A new decision has come down from the Court of Appeals for the DC Circuit Court, affirming last year’s designation of broadband internet as a utility by the Federal Communications Commission (FCC). Such a designation gives the government much broader power to regulate high-speed internet, and is a victory for the champions of “net neutrality” -- such as Alphabet (NASDAQ:GOOGL) and Netflix (NASDAQ:NFLX). This will not be the end of the matter; most observers expect the battle to find its way to the Supreme Court.
Back in 2014, we wrote on net neutrality while the FCC’s rules were still being drafted. We think some of that piece is worth presenting again, because it gives a good breakdown of who is on each side of the argument and why. Although it is presented as a civil rights or property rights issue by both sides, we see it as being a much more simple and straightforward economic battle; with the fight being over who will pay to build the roads that comprise the “information superhighway”.
"Net Neutrality”: More Heat Than Light
Consumers love data, particularly in the form of movies. NFLX streaming video data account for about a third of peak internet traffic in the U.S. Traffic has to flow along a road, and roads need to be built for that traffic to flow. Both consumers and producers have a strong interest in a good road system -- since without it, they couldn’t buy or sell any goods.
The question is: who will pay for the roads that make commerce possible? In the case of the interstate highway system -- one of the foundations of post-WW2 U.S. prosperity -- the answer is simple. They’re public, since it would make no sense to have competing privately-run interstate highway networks. So we fund them through our taxes.
This same question -- who will pay for the infrastructure? -- is the driving force behind the “net neutrality” debate. As internet-delivered applications get more data intensive, and as consumer demand for them grows, settling that question becomes more contentious.
Consumers think of the internet mostly in terms of their own “last mile” provider. If the internet is a highway system, the last mile provider is the road that goes from the off-ramp to your driveway. This provider is your internet service provider (ISP) -- either a big national company like Sprint Corp (NYSE:S) or AT&T (NYSE:T), or a regional company like Cox, Frontier Communications Corporation (NASDAQ:FTR), or EarthLink Inc (NASDAQ:ELNK). However, the trip that data takes from a “content provider” like NFLX to your last mile provider can be complex, potentially passing through national internet service providers (ISPs), content distribution networks (CDNs), and your own local ISP.
How That Movie Makes It To Your Screen
Source: Guild Investment Management, Inc.
Deals happen and the conflicts arise as players upstream from the final consumer negotiate with one another, jockey for position, and try to get someone else to help pay for the infrastructure to deliver the ever-growing torrent of data that consumers want and producers want to sell to them. Data cargoes are constantly getting bigger, and big network peers are sparring over who should pay to build the roads.
Content Providers and Broadband Suppliers Are Jockeying For Position
The argument goes something like this. Content producers, like NFLX, talk to the national networks and service providers and say, “Retail customers are demanding our content. When they signed up with you, you promised to deliver all the content available on the web -- so you should pay to build the roads and deliver it to them.”
In response, the people who build and run the internet’s backbone turn the demand around, and say to the content providers: “Retail customers are demanding your content. Your content has gotten much more data intensive, so clearly you should pay to build the roads that carry it to them.”
You could look at either argument and think, “That’s a reasonable position.”
If content providers like NFLX are prohibited from paying the various data transit companies (which is what “net neutrality” means), then the burden of building out infrastructure capable of handling ever-increasing data streams will fall on those transit companies themselves, if they want to keep the customers who demand the data. So of course, content providers like GOOG and NFLX have a motive to convince the public -- and regulators -- that something nefarious would be going on if they had to contribute more directly to the infrastructure that makes it possible for their products to reach consumers.
Likewise, the transit companies like AT&T or Sprint make a similar pitch to the public and to legislators -- but theirs is about property rights. They want convince the public that something nefarious would be going on if they were the ones who had to pay the price for infrastructure expansion. “Net neutrality,” to them, means that they can’t accept payment from content providers that will help them build out the infrastructure. So they say, “It’s our system -- we can make whatever arrangements with content providers we want to. That’s our right as property owners!”
All we’re witnessing is a tussle between the two sides -- and we’re watching as they make appeals to the public and to lawmakers to try to get a regulatory regime that’s more economically friendly to them. The recent decision is a victory for the content providers, but it will not be the last word; that will indeed likely fall to the Supreme Court for resolution.
In the longer term, we think it is likely that many of the online platforms currently disrupting retail, hospitality, and transportation industries will also come under increasing regulatory scrutiny. We see this process unfolding in Europe -- and eventually, it will come to the U.S. as well. Every industrial revolution brings its disruptors -- and then eventually, those disruptors are forced into the system and regulated.
Investment implications: “Net neutrality” has won a big battle, with a Circuit Court appeal upholding the FCC policy that puts high-speed internet in the same regulatory category as other utilities. The battle will go on -- likely to the Supreme Court -- but for now, this is a victory for companies that provide content, and a loss for companies that carry the data. In the long run, we think the writing is on the wall: in every industrial revolution, the disruptors are eventually tamed and integrated into a regulatory framework. Slowly, that’s happening with the internet revolution as well. If Europe is a harbinger, it will also happen eventually to disruptive platform services in the retail, hospitality, transportation, and other industries. Although the great tech leaders of the past several years may be excellent investments once the market declines, we need to be careful to differentiate the long-term growth stories, which are content suppliers, from the commodity producers of internet access. Content suppliers can grow for some time to come; access suppliers are becoming regulated.