Net neutrality may be at risk when companies like Netflix subsidize your data

The Federal Communications Commission (FCC) made net neutrality the law of the land and pledged to enforce it when it issued its “open Internet order” 13 months ago. That ruling barred Internet service providers (ISPs) from discriminating against certain types of traffic or creating pay-to-play fast lanes.

But a recent trend in the industry in which ISPs such as AT&T or Comcast allow consumers to stream certain content for free (without counting against their data quota) threatens to undermine net neutrality. Such practices, in which content companies typically subsidize or sponsor the bandwidth cost of their data, are known as “zero rating” plans.

So who wins and loses from this arrangement? Does it benefit consumers? And does it violate the FCC’s net neutrality rules, something the commission is currently investigating?

Using game theory, we created a framework in which to analyze the impact of these new zero rating plans, as well as the social welfare and policy implications – something particularly important as Congress and the courts continue to evaluate the FCC’s net neutrality rules.

Origins of zero rating

AT&T was the first to create a sponsored data plan in January 2014. Under the plan, the company decided to let data subsidized by app makers or other content providers pass through its network for free – that is, without consumers being charged against their monthly quotas.

It didn’t take long for its competitors to imitate the idea.

Verizon announced a similar “FreeBee Data 360” in January. The company said it was starting trials with AOL, Hearst Magazines and Lantern Software’s GameDay with full commercial availability later this year.

Comcast, meanwhile, allows subscribers to watch videos for free through its own StreamTV service. Streamers of Netflix and other providers must still use up their data.

T-Mobile’s Binge On program allows subscribers to stream video from Netflix, Amazon and about 40 other sites on their phones without worrying about using up their data. In contrast to its rivals, the carrier so far hasn’t charged for the privilege but seems to favor the bigger providers.

The zero rating model got Facebook into trouble recently. Its Free Basics platform provides free Internet to a limited number of websites in countries like India, Kenya and Colombia through local ISPs. India’s telecom regulator banned Free Basics because it said it violates the principles of net neutrality. The biggest objection is that it offers only a few content providers that are chosen and controlled by Facebook.

Even Netflix, one of the biggest proponents of net neutrality, came under criticism. Its arrangement with Australian ISP iiNet allows consumers to stream Netflix content without worrying about running against their data cap. Netflix conceded that their arrangement could distort consumer choice, but at the same time it said that it “won’t put our service or our members at a disadvantage.”

Provider’s dilemma

In our research on the topic, we developed a game theory model to analyze the impact and incentives of this type of data sponsorship given three players: a monopolist ISP and two content providers who want to maximize their customer reach.

Is there a risk that this type of plan would force the content providers – whether they are behemoths like Netflix or promising upstarts like Fandor – into a bidding war? And, as a result, produce a monopolistic digital content landscape that limits the amount of content available to consumers and tests the bounds of current net neutrality laws?

In our model, we found that under certain market conditions both content providers would pay to subsidize data going through the ISP, when in reality neither of them would prefer to do so. In effect, the content providers are in a classic “prisoner’s dilemma”: both would prefer not to pay – even if they have the wherewithal to do so – but both know that if they don’t pay, the other one will, and drive their rival out of the market.

Our research’s overarching finding is that the ISP always stands to gain when the content providers are subsidizing data usage fees – that is, it will always make more money as a result. The ISP, which knows the game’s results before it even starts, can therefore decide on a pricing strategy that forces both of them to pay.

Consumers and smaller content providers, on the other hand, both stand to lose. Since smaller companies are less able to afford the fees, they risk losing customers to the subsidized websites and apps. A content provider with an established revenue model can drive the others out of the market.

At first glance, zero rating plans would seem to be good for consumers because they allow users to consume traffic for free. But our research suggests the variety of content may be reduced, which in the long run harms consumers.

Once a plan with subsidized content is added, our research shows that many consumers might find that switching to that service – even if it’s deemed to be of lower quality – makes sense given the tradeoff: less favored content but lower connectivity costs. Thus, even a provider with higher-quality content could be completely driven out of the market if it is not in a position to pay to subsidize its data.

Does it violate net neutrality?

Supporters of net neutrality have argued that such arrangements contradict the spirit of net neutrality laws, which hold that all content that is transmitted over the Internet should be treated equally – every single data packet, regardless of its origin, destination or content.

They contend that zero rating plans treat the subsidized packets preferentially, since consumers have more incentive to consume “free” packets over unsubsidized ones. The telecom companies, however, claim that these plans do not violate net neutrality because the sponsored data are delivered at the same speed and performance as the nonsponsored data.

Our study shows, however, that with a zero rating plan in place with one dominant content provider controlling the market, it would make it virtually impossible for new entrants to gain a foothold.

Essentially, zero rating plans undermine the core vision of net neutrality: ISPs should not act as gatekeepers that pick winners and losers online by favoring some content providers over others.

Subsidizing consumers in these zero rating plans will quickly become a way for certain content providers to get a leg up on competition. In digital content markets, it’s a self-perpetuating cycle: the stronger content provider can keep getting stronger.

For startups and entrepreneurs hoping to have their content spread naturally or virally – one of the ways the Internet has leveled the playing field – they are suddenly at a disadvantage after the introduction of data sponsorship. The ultimate result could be a digital marketplace with fewer options for consumers.

Keeping an eye on zero rating plans

The FCC is closely monitoring the practices of zero rating plans to see if they violate net neutrality laws.

In letters to AT&T and T-Mobile, the FCC wrote:

We want to ensure that we have all the facts to understand how these services (data subsidization) relate to the commission’s goal of maintaining a free and open internet while incentivizing innovation and investment from all sources.

But Chairman Tom Wheeler has sent mixed messages. While he has said the commission would be “keeping an eye on” the data subsidization programs, he has also praised them as “highly innovative and highly competitive.”

Our research should help policymakers within the FCC and elsewhere better understand the impact of these zero rating plans and how they can result in less choice for consumers in the long run.

Liangfei Qiu receives funding from Networks, Electronic Commerce, and Telecommunications (NET) Institute.

Soohyun Cho and Subhajyoti Bandyopadhyay do not work for, consult, own shares in or receive funding from any company or organization that would benefit from this article, and has disclosed no relevant affiliations beyond the academic appointment above.