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A response to a GoodEconomics post on regulating Internet service

R1: I have been browsing GoodEconomics and came across this post(https://np.reddit.com/technology/comments/3sonfk/is_comcast_marking_up_its_internet_service_by/cwz896w) on why Comcast should be regulated. Having read this piece, what is missing here is a lot of history, regulation, and, yes, economic nuance both of networks and of IO. Part of the purpose of this post is to push back against a lot of things people tend to get wrong in this industry, but it is also to collect my thoughts into something more coherent for publication some day. Full disclosure: I work in economic analysis and the tech policy world.
Some Words on Words
twenafeesh begins:
The market is structured in such a way as to give them (telecoms) an unfair advantage.
Let me be clear. There are definitive economic benefits in allowing a company with incredibly high infrastructure costs to have a monopoly over a service area. In economics this is called Natural Monopoly theory. This prevents the duplication of efforts, and allows for a more efficient use of resources, avoiding problems like this and this (early 20th century NYC), where countless companies have overlapping, redundant infrastructure.
First, it is important to note the distinction between the types of companies and the markets involved. Comcast is a cable company that is vertically integrated with NBCUniversal. It is a unique case in having both a programming division and a transmission delivery division. On the other hand, Verizon, AT&T, and Level 3 are more traditionally understood as telecom companies because their base technology is the telephone line. While telecoms is a term used widely in the UK and Europe, the regulation of telecom and the underlying technology is different than cable in the US. Cable-as-TV is regulated under Title VI of the Communications Act, while telephone is regulated under Title II of of the Communications Act. Both cable-as-Internet and telephone-as-Internet were regulated under Title I of the Communications Act, until the FCC reclassified both last year, which is for another post. I should also mention that franchises are the legal contracts stipulating how a video, telephone or Internet providers will service a municipality. Theses include a combination of social regulation and economic regulation, which is what I am going to explore in this post.
A Quick Regulatory History of Cable TV
Cable systems were created to circumvent a problem. Broadcast transmissions couldn’t be received in valleys because the radio waves were cut off by mountains. Even today, the basic technology of cable relies on a satellite dish that collects broadcast transmission and then coax cable to pipe that content to a home. When cable systems first began to appear in the 1950s in the Pennsylvanian valleys, many cities explicitly made a decision to have a monopoly provider of cable by granting them an exclusive franchise in the city and regulating rates, in part to limit broadcasters expansion into this new technology. Franchises were typically coterminous with the municipality, so a cable company had to serve all parts of the city, even those less dense suburban tracts. However, this was not universal and some cities allowed for competing networks. It is important to note that the tenor of regulation changed dramatically right before World War I and especially after the Great Depression, a view completely different than today. Creating monopolies was in vogue by the time that the nascent cable companies came around in the 1950s. For example, the Justice Department settled with AT&T in 1913 under the Kingsbury Commitment, nationalized the telephone system during World War I, then passed the Willis Graham Act, effectively making AT&T a monopoly even though there were typically two phone systems in a region before.
In 1966, the FCC limited cable’s encroachment on broadcasters by requiring the largest ones to import local broadcast TV, cutting off distant signal important to just the smallest companies. In 1972, the FCC required cable to carry all local broadcast signals, banned premium programming and sporting events, and set aside channels for government, education and public access, all of which increased the entry barriers and limited content. In 1977, the courts got rid of the premium channel restrictions and then in 1979 many of the other rules were vacated by the FCC. It was only after a court decision in 1979 that HBO was able to deliver content, which helped to spark the content explosion in the 1980s. It is important to remember that cable, and indeed all transmission services, are complements to the content that they serve. The value of cable comes not from its existence, but what it can put across its wires. By 1989, the number of available channels had trebled and the average number of channels had doubled.
In 1984, the Cable Act was passed which took power from local municipalities and placed it in the hands of the FCC, effectively deregulating prices, which had until then been regulated at different rate in different regions. Between 1986 and 1992 when new regulation was adopted, the market changed, as explained in this often-cited GAO report. Looking from 1986 to 1989, cable prices rose from 39 to 43 percent due to deregulation. However, regions regulated before 1986 had prices that rose faster than those regions which didn’t. Average channel capacity grew from 34 to 40 during that time period, and the average revenue per channel remained constant in nominal dollars but fell in real dollars. One way to interpret this is that the value of cable rose rapidly because of the expansion of content. Thus, transmission and content are complementary goods.
In 1992, the Cable Television Consumer Protection and Competition Act was passed which set new requirements on cable, including uniform pricing rules, must carry provisions and what is known as retransmission consent. This law also formally repealed exclusive franchises for the first time, which made it illegal for municipalities to grant an exclusive monopoly contact to the region. Effectively, the damage was already baked in. New cable companies were gradually succumbing to fiber technology, so building a new coax network was considered a bad bet. Moreover, since many franchise contracts had a buildout requirement, any new player in the market would have to provide service everywhere. As one report in 1998 noted, “there are very few actual cases where a cable overbuild has proven successful in the long term and virtually all of those cases involve cable plants that compete in only a small slice of each operator's given franchise area.” Only in 2007 did the FCC take a stab at buildout requirements, however they just limited the most egregious rules at the local level.
All the while, telephone companies were faced with their own regulations, which included limits on providing TV. Those were lifted formally with the 1996 Telecommunications Act, which aimed to spark competition between technologies, pitting cable against copper, and broadcast against both, in what is known now as intermodal competition. Most tech policy is focused on this kind of competition.
All of this is to say that this is incorrect when twenafeesh notes:
Due to the market power this gives a company, they must also be heavily regulated in order to prevent them from taking advantage of their customers. The alternative is to allow governments to take on this function for themselves.
The thing is, all water, gas, and electric utilities are heavily regulated by state and federal agencies in a way that telecoms are not. The three so-called "public" utilities are seen as necessities for life, while telecom has only recently begun to be viewed that way. As a result, public utilities cannot charge excessive fees for service, and in exchange we give them a near-monopoly over their service territory.
When it comes to video law, cable-TV is already heavily regulated and is a result of the local monopoly regulation that only recently came to an end. Basic TV rates are often explicitly rate regulated, but more importantly, TV has additional regulation in the form of social regulation, meant to ensure certain kinds of programs are maintained. This maintains a price floor and shifts the negotiating power away from the service providers to the programmers. For a visual representation of the complexity of video regulation in this space, see this. Keep this in mind for later.
Price Regulation in Telephone
Telephone regulation is also complex, but has in fact gone through many of the same kinds of rate regulations after the 1996 Telecom Act as noted here by twenafeesh:
In California, for example, regulatory requirements only allow gas and electric utilities to make money on capital investments. This gives utilities a direct incentive to invest in new infrastructure, because that's how they make money. This simultaneously removes any incentive to overcharge per kWh or to induce customers to use more electricity - even if they did, California utilities wouldn't make any additional money from this practice.
Instead, the California Public Utilities Commission (CPUC) authorizes a certain rate of return - usually a 5%-10% markup on base electricity cost - based on capital investments and how well the utility runs its business. (Bit of an oversimplification here - this is called "decoupling" if you want to look for more details.)
If we had a policy like that for telecoms, you can bet it would be cheaper and bandwidth would be higher.
There are four basic approaches to price regulation: rate of return regulation, price cap regulation, revenue cap regulation, and benchmarking. Rate of return regulation adjusts overall price levels according to the operator’s accounting costs and cost of capital as determined by the regulator. Price cap regulation allows for price level changes according to an index that is typically comprised of an inflation measure (I) and a productivity offset (X). Revenue cap regulation establishes a similar index for service baskets and allows the operator to change prices within the basket so long as the percentage change in revenue does not exceed the revenue cap index. Benchmarking looks at the performance of an operator and then penalizes or awards them based on relative performance.
The FCC has experience with rate regulation both on the retail side (for consumers) and on the wholesale side (for business), using both rate of return and price cap methods. On the retail side, rate regulation was in place for most of the 20th century with state based public utility commissions regulating local rates and the FCC regulating long distance. Each of the regions often had different prices because the states would regulate the rates differently. The 1996 Act changed this and many localities liberalized (ie got rid of rate regulation). The effect of moving from rate regulation to none seems to have been negligible on prices, though this might be due to wireless competition. The FCC currently has rate of return regulation for the Connect America Fund. Here is their resource page.
After AT&T was broken up in 1982, competition was injected into the wholesale market through the creation of competitive local exchange carriers or CLECs, which have access to many of the backend components of the local telephone system under regulated terms. These unbundled network elements (UNE) are regulated under the total element long-run incremental cost (TELRIC) method. One of the problems with this method is that TELRIC only allows for recovery of only current costs. Second, it under-compensates the incumbent for potentially risky investments. See this NBER paper on the issue. A lot of ink has been spilled on UNE regulation, and I tend to believe that other methods of rate regulation would be preferable if we must have regulation of this type, like revenue cap regulation. See this for an overview.
So here is the rub. For one, retail and wholesale telephone price regulation exists and existed in much the way that twenafeesh is suggesting. I have not seen many papers showing that it is a massive boon to consumers on the retail side, in part because there is variation. This paper finds that it has had negative effects on consumer welfare. Actual consumer rates are a result of federal, state, and local regulation in both retail and wholesale markets in addition to the competition from wireless and the size of the market itself. Please post anything you may find on this issue below.
The Economics of Providing Internet Service - Video
Comcast is a company that provides a bundle, both TV and Internet. As of right now, it would be impossible for a new company to offer Internet service without also offering pay TV service. Why is this? Once you build out into a neighborhood, you need 30% of those people to select your service, which is known as the uptake rate. Because cordcutters are only 15% of the market, you can’t survive on Internet alone.
So you need to provide TV to provide Internet. However, the regulatory system is such that you aren’t on a level playing field with programmers. In most regions you have to provide basic service, which is rate regulated, and that basic service has to include broadcast content. But when you buy this programming, you don't just negotiate to buy the broadcast content, you are negotiating for the whole suite of content. You don’t just get Comedy Central from Viacom, you bargain for all of their properties, including ones that you and your consumers might not want. One of the best ways to see this in action is when program negotiation breaks down, which happened between Time Warner Cable and CBS when CBS pushed for $2 more per TWC customer leading to a programming blackout. At the end of the skirmish, TWC lost 306,000 cable video subscribers.
This is why Verizon went through with the suit to maintain skinny bundles. As one article noted:
Industry analysts saw it as a move by Verizon to test the market strength of -- and customer demand for -- some of the channels, particularly ESPN, that extract high per-subscriber fees from pay-TV providers. ESPN is the most expensive channel for cable and satellite companies, collecting nearly $7 per subscriber.
So, consumers want specific content, typically about 15-17 channels including sports, and each of those properties are spread among many different content providers. It should be noted that American households watch the most television of any country, besting the number two spot by about 77 percent. And with it come cost. As Google Fiber’s Milo Medin noted, video programming is the “single biggest impediment” to deployment since “we may be paying in some markets double what incumbents are paying for the same programming.”
Between 2005 and 2008, about 19 states reformed the video franchising process, creating a state standard instead of many local ones. This paper used a difference-in-difference approach and found that prices for the basic service declined about 5.5 to 6.8 percent, even though there was no change in the expanded basic service packages. However, actual entry in those reformed states was about 11.6% higher than non-reformed states. As the authors concluded,
Our results are consistent with limit pricing models that predict incumbents respond to increased threat of entry, and suggest that the reforms facilitated entry and modestly benefitted consumers in reformed states.
So how would a new player actually enter into a market?
The Economics of Providing Internet Service - Deployment
Building the infrastructure to provide that video is fairly costly on the front end, with high fixed costs and low marginal costs, but the extent of these costs vary widely, depending on population density, local ground conditions, and regulatory costs. In one study of rural consumers, 65 locations per mile translated into about $4-5K per residence for a new fiber buildout. For urban settings, the cost per home drops with higher density, but additional costs can be added due to civil engineering issues ie obtaining permission from the municipality to build.
Google’s cost in providing an overbuild in Kansas city was projected to be between $674 and $500, but the project was completed in waves. That first wave of 12,000 homes was just an 8 percent penetration of its total footprint, costing an additional $10 million on top of the $42 million in Kansas and $52 million in Missouri. In other words, the upfront investment per household on the first day of service was something like $7833.34 per house. In the above cited source, the analysts went on to calculate the cost of a network covering 20 million homes, making it a mid-tier provider, which would have required $11 billion even before a single consumer could sign up.
A couple other cost estimates
EDIT: Most in economics would now agree that the variation in cost, from $674 to $4,000, should translate into higher service prices. Among other problems in the original post is the lack of clarity on the barriers to entry, are they signs of market power, or are they merely a cost of production? This is the Bain/Stigler fight in a nutshell. As Bain had defined them, an entry barrier is "an advantage of established sellers in an industry over potential entrant sellers, which is reflected in the extent to which established sellers can persistently raise their prices above competitive levels without attracting new firms to enter the industry." On the other hand, Stigler saw barriers to entry as "a cost of producing that must be borne by a firm which seeks to enter an industry but is not borne by firms already in the industry." In addition to the initial deployment costs, all of the other social and regulatory costs I am laying out in this post should be understood as adding to the cost of production a la Stigler, not necessarily a sign of market power a la Bain. For a discussion on this issue, see this paper.
The development of Google Fiber’s Kansas City network very much changed the negotiating behavior between service providers and municipalities. By publically running a selection process, a number of cities vied for the new service and in doing so, the company was able to dictate the terms of the final agreement. Among the things required for any new city is a quick turn around from the city on rights of way. Indeed, when San Francisco conducted a feasibility study for a city-wide network, it cited “the considerable City’s right-of-way knowledge and utility maintenance capabilities” as an asset.
Again, Medin explains:
Governments across the country control access to the rights-of-way that private companies need in order to lay fiber. And government regulation of these rights-of-way often results in unreasonable fees, anti-investment terms and conditions, and long and unpredictable build-out timeframes. The expense and complexity of obtaining access to public rights-of-way in many jurisdictions increase the cost and slow the pace of broadband network investment and deployment.
It is hard to explain how expensive and costly these deals are in part because some of the contract specifications aren’t detailed publicly and the exact cost is buried in city reports. For example, LA had $35 million in cable franchise fees just sitting in a bank account unused. The cost of franchise fees is something I am currently studying, but most cities have at least a 5% revenue fee. Interestingly, when Google was working to provide municipal WiFi in 2006, the city of San Francisco drug their feet: “talks to come up with a final contract have advanced little since they started and that officials have made unreasonable demands, including a request for free computers and a share in revenues.”
Google was able to route around many of the deployment cost issues that face entrants in Kansas City. In particular, permit applications were contractually obligated to be reviewed within five business days. They have since created a checklist, which had served as a roadmap for general state and federal reform efforts. Google Fiber also choose specific neighborhoods to deploy, which were based on consumer demand, thus circumventing the buildout requirements that will limit entrants.
Putting It Together / The State of Competition on the Internet
The reason for laying out all of this history and regulatory structure is to detail the source of costs in the Internet service market, which leads to the market structure. Saying that “we can't also allow them carte blanche with their price structure” denies that various kinds of economic and social regulation do just that.
And how exactly would we describe the market? Most tend to describe it as oligopolistic, including the DoJ. Now there might be some debate as to the level where competition exists, but according to the most recent FCC data from June 2014, which won’t reflect changes from AT&T’s VIP upgrade and fiber upgrades in 2015, 89% of all census tracts have 2 or more providers at speeds of at least 10 Mbps downstream. While the FCC only just put out data, this report from earlier this year found substitution among cable and DSL providers and suggests that midlevel tiers are typically the competitive level within any specific region.
And while the rising cost of Internet and cable are often detailed in the press, making the firm case that Internet service has monopoly characteristics is a little more difficult. For one, Internet connection speeds have tripled over the last 3.5 years as detailed by the FCC. Yet, there are clear differences in this speed since Delaware and Virginia actually have average download speeds around the same as Japan. At the same time, the CPI for Internet services has basically remained flat over that time, the July index is 76.955 with a 1997 base. As recent as 2006, the CPI was 95. It is also worth mentioning that Internet access isn’t modeled hedonically, so this number is probably off.
Given the available evidence, I tend to think the market is oligopolistic, which is not a sufficient condition for regulation, especially if the market conforms more towards Bertrand competition than Cournot competition, both of which are still lower than the monopoly price. A combination of the two, known as the Kreps-Scheinkman model, is often relied upon in analysis of these kinds of communications firms. In this two stage model, two firms first make a binding choice about future production capacity, which is basically a Cournot decision. In the second stage, each firm chooses a price a la Bertrand.
This basic model seems to jive with econometric analysis of the markets. These researchers found that DSL service gets better when a cable player enters the market, and also when cable operators start to offer DOCSIS 3.0 speeds. This paper found that increased numbers of fixed wireline broadband providers generally have no statistically or economically significant impact on download speeds, suggesting price competition. The authors concluded that,
Quite interestingly and perhaps provocatively, the same model shows statistically significant impacts on fixed connection broadband service quality associated with the presence of larger numbers of wireless mobile internet providers.
In other words, imperfect substitution among wired and wireless broadband providers probably exists. Admittedly, there is a lot I am missing here and I am working on some papers on this subject right now.
Also, a couple other basic points, the net profit margin for Comcast was 10.96% last year, while the utilities sector typically ranges between 8% and 10%. ROIC was 9.53% last year, which is basically the same as the S&P. Comcast also ranks within the top ten in total cap ex. As for telecoms that are derided, and I didn't spend much time on the competitive side of wireless, AT&T and Verizon constantly rank as the highest in total investment with 21.2 billion and 16 billion in 2014 respectively.
Practically speaking, the maintenance of a regulatory apparatus that could deal with the variation in cost is one of the primary reasons why open access regulation is generally preferred. Instead of determining rates of the end user price, you unbundle the network elements and let companies compete down the price. This is what the EU largely maintains. However, this doesn’t come without its own problems. As Laffont and Tirole point out that, and I am going to pull a Rule VI here, ‘‘[T]here is in general a trade-off between promoting competition to increase social welfare once the infrastructure is in place and encouraging the incumbent to invest and maintain the infrastructure.’’ In one study of this phenomena, investment per household in the EU was about half the US. Europe does have many dense urban cities (see figure 35), so a general reduction in long term investment for tradeoff in lower consumer prices this might not be a huge deal, since the total amount of investment for a region will be enough to maintain a fast network. However, given how suburban the US is, this might not be the best.
I’ve written a lot here. Please rip me to shreds. I need to be better.
submitted by wrineha2 to badeconomics

The Laptop is Dead, Long Live the Laptop!

Well that laptop I just got to get back into EVE died already, got to get a new one.
Funny thing happened today right after the karma fleet how to make ISK lesson, I plugged my laptop in when it told me it had 11% battery left and it did not charge. I tried to do it a second time and it made a small electric pop noise and when I put my nose to it, it smelled like something inside had burned. Looking inside there is a bunch of small metal pins coming out of it and it seems like the laptop side of the AC adapter is damaged.
TL;DR I can't believe I killed my laptop in only 2 months. I found a really cheap nearby its a $180 potato laptop sale, going to buy it tomarrow when the bank is open.
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I am going to try to run 2 clients on this thing. Wish me luck!
submitted by Destman to Karmafleet

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