Mandatory Interconnection: Should the FCC Serve as Internet Traffic Cop?

Economists Ink: A Brief Analysis of Policy and Litigation


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Hal Singer is a principal at Economists Incorporated, a senior fellow at the Progressive Policy Institute and an adjunct professor at Georgetown’s Business School. The PPI study is available at http://www.progressivepolicy.org/wp-content/uploads/2014/05/2014.05-Singer_Mandatory-Interconnection_Should-the-FCC-Serve-as-Internet-Traffic-Cop.pdf

To date, interconnection agreements between the networks that constitute the Internet have been privately negotiated without a regulatory backstop. The vast majority of these negotiations have gone without a hitch. While transit companies, such as Cogent and Level 3, have complained about the quality of interconnection with certain Internet service providers (ISPs), those disputes largely do not affect consumers. Such disputes only rarely result in a prolonged service disruption. Yet several parties, including public-interest advocates and Netflix, have suggested that the Federal Communication Commission (FCC) should be allowed to mandate interconnection among these “core” networks.

The interconnection controversy is distinct from but related to the FCC’s ongoing effort to deal with “net neutrality.” Net neutrality rules are designed to protect “edge” providers, such as content providers, application providers, and device makers. They address the management of traffic within an ISP’s network, rather than the movement of traffic between networks. Nonetheless, in its May 2014 Notice of Proposed Rulemaking, the FCC sought comment on how it can ensure that an ISP “would not be able to evade open Internet rules by engaging in traffic exchange practices that would be outside the scope of the rules as proposed.”

Missing from much of this debate is an analysis of the social costs and benefits associated with mandatory interconnection. Economic history shows that sector-specific interconnection obligations and antitrust enforcement serve as complements in partially deregulated industries. Antitrust enforcement acts as a substitute for sector-specific interconnections obligation in fully deregulated industries. Because the Telecommunications Act of 1996 set the communications sector on a deregulatory path nearly 20 years ago, has the time come to rely on antitrust to adjudicate interconnection disputes on the Internet?

The original basis for mandatory interconnection was to address a monopoly problem in long-distance phone service. While we may not have arrived at a competitive nirvana, there is no debate as to whether the communications market may be fairly characterized as a monopoly nearly 20 years after the 1996 Act. In light of evidence of falling broadband prices and expanding output, it is a stretch to defend an interconnection obligation as a means to address monopoly. But perhaps there is some other compelling basis for interconnection not rooted in monopoly? One recent article cites several notable interconnection disputes and argues the mandatory interconnection serves as an “anti-fragmentation policy” that prevents service disruptions, reduces transaction costs, and fosters efficient integration.

A study from the Progressive Policy Institute reviewed six major interconnection disputes in the United States and their associated impact on Internet customers. Three of the six disputes did not lead to service outages, and even those that did were resolved within a week. No doubt exists that such disruptions could be costly if they are not resolved quickly. When assessing the purported benefits of mandatory interconnection, however, the relevant question is whether, in the absence of a regulatory obligation, the likelihood of such a disruption is significantly greater than zero. One estimate of that probability is the historical frequency of disputes that lead to service disruptions. And the historical disruption rate seems very small. Thus, even assuming high associated disruption costs, the expected cost of not imposing an interconnection obligation is likely small.

Against these suggested benefits, one must weigh the social costs of imposing mandatory interconnection obligations on ISPs. There are at least three potential disadvantages. First, mandatory interconnection could undermine the incentive of ISPs to expand or enhance broadband networks. If a telecom believed that it could not be compensated for upgrading its capacity (either switching from DSL to fiber or increasing the density of a fiber network) due to restrictions on what it could charge for paid peering, then it might abandon or curtail the investment decision. Second, mandatory interconnection could undermine the incentive of transit providers to extend their reach into the last mile. Just as mandatory interconnection (and unbundling) undermined the Competitive Local Exchange Carriers’ incentive to invest in their own facilities, regulated interconnection rates could deter transit or even content providers from building the last-mile connections. Third, mandatory interconnection could unravel paid arrangements between large content providers and ISPs if better terms could be secured via intermediary networks through regulation.

Assuming the social costs of mandatory interconnection exceed the benefits, what might an alternative, less-invasive policy look like? To the extent that content providers (as well as application, service, and device providers) could be protected by an effective Open Internet regime, including a “minimum level of access” established by the no-blocking rule, the only remaining class of providers that could benefit from mandatory interconnection would consist of intermediaries that operate at the core of the network, such as standalone Content Delivery Networks (CDNs) or transit providers. The rationale for protecting these intermediaries—who aggregate content across several content providers and deliver the package to ISPs—is less compelling than the rationale for protecting content providers, who cannot be expected to monetize their investment because they generate positive spillovers, such as information and artistic content, that can be viewed as “public goods.”

Although intermediaries might be marginalized without regulatory protection on transactions involving large content providers—Netflix and Google have developed their own CDNs—consumers are unlikely to benefit from rules that reinsert the presence of intermediaries. Moreover, these intermediaries might not need interconnection revenues to thrive. For example, Level 3 acknowledged in a first quarter 2014 earnings call that Netflix is “not even in our top 30 customers, so the revenue impact is relatively small.” Small and mid-sized content providers will continue to rely on third party CDNs and transit providers in the absence of mandatory interconnection.

Finally, transit providers, CDNs, and other intermediary networks can avail themselves of antitrust courts if ISPs refuse to deal as a means of extending their (alleged) market power into adjacent markets. To be fair, antitrust cases do not proceed quickly, and with the exception of cases like Aspen Skiing and AT&T, antitrust rarely imposes mandatory obligations to interconnect, other than as a remedy for an independent antitrust violation. In Trinko, the Supreme Court recognized that antitrust has only weakly embraced affirmative duties to interconnect. Nonetheless, in Otter Tail, the Supreme Court found antitrust liability for an electric utility company’s failure to interconnect with another utility even though the Federal Power Commission could order such interconnection. Accordingly, excluded networks should have a reasonable chance of prevailing as long as they can establish monopoly power (presumably in terminating access) and antitrust impact (in the form of higher prices or reduced output in some relevant product market).