Does Net Neutrality Create Incentives, or Not?

Net neutrality impact on revenue

"Policy advocates have been arguing about network neutrality for years. Some even argue that Internet access providers have less incentive to invest unless strong network neutrality rules are in place. 


Some might find that an odd argument, given the universal opposition to strong forms of network neutrality on the part of entities that actually own and operate access networks. Though service providers who operate networks nearly universally claim that incentives for investment are higher when there is freedom to create new services that prioritize packets in ways that enhance end user experience, some argue the reverse is true. 


Professors H. Kenneth Cheng, University of Florida Warrington College of Business Administration; Subhajyoti Bandyopadhyay, University of Florida Warrington College of Business Administration and Hong Guo, University of Notre Dame, argue that ISPs gain from encouraging "scarcity," which creates incentives for users to buy prioritization services. 


"We find that if the principle of net neutrality is abolished, the broadband service provider stands to gain from the arrangement, as a result of extracting the preferential access fees from content providers," they argue. 

"When compared to the baseline case under net neutrality, social welfare in the short run increases if one content provider pays for preferential treatment, but remains unchanged if both content providers pay," the professors argue. 

"Finally, we find that the incentive to expand infrastructure capacity for the broadband service provider and its optimal capacity choice under net neutrality are higher than those under the no net neutrality regime except in some specific cases," the professors say.  Consumer welfare under net neutrality rules

"Under net neutrality, the broadband service provider always invests in broadband infrastructure at the socially optimal level, but either under- or over-invests in infrastructure capacity in the absence of net neutrality," they maintain. 

But analysts at Frost & Sullivan argue that net neutrality has the potential to significantly discourage infrastructure investment. This is because investments in infrastructure are highly sensitive to expected subscriber revenue. Anything that reduces the expectation of such revenue streams can either delay or curtail such investments.

Operators would likely reduce investment due to the increased business risk, they argue. 

An operator denied the opportunity to generate service revenue would be forced to adopt other methods for covering deployment costs, Frost analysts argue. These could include simply passing along the costs to the consumer, creating service bundles that limit consumer choice or passing the cost along to content providers.

"To the extent that consumers were unwilling or unable to incur such costs, net neutrality could, ironically, have the effect of actually reducing broadband penetration," the analysts argue. 

Net neutrality acts like a tax on the Internet. It imposes overheads on network operators, which, in turn, decrease network investments, providing less opportunity, not only for the operators, but also for those that use the operators' networks as well. Net neutrality reduces investment


Frank Gallaher, Stifel Nicolaus analyst, warned of just that outcome in 2009. At least some other policy advocates are too sanguine about the impact on investment if harsh new rules are enacted, he argued. 


Likewise, Matt Niehaus, Battery Ventures analyst, warned in 2009 that telecom investment capital has been declining over the past 10 quarters. The capital flight is caused in large part because of a perception that there is too much competition in telecoms, and therefore further investment is less likely to provide an adequate return on capital investment.

 "It's a perception in Wall Street, there's too much competition, and therefore it's difficult for entities to obtain a great return, " he says.

  "One of the things that worries me, is you can execute very well, and the problem is you may do all those things right, yet it's not clear you will be rewarded on the back end for it," Niehaus says.

But S. Derek Turner, Free Press research director, says carrier investment decisions are driven by a variety of factors, but regulation plays only a minor role.

"In general, firms’ investment decisions are driven primarily by six factors: expectations about demand; supply costs; competition; interest rates; corporate taxes; and general economic confidence -- making the overall decision to invest a complex process that is highly dependent on the specific facts of a given market," says Turner. "It is simply wrong to suggest that network neutrality, or any other regulation, will automatically deter investment."


Carriers worry about investment climate