4 Questions Regulators Should Ask on Zero Rating and Free Data

This article originally appeared on TechPolicyDaily.com

By Roslyn Layton and Bronwyn Howell

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The FCC’s open internet rules address free data and zero rating on a case-by-case basis. The Body of European Regulators of Electronic Communications’ (BEREC) non-binding guidelines for implementing net neutrality in the EU also support this approach.  While case-by-case assessment may be a workable solution for zero rating, it is not unproblematic. Allocating scarce regulatory resources and selecting the forum in which the analysis takes place is not straightforward. Given the dearth of academic literature on the topic, here are four questions to help regulators assess the economic merits of specific zero rated offers and to prioritize whether a given zero-rated offer warrants scrutiny.

1. What perfect or very close substitutes would the zero rating offer foreclose?

One concern of zero rating opponents is that if users perceive two applications as close substitutes, then they will choose the zero rated one over the non-zero rated one. This presumes that content markets conform to perfect competition (no market power, homogeneous products, no transaction costs, no barriers to entry, and perfect information). But in reality, content markets are imperfectly competitive. If content and applications have different value propositions, zero-priced offers won’t succeed to force out offers that are not zero-rated. In a recent paper, my co-author and I show that while WhatsApp was zero rated in Chile, more than half a dozen competing messaging apps enjoyed significant popularity in the country. Messaging apps have different value propositions (games, celebrity chats, video chat etc.), and being free proved insufficient to make customers switch en masse. It seems somewhat paradoxical to claim to be preserving consumer sovereignty by limiting the real rights of real consumers to uphold an artificial right for consumers to participate in an outcome that exists only in a theoretical model of perfect competition. Because the market for content is imperfectly competitive, an ISP can zero rate its own content and not create harm.

2. Is the zero-rated offer intended to increase the number of individuals using the internet?

Net neutrality advocates frequently argue that it is “unfair” to provide free or discounted access to a narrow range of internet applications or applications with some functionality removed. They assert that users should instead pay a higher fee for unrestricted access. While such detractors may assert that the flat-rate offer is morally superior, it obliges some users to pay for capacity they don’t want or cannot afford. This is effectively pure bundling, which not only could amount to a competition violation, but also effectively blocks certain consumers from getting online by creating an all-or-nothing market.

3. Which party makes the zero rating complaint?

Regulators should take into account the party that files the complaint, as it may reveal important competition information. If the complaint comes from an existing content or app provider, it may simply be an effort to foreclose entry by rival providers. The complaint could be more credible if a potential content provider complains that the offer creates a barrier to entry. This information is indicative of the fact that the internet is an ecosystem of complex interactions of multi-sided platforms, and reminds telecom regulators, charged with policing just a subset of the many actors, not to overlook other parts of the system.But this complexity also impugns the premise of scrutiny of zero rating, which falls asymmetrically on broadband providers, itself a form of regulatory discrimination. There is no parallel obligation on content and application providers to refrain from activities that could inhibit innovation in the network elements of the internet ecosystem, or from “picking ISP winners.” Unsurprisingly, inconsistencies have emerged in the determination of acceptable behaviors in different jurisdictions. For example, while the Netherlands has banned forms of zero rating, Slovenia has upheld it.

4. Is free data being used to lower consumers’ search costs, thereby boosting competition?

The internet is an “experience good,” which means that its value cannot be ascertained until it is consumed. In markets with heterogeneous products, consumers with different preferences and information make it costly, if not impossible, for consumers to identify the attributes of the products or assess the fit vis-a-vis their preferences before the products have been consumed. Similarly the provider cannot accurately match the offer to the consumer without some amount of trial and error. This process of the user switching, learning and adjusting comprise a user’s “search costs.” The larger the search costs, the smaller the expected benefit of the second product over the first, and the less likely it is that the consumer will try to find a better match, even though there is definitely a better one out there. Thus, high search costs lead to suppliers having some market power over their existing customers – even though there are many different variants of the product available. Thus, regulators should keep in mind that free data may be helpful to reduce the user’s search costs to find alternative applications and to lower entrance barriers for entrant applications.

These questions are by no means comprehensive or prescriptive, but they can facilitate both a clearer understanding of the interactions occurring within the internet ecosystem, indicate more appropriate selection of the relevant economic models for assessing the effects, and increase the likelihood that case-by-case assessment will facilitate total long-term welfare.

This article is based on a recent paper, which is available in full here. For a live presentation of the paper, join us at the Telecom Policy Research Conference this Friday, September 30.

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