Net Neutrality and Price Discrimination

Posted by: Stephen Wildstrom on January 10

In the latest of a series of looks at the economics of the Internet, mathematician Andrew Odlyzko, director of the Digital Technology Center at the University of Minnesota, takes a dispassionate look at the dispute and concludes that while carriers certainly have a strong interest in charging premium prices, it is hard to come up with an economic justification for them doing so.

“[T]here are precedents for telecom companies to ask for ability to charge special fees to companies like Google that might be deriving large profits from the use of the infrastructure.,” Odlyzko writes. “The question is, do they need it? And there is no evidence that they do.” In the end, he believes, some form of net neutrality regulation is likely: “The general conclusion is that some form of government intervention, to set the rules, is inevitable. (And at some point it may be welcomed by the players, just as government intervention was welcomed in the end by the railroads.)”

The paper, "Network Neutrality, Search Neutrality, and the Never-ending Conflict Between Efficiency and Fairness in Markets," is non-technical and well worth reading. It recasts the net neutrality debate largely as an argument over what economists call price discrimination, a difference in prices that reflects a buyer's willingness or ability to pay rather than differences in the cost of providing a good or service. Sellers generally like price discrimination because it leads to higher profit margins; consumers tend to hate it in large part because they are always left with the feeling that someone is getting a better deal than they are.

Odlyzko's bottom-line conclusion, based on an analysis of rates of return and the cost of capital, is that the operators of the Internet backbone don’t need to charge premium rates for the transmission of high-quality media. In large part, that's because the ungraded networks required will actually cost less than the book value of the systems they are replacing.