Net Neutrality Means No More iPhones

The Reason Foundation releases my policy brief today looking at the effect network neutrality regulation will have on wireless applications and services.

Much has been written about the deleterious effect that regulating network management would have on broadband investment and innovation, and when applied to wireless, which is what FCC Chairman Julius Genachowski proposes to do, problems would only get worse.

The non-discrimination principle that Genachowski seeks to mandate would prohibit service providers such as AT&T, Verizon Wireless, T-Mobile and Sprint from using their network resources to prioritize or partition data as it crosses their networks so as to improve the performance of specific applications, such as a movie or massive multiplayer game. Yet quality wireless service is predicated on such steps. The iPhone, for example, would not have been possible if AT&T and Apple did not work together to ensure AT&T’s wireless network could handle the increase in data traffic the iPhone would create.

The irony is that the argument for network neutrality is that it would prevent service providers from controlling the so-called bottleneck between the Internet and end-users. The worry is that carriers are in a position to pick and choose winners or block competing players by choosing to improve or impede the performance of their respective applications, although there is no pattern of this behavior to justify preventative regulation.

The iPhone story is relevant because, while Apple and AT&T collaborated, it was Apple that was calling the shots while AT&T took most of the risk. Fred Vogelstein addressed the significance of this in “The Untold Story: How the iPhone Blew Up the Wireless Industry,” which appeared in January 2008 issue of Wired, January 2008.

After a year and a half of secret meetings, [Apple Chairman Steve] Jobs had finally negotiated terms with the wireless division of the telecom giant (Cingular at the time) to be the iPhone’s carrier. In return for five years of exclusivity, roughly 10 percent of iPhone sales in AT&T stores, and a thin slice of Apple’s iTunes revenue, AT&T had granted Jobs unprecedented power. He had cajoled AT&T into spending millions of dollars and thousands of man-hours to create a new feature, so-called visual voicemail, and to reinvent the time-consuming in-store sign-up process. He’d also wrangled a unique revenue-sharing arrangement, garnering roughly $10 a month from every iPhone customer’s AT&T bill. On top of all that, Apple retained complete control over the design, manufacturing, and marketing of the iPhone. Jobs had done the unthinkable: squeezed a good deal out of one of the largest players in the entrenched wireless industry.

Further down, the article continues to elaborate on the broader significance of the iPhone deal.

But as important as the iPhone has been to the fortunes of Apple and AT&T, its real impact is on the structure of the $11 billion-a-year US mobile phone industry. For decades, wireless carriers have treated manufacturers like serfs, using access to their networks as leverage to dictate what phones will get made, how much they will cost, and what features will be available on them. Handsets were viewed largely as cheap, disposable lures, massively subsidized to snare subscribers and lock them into using the carriers’ proprietary services. But the iPhone upsets that balance of power. Carriers are learning that the right phone — even a pricey one — can win customers and bring in revenue. Now, in the pursuit of an Apple-like contract, every manufacturer is racing to create a phone that consumers will love, instead of one that the carriers approve of. “The iPhone is already changing the way carriers and manufacturers behave,” says Michael Olson, a securities analyst at Piper Jaffray (emphasis author’s).

These observations have been borne out in the two years since that article appeared. The iPhone sparked a new market in smartphones. Research in Motion rolled out new BlackBerry devices. LG, Samsung and Motorola also entered the fray. The collaborative model has since moved beyond smartphones and takes in e-book readers like Amazon’s Kindle and devices such as Apple’s new iPad.

The fundamental flaw in network neutrality policy is that it assumes that service providers are in a position to dominate Internet service and applications. This premise was questionable to begin with, but the market forces that have come into play in the past two years has been shown it to be plain wrong. Competition has always served as a check on applications blocking. Now, it’s plain to see that service providers rely on equipment and applications providers to create differentiated devices and services that attract customers in greater numbers, bucking the recession. According to research firm NPD Group, smartphones accounted for 28 percent of all handset sales in the United States in the second quarter of 2009—a 47 percent increase in the category’s share since the same period in 2008.

It has turned out that the most effective wireless broadband business model is cross-platform collaboration. This should be enough to give the FCC pause before mandating a non-discrimination rule that would prohibit it. If a non-discrimination rule had been in force two years ago, the iPhone, the Kindle and the iPad would never have happened.

In my longer network neutrality policy study published last year, I argued that the evolution of Internet access service was a movement away from the neutral conditions that existed at the Internet’s birth. Users went from text commands to graphical browsers. Web sites went from dedicated servers to multi-site caching. Video compression algorithms were refined so video could be streamed. XML was developed so different Web applications could work together smoothly. Now, greater collaboration and bundling among service providers and other companies in the information services supply chain that are as large or larger is becoming an important way not simply to compete, but to build a strong business case for greater broadband investment.

As the industry comes to understand the benefits of these collaborative business models, it has become more unified in its opposition to network neutrality. A look at some of the filings in response to the net neutrality Notice of Proposed Rulemaking finds that most of the companies that had supported it a few years ago—Google, Apple, Amazon—are now urging caution.

The FCC would be well-advised to listen. The telecommunications industry no longer fits into neat silos of service provider, applications provider and content providers. It’s all a big mash-up, to use a buzzword of our time. These regulatory efforts to create and enforce structural separation between service providers and apps providers are now running directly against strong market and technology winds. The U.S. digital economy has been one of the few bright spots in what has been an otherwise dismal two years. The FCC needs to rethink its network neutrality plan lest the commission be remembered as the regime that killed U.S. broadband growth and innovation.