costs from edge providers.”

Of all the implausible things claims Pai has made, suggesting that Comcast and Verizon are going to give you free money if we let them fleece startups is uniquely insane.

The fact that Pai couldn’t come up with anything better to support his plan to end net neutrality is itself proof of his intellectual dishonesty.

Engine is the voice of startups in government, and we’re telling Members of Congress to stop the FCC’s December 14th Net Neutrality vote. Add your startup’s voice to our petition delivery here.

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