United States: Net Neutrality -- Revisited

Last fall, we discussed the legislative and regulatory debates concerning "net neutrality" for providers of broadband Internet access services. (See our Nov. 30, 2006 Telecom Alert.) Subsequently, we reported on net neutrality conditions that the FCC imposed for its approval of AT&T's acquisition of Bell South. (See our Jan. 23, 2007 IT Alert.) The most recent manifestation of net neutrality arises in connection with the FCC's 700 MHz auction decision.

Background

While there may be as many different definitions of net neutrality as there are proponents, the concept is generally understood to require that consumers be entitled to (1) access the lawful Internet content of their choice; (2) run applications and use services of their choice, subject to the needs of law enforcement; (3) connect their choice of legal devices that do not harm the network; and (4) have the benefit of competition between and among network providers, application/service providers and content providers.

With intense lobbying from content and application providers on the one side and telco and cable companies on the other side, Congress considered adopting net neutrality legislation in 2006, but ultimately failed to do so. In significant measure, the proponents' case foundered due to arguments that they had failed to establish any pattern of marketplace failure sufficient to justify legislative intervention -- that mandatory net neutrality was a "solution in search of a problem," in the words of opponents. Opponents further argued that net neutrality mandates entailed a return to heavy-handed, common carrier-type regulation that would chill the investment incentives needed for the spread of high-speed access.

The next episode came late last year when the FCC was called upon to assess the public interest merits of AT&T's proposed merger with Bell South. Due to the recusal of one of the three Republican Commissioners, the FCC was evenly divided, with two Republicans and two Democrats. Since a majority of eligible Commissioners is required in order to approve an item, the two Democratic Commissioners (Michael Copps and Jonathan Adelstein) were able to gain significant concessions from the applicants. One of those concessions was an agreement to abide by net neutrality principles.

The 700 MHz Decision

In a decision released August 10, 2007, the FCC set rules for the next big spectrum auction, namely those involving spectrum to be freed up by the conversion of the television industry to digital broadcasting in February 2009. While the decision is noteworthy in a number of respects (including its determination to authorize a public-private partnership to facilitate the construction of a nationwide broadband wireless network for public safety), the immediate issue is the requirement by the FCC that the winners of the bidding for the largest spectrum block (the so-called "C Block") allow any and all devices and applications to run on their networks consistent with network integrity and safety.

The FCC's decision, known colloquially as "no lock, no block," was motivated in part by the introduction of Apple's iPhone, which is available only over AT&T's network. But it should also be seen as an interesting concession to the regulatory-minded Commissioners and to influential Democrats on the Hill, who weighed in strongly in favor of open access.

The marketplace effects of the open access policy remain to be seen. But certain observations can be made even now.

First, open access, even though limited to the one spectrum block referenced above (not all cellular spectrum), is a major departure from the business model that has been so successful for the cellular industry to date. That model is based upon offering consumers a bundled solution (handset and service). Bundling has met with widespread consumer acceptance (witness the extraordinary growth in cellular phone usage over the last 10 years). The FCC itself has determined the cellular market to be competitive with multiple carriers vying for the consumer's dollar. Whether a business model based on open access will be as successful remains an open question.

Second, the details of open access will not be known when the auction begins several months hence. The scope of open access will be resolved only in the context of further FCC proceedings on reconsideration and, no less importantly, in enforcement proceedings for this, that, or the other alleged infraction of the open access rules. For example, while the FCC mandates technological neutrality for the C Block, it remains unclear what obligations winning bidders might have to optimize the experience for customers choosing to use their own devices or applications, or what network management standards might be deemed reasonable. This uncertainty will impact bidders' behavior and, quite possibly, reduce the number of bidders as well as the prices that bidders are willing to pay. In this regard, the FCC has suggested that the reserve price for the C Block must aggregate $4.6 billion, or the spectrum will be re-auctioned without open access requirements.

Third, while the FCC refused to require the provision of service on a wholesale basis as a part of open access, this is likely to be the focus of petitions for reconsideration by Google and others which had pushed for such a requirement. The wholesale service requirement has also been viewed as key by those seeking auction rules that could facilitate the creation of another nationwide competitor to incumbent cellular carriers.

Conclusion

The 700 MHz auction is expected to generate $10 billion to $15 billion for the U.S. Treasury. It remains to be seen whether this will be realized, given the restrictions adopted by the FCC. In the meantime, it is increasingly true that radio spectrum is to the 21st century what oil was to the 20th -- an essential driver of economic growth and the public welfare.

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