Industry Structure and Opportunities for Innovation with the Internet

By TAP Staff Blogger

Posted on February 25, 2010


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On January 31st & February 1st, 2010, Silicon Flatirons presented a conference on The Digital Broadband Migration: Examining the Internet's Ecosystem. The third panel addressed the structure of the industries involved in the Internet and delved deep into competition policy, specifically the underlying economics and theory in regards to regulation of the Internet “ecosystem.” The following is a summary of this panel.

One highly regulated and competition policy laden area is when one company merges with another. Mergers can be very important to the health of a given industry and often they are one way to generally increase the efficiency within the sector and make it more competitive, through the elimination of duplicitous costs when two former competitors become one, or as the carrot luring a potential competitor to enter the industry when they are evaluating potential exit strategies. On the other hand, mergers can be a way for dominant firms to eliminate competition and increase prices for consumers. Balancing the potential gains of a merger against the potential losses to competition and consumers is a large theme in competition and innovation policy. Carl Shapiro, Deputy Assistant Attorney General for Economics in the Antitrust Division at the Department of Justice, began his presentation by discussing the effects of a merger on innovation in a given industry and how this dynamic has recently come into the analysis for many of the merger challenges at the Department of Justice (DoJ). One underlying note of caution though, he pointed out, is how the specific effects of a merger can be difficult to predict when markets are changing quickly.

Laying the groundwork, Shapiro pointed to three different notions of competition: (1) Product Market Competition—which is the traditional rivalry between competitors on price and quality of competing products and is usually in the short run; (2) Next-Generation Contestability—this is the extent to which product sales will shift to the firms offering the best next-generation products and is in the medium run; and (3) Innovation Rivalry—where there is simply a diversity of approaches and it can be very hard to bring a merger challenge based solely on this. Looking at the product market competition view, he said the “structural presumption” has weakened and the prevailing thought is larger companies, even in highly concentrated markets, may be able to innovate more successfully than a number of smaller competitors. The larger companies can have significant budgets and resources allocated to innovation, as well as incentives to innovate in the form of potentially higher profits on their larger sales. Focusing in on the next-generation contestability notion of competition, Shapiro said some markets have high levels of “inertia”—the switching costs from one product to a competitor’s product are too high for the consumer—and these markets are not as contestable. It is in the high contestability markets—where there are lower costs of switching—that there can be a larger reduction in competition from a merger. In short, it is in these highly contestable markets that a merger is more strictly scrutinized.

Taking a broader view of the Internet “ecosystem,” Howard Shelanski talked at length on how different parts of the Internet, in this case last-mile networks versus applications, could have very different issues and different policy implications. In discussing the applications market, Shapiro felt it is often seen as a single entity, but in reality it is a “basket” of different markets—a layered and varied set of markets—for antitrust purposes. Turning to the last-mile network market, he pointed out that though it is a very concentrated market, billions of dollars were being invested and this high level of investment indicates there is no need to regulate based solely on a fear of monopoly. He also highlighted how modern markets may end up smaller and more concentrated than it was once thought healthy and still be sufficiently innovative because—based on modern economic research—tiny oligopolies are not necessarily terrible for innovation. Finally, Shelanski pointed out to the jurisdictional issues in deciding which agency should be protecting consumers from unfair competition practices in the “ecosystem.” Specifically, he felt the FCC may not have the ability to police the applications providers under its “ancillary” jurisdiction, and it might fall under the DoJ’s purview, but Congress should act in order to clarify this.

The panelists felt competition policy must support innovation. Daniel Weitzner, Associate Administrator for the Office of Policy Analysis and Development in the Commerce Department’s National Telecommunications and Information Administration (NTIA), said any new innovation policy concerning the Internet “ecosystem” must lead to continued innovation, but questioned what the specific goals should be. Is preserving the Internet itself a proper policy goal, or is it better to simply preserve a broadband-connected marketplace; in essence, is the Internet merely a specific technology or a bigger phenomenon? Weitzner wondered if mandating an “open” Internet was locking the fundamental desired result into a specific technology or if it was doing something else.

Probing further into the underlying nature and function of the Internet, Weitzner alluded to the “undulating chaotic beast” metaphor from earlier in the conference, but said, in contrast, the Internet was remarkably stable when it came to the standards and business models used. Using the fundamental stability as a starting point, he then asked where the status quo was valuable and what core characteristics should be preserved as policy makers move forward. He pointed to the stability and simplicity of the basic network standards used and how these were the key to the innovations at the application layer. He also pointed out these simple and stable standards were also free to use, which is what made the Internet so usable and popular with innovators and entrepreneurs in the first place. In order to move forward, according to Weitzner, it will be key to: (1) find clarity around the public policy goals; (2) find better analytic tools to gather data on it; and (3) find better regulatory tools.

Discussion

Hon. Stephen Williams, Senior Judge for the U.S. Court of Appeals, D.C. Circuit, began the discussion portion of the panel by critiquing some of the difficulties with an intensive factbased analysis of a merger; where he characterized the underlying principle as fact-based analysis first and action later. He felt there were high costs in terms of the: (1) Expense—the lawyers and economists gathering data have a cost; (2) Delay of the merger; (3) Disincentives in contemplating a merger (even a good merger); and (4) Reduced entry—because a reduction in mergers makes exit more difficult, meaning fewer firms will enter that market because a major exit strategy is to sell to another, and often larger, company in that same market. Williams felt false positives were an issue in the merger analysis, in they prevent mergers that otherwise should take place. He felt the factors involved in any inquiry should be easily ascertained and bright line rules would be helpful.

Jon Nuechterlein, partner at the law firm of WilmerHale in Washington, D.C., echoed the concerns with regulatory jurisdiction over the Internet. He said the current regime does not address how to regulate the Internet “ecosystem” under a single agency’s jurisdiction and thus there are entirely different models regulating different sections, resulting in regulatory anomalies. The FCC, according to Nuechterlein, has come close to being the sole regulator but the courts are questioning its jurisdiction. Finally, he said the FCC may reclassify broadband traffic as telecommunications—due to its growing voice traffic and which would make all network providers common carriers—but this may stifle innovation on the Internet due to the regulatory uncertainty.

Kathryn Brown, Senior Vice President for Public Policy Development and Corporate Responsibility at Verizon, critiqued the current state of telecommunications public policy by pointing out the need to revise the 1996 Telecommunications Act. She said the 1996 Act did not envision much of the new technology and had not even contemplated the “Internet,” thus leaving enforcement of the Act in a “muddle.” Brown felt the government policy should be changed, with an eye towards being: (1) transparent; (2) open; (3) user-driven; and (4) technical—giving engineers the “first crack” at technical issues.

Conference summary provided by Kaleb A. Sieh, Silicon Flatirons Research Fellow and 2009 graduate of the University of Colorado Law School.

Video of the panel.



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