The economics of online television: Industry development,aggregation, and “TV Everywhere”

Although still dominated by standard television, the online TV industry is growing rapidly. Entrants employ a range of business models, and we identify a prevalent tendency for leading providers to aggregate programming from a variety of different content owners. We focus on one form of content aggregation by multi-channel programming distributors (MPVDs) widely known as “TV Everywhere (TVE).” Following a brief taxonomy of TVE systems, we develop an economic model to show how this “free-with-authentication” (of MVPD subscribership) bundling practice can be explained as a price discrimination device intended to slow MVPD disconnections. We show that TVE bundling could also deter entry into the online TV market. We discuss the potential roles of horizontal and vertical integration of MVPDs and ISPs in online TV industry development, again focusing on TVE, and conclude with policy implications.     

The exclusion of competing one-way essential complements: Implications for net neutrality

We analyze the incentives of internet service providers (ISPs) to break net neutrality by excluding competing one-way essential complements, i.e. internet applications competing with their own products. A typical example is the exclusion of VoIP applications by telecom companies offering internet and voice services. A monopoly ISP may want to exclude a competing internet app if it is of inferior quality and the ISP cannot ask for a surcharge for its use. Competition between ISPs never leads to full app exclusion but it may lead to a fragmented internet where only one ISP offers the application. We show that, both in monopoly and duopoly, prohibiting the exclusion of the app and surcharges for its use does not always improve welfare.     

Discussion of Papers by Bruce Owen and Christopher Yoo

The ambiguity in allocating economic stages to regulatory stages that arises in some contexts does not prevent either antitrust or regulatory intervention with respect to content and distribution. However, the feasibility of intervening with respect to vertical integration does not by itself make such intervention wise. In general, cases when a dominant distributor over substantial areas tries to integrate with an established content provider that dominates its programming segment, antitrust intervention on potential competition grounds may be warranted. This rationale does not justify an outright ban on ISP investment in content, but such a ban would not stop rapid development of web content and might be worth it if it prevents limitations on ISP pricing flexibility.     

Internet peering as a network of relations

This paper applies results from recent theoretical work on networks of relations to analyze optimal peering strategies for asymmetric Internet Service Providers (ISPs). From a network of relations perspective, ISPs’ asymmetry in bilateral peering agreements need not be a problem, since when these form a closed network, asymmetries are pooled and information transmission is faster. Both these effects reduce the incentives for opportunism in general, and interconnection quality degradation in particular. The paper also explains why bilateral monetary transfers between asymmetric ISPs (Bilateral Paid Peering), though potentially good for bilateral peering, may have negative effects on the sustainability of the overall peering network.     

Net neutrality and inflation of traffic

Under strict net neutrality Internet service providers (ISPs) are required to carry data without any differentiation and at no cost to the content provider. We provide a simple framework with a monopoly ISP to evaluate the short-run effects of different net neutrality rules. Content differs in its sensitivity to delay. Content providers can use congestion control techniques to reduce delay for their content, but do not take into account the effect of their decisions on the aggregate volume of traffic. As a result, strict net neutrality often leads to socially inefficient allocation of traffic and traffic inflation. We show that piece-meal departures from net neutrality, such as transmission fees or prioritization based on sensitivity to delay, do not necessarily improve efficiency. However, the ISP implements the efficient allocation when allowed to introduce bandwidth tiering and charge for prioritized delivery.     

Multihoming, content delivery networks, and the market for Internet connectivity

Peering points between different Internet service providers (ISPs) are among the bottlenecks of the Internet. Multihoming (MH) and content delivery networks (CDNs) are two technical solutions to bypass peering points and to improve the quality of data delivery. So far, however, there is no research that analyzes the economic effects of MH and CDNs on the market for Internet connectivity. This paper develops a static market model with locked-in end users and paid content. It shows that MH and CDNs create the possibility for terminating ISPs to engage in monopolistic pricing towards content providers, leading to a shift of rents from end users and content providers to ISPs. Implications for future innovations are discussed.     

Vertical Foreclosure in Broadband Access?

The merger of AOL and Time Warner involved a vertical combination of the largest Internet content provider and aggregator and a large cable system operator which offers a conduit through which broadband customers can access Internet content at high speeds. We consider the economic incentives of such a firm to engage in two distinct vertical foreclosure strategies: (1) conduit discrimination—insulating its own conduit from competition by limiting rival platform distribution of its affiliated content and services, and (2) content discrimination—insulating its own affiliated content from competition by blocking or degrading the quality of outside content.     

Horizontal Concentration and Vertical Integration in the Cable Television Industry

In the recent past, the cable industry has exhibited a pronounced tendency toward increased vertical integration and concentration of cable system ownership. As a result, the 1992 Cable Act proposed and the Federal Communications Commission implemented restrictions on such activity. Two antitrust concerns include the size of programming discounts offered to large multiple-system operators and price and carriage discrimination by vertically integrated programming networks. The empirical model in this paper attempts to systematically measure the effect of ownership concentration and vertical integration on the programming cost and price of cable operators. We find that concentration and integration lower the programming cost to cable systems affiliated with larger multiple-system operators. These discounts are partially passed along to consumers in the form of lower prices.     

Bill-and-Keep peering

Peering arrangements between Internet Service Providers (ISPs), in which providers agree to carry traffic originating from a peer, are common in the Internet. A common contractual peering agreement between smaller ISPs is “Bill-and-Keep”, where no money changes hands between the peers. This paper first investigates a situation when ISPs who have access to a transit ISP capable of handling their traffic for a fee, decide to peer incurring some fixed peering cost. Using a simple model it is shown that Bill-and-Keep peering is the fair and efficient outcome if the transit ISP charges for both inbound and outbound traffic and transit charges as well as costs of peering are symmetric. Next, complementarity between providers at the operational level, as measured by improvement in quality of service (QoS), is analyzed using an idealized model. Assuming that each provider incurs costs, or degradation in QoS, from its traffic traversing its own as well as the peer's links and chooses the amount of traffic to send on its peers’ links in its self-interest, the Nash equilibria of the resulting one shot game and then of an infinitely repeated game are analyzed. For the one-shot game, it is established that, while it is not possible for all the providers to be worse off, it is certainly possible for all of them to be better off. An intuitive sufficient condition for each of the providers to be better off in Nash equilibrium is then derived. Further, it is shown that providers that are better off in the one-shot game can cooperate using threat strategies in an infinitely repeated game and can each be even better off. Coalition formation between peers as a dynamic process is also investigated and some examples and conjectures on some preliminary findings are provided. Finally, the policy implications of the findings are discussed.     

Network neutrality and difference in efficiency among Internet application service providers: A meta-frontier analysis

As Internet applications evolve and require wider and more stable bandwidth, Internet service providers (ISPs) try to maximize their profit by controlling application service providers (ASPs); this has caused a network neutrality debate. This article categorizes ASPs into four groups by bandwidth-usage attributes and latency sensitivity. By estimating the efficiency of these groups, their efficiency differences are estimated, indicating evidence of discrimination of ISPs when network neutrality is not maintained. Meta-frontier analysis is used to compare efficiencies across companies using different production function technologies. Finally, a Tobit regression model is used to determine which variables explain the difference of efficiencies. The estimation result indicates that the discrimination of ISPs against ASPs is not significant enough to decrease the efficiency of any application group.     

Antitrust and Vertical Integration in “New Economy” Industries with Application to Broadband Access

Whether the firms that supply Internet hardware and software should face restrictions on the use of their property is an important and controversial policy issue. Advocates of “net neutrality”—including President Obama and the current FCC majority—believe that owners of broadband distribution systems (hardware used to distribute Internet and video services) and producers of certain “must-have” video content should be subject to prophylactic regulation that transcends present-day antitrust law enforcement. In the economic terms that are used in debates on competition policy, the concern is with vertical integration that may give firms both the opportunity (through denial of access or price discrimination) and incentive (increased profit) to restrict competition. This paper’s central point is that virtually every production process in the economy is vertically integrated, and economics predicts changes in the extent of vertical integration—that is, changes in the boundaries of the firm—in response to changes in relative prices, technology, or institutions. Both vertical integration and changes in the extent of vertical integration are benign characteristics of efficient, dynamic, competitive markets. While there is no shortage of theoretical models in which vertical integration may be harmful, most such models have restrictive assumptions and ambiguous welfare predictions—even when market power is assumed to be present. Empirical evidence that vertical integration or vertical restraints are harmful is weak, compared to evidence that vertical integration is beneficial—again, even in cases where market power appears to be present. Thus, it is reasonable to conclude that prophylactic regulation is not necessary, and may well reduce welfare. Sound policy is to wait for ex post evidence of harm to justify interventions in specific cases. Net neutrality, recently enacted by the FCC but subject to judicial review, is an unfortunate idea.     

Vertical integration in the TV market: Exclusive provision and program quality

We study how vertical integration in a media market affects investments in premium content. We show that a content provider provides the premium content exclusively to a platform, regardless of the vertical structure of the industry. However, a vertically integrated content provider has lower incentives to invest in quality than an independent one. With asymmetric platforms, the platform with a competitive advantage in the advertising market obtains the exclusive content, and the content provider invests even less when it is integrated with it. We show that the content provider prefers to merge with the platform with a competitive advantage in the advertising market. Vertical integration reduces both consumer and total surplus. Our results suggest that authorities should carefully assess the effects of vertical mergers on the incentives to invest in content quality, incorporating non-price measures in merger analysis. An intervention at the distribution stage that enforces non-exclusive provision reduces quality and may have adverse effects on consumer and total surplus.     

A two-sided model of paid peering

Internet users have suffered collateral damage in tussles over paid peering between large ISPs and large content providers. Paid peering is a relationship where two networks exchange traffic with payment, which provides direct access to each other’s customers without having to pay a third party to carry that traffic for them. The issue will arise again when the United States Federal Communications Commission (FCC) considers a new net neutrality order.We first consider the effect of paid peering on broadband prices. We adopt a two-sided market model in which an ISP maximizes profit by setting broadband prices and a paid peering price. We analytically derive the profit-maximizing prices, and show that they satisfy a generalization of the well-known Lerner rule. Our result shows that paid peering fees reduce the premium plan price, increase the video streaming price and the total price for premium tier customers who subscribe to video streaming services; however, the ISP passes on to its customers only a portion of the revenue from paid peering. ISP profit increases but video streaming profit decreases as an ISP moves from settlement-free peering to paid peering price.We next consider the effect of paid peering on consumer surplus. We find that consumer surplus is a uni-modal function of the paid peering fee. The paid peering fee that maximizes consumer surplus depends on elasticities of demand for broadband and for video streaming. However, consumer surplus is maximized when paid peering fees are significantly lower than those that maximize ISP profit. However, it does not follow that settlement-free peering is always the policy that maximizes consumer surplus. The peering price depends critically on the incremental ISP cost per video streaming subscriber; at different costs, it can be negative, zero, or positive.     

Net Neutrality and internet fragmentation: The role of online advertising

We investigate the relation between Net Neutrality regulation and Internet fragmentation. We model a two-sided market, where Content Providers (CPs) and consumers interact through Internet Service Providers (ISPs), and CPs sell consumers' attention to advertisers. Under Net Neutrality, a zero-price rule is enforced. By contrast, in the Unregulated Regime, ISPs make access to their subscribers for CPs conditional on payment of a termination fee. Multiple impressions of an ad on the same consumer are partially wasteful. Thus, equilibrium ad rates decrease when audiences overlap. We show that ISPs may strategically set termination fees to induce fragmentation. This takes place when advertising revenues are potentially large but strongly diminished by competition among CPs, and when consumers are not highly sensitive to content availability. We therefore identify an important link between termination fees, the online advertising market and Internet fragmentation. We extend the model to account for multi-homing consumers, vertically integrated ISPs, third-party advertising platforms and heterogeneous CPs.     

Exploring the potential of wireless technologies to accelerate universal Internet access in Ghana

Ghana was one of the first countries in sub-Saharan Africa to be connected to the Internet, yet has very low Internet usage (5.3 users per 100 inhabitants). A qualitative study including in-depth interviews with ISPs explored Internet diffusion in Ghana. Findings suggest that due to Ghana's inefficient and outdated fixed-line infrastructure, universal Internet access goals might not be achievable through fixed-line technologies. Rather, wireless technologies may be more efficient. However, high access costs continue to be a barrier. Policy options to encourage widespread deployment of wireless broadband and cost reduction are presented as suggestions for further research. These include using universal service funds to expand the national backbone with an open access high capacity wireless backbone to reach unserved and underserved areas, reducing license and regulatory fees for the wireless industry to encourage coverage and capacity expansion, and mandatory infrastructure sharing to reduce cost.     

The FCC’s Net Neutrality Decision and Stock Prices

More than a year after a court invalidated its “net neutrality” rules on broadband Internet service providers (ISPs), the Federal Communications Commission (FCC) decided to extend public-utility (Title II) regulation on broadband services. This paper uses traditional event analysis of the movements in the values of major communications and media companies’ equities at key moments in the FCC’s path to this decision to estimate the financial market’s assessment of the likely effects of regulation on ISPs, traditional media companies, and new digital media companies. The results are surprising: the markets penalized only three large cable companies to any extent, and even these effects appear to have been short-lived. The media companies, arguably the intended beneficiaries of the regulations, were unaffected.     

Internet telephony: Costs,pricing, and policy

This article analyzes Internet Service Provider costs and regulatory and policy issues raised by Internet telephony. Transport and non-technical items such as customer service, sales and marketing, represent a substantial portion of an ISP’s costs with Internet telephony. Pricing models and yield management techniques supporting Internet voice services might be employed for other Internet differentiated services as well. An integrated regulatory framework will be required, because of convergence, to formulate policies for multimedia services. We conclude that governments should develop appropriate policies without introducing economic and technical distortions into the nascent Internet telephony market.     

INNOVATION IN VERTICALLY RELATED MARKETS*

We examine the impact of vertical industry structure on upstream process innovation. We find that vertical integration (VI) generally enhances innovation under downstream Cournot competition, but can diminish innovation under downstream Bertrand competition. We also find that under Bertrand competition, VI can increase innovation when the direct incentives for innovation are limited, but can reduce innovation when the direct incentives are pronounced.     

Sorting things out: valuation of new firms in uncertain markets

New business models combined with a lack of objective operating data result in significant information asymmetry and uncertainty in the valuation of new firms in emerging markets. Information asymmetry increases the risks of both adverse selection and moral hazard. When traditional differentiators of firm quality are lacking, such as in emerging economic sectors, markets may turn to secondary information sources to filter and sort firms. We investigate the roles played by observable corporate governance characteristics as indirect indicators of new firms' potential qualitative differences. Markets may sort firms based on such characteristics because they are perceived to be correlated with desired but unobservable characteristics and actions and they lower the risks of both adverse selection and moral hazard. Our study of publicly traded U.S. Internet firms found that firm market valuation was strongly associated with corporate governance characteristics (e.g., executive and director stock‐based incentives, institutional and blockholder stock ownership, board structure, and venture capital participation). In addition, firm age moderated how markets used some quality proxies to determine firm valuation during the post‐IPO period. Copyright © 2003 John Wiley & Sons, Ltd.