Wednesday, June 11, 2014

How much competition is enough?

The topic of competition is a very interesting one and with layers and layers of complexity. While I firmly believe that the path to an Open Internet goes through building competition at the broadband level, and not through complex network neutrality regulations, the issue is not simple.

On the one hand, we have the example of UK, where OfCom has kept a pretty much hands off approach to Network Neutrality, the result has been a very open Internet that is market and competition driven. Almost every consumer in the UK has access to 4 ISPs that are similar in terms of capabilities and the Internet has remained "neutral". On the other hand we have the example in the US, where although significant portions of the nation have at least two comparable broadband providers (say, metropolitan DC and New Jersey where Comcast and Verizon FiOS are widely available) the "openness of the Internet" has been a problem. Specifically there have been peering disputes between Netflix and broadband providers, or the CDNs employed by Netflix and broadband providers. Netflix and Level3 have been complaining loudly that this is coercion from the ISP and quality is being deliberately deteriorated to extract a toll from the content providers. So the question is - if 4 competitors provide Internet openness in the UK, why do 2 providers fail to do so in the US? What gives the broadband providers in the US the confidence to flex their muscles, whereas similar profit oriented entities in the UK don't?

The answer to that involves a lot of factors. First off is the question of long term contracts - in the UK they are prohibited as far as I know, whereas in the US they are commonplace. This makes "competition" less than perfect. Secondly, since the broadband providers in the US are also invariably cable providers, there are vertically integrated monopolies in the US that are absent in the UK. There are many factors that make an ISP sticky for a consumer.  However, the point that I wanted to bring across in this post is what happens when there is "true" competition  - is there a magic number of competitors (4 vs 2) that ensures openness and "good behavior" by ISPs? Isn't 2 providers competing the same as 4 providers competing?

The answer to that is no. Competition is monotonically better for consumers. 3 providers competing is better than 2, and 4 is better than 3. And this is with the assumption that there is no collusion etc. happening with a smaller number of competitors, i.e. the best case scenario for competition. In a prior work, we applied cooperative game theory techniques to analyze the Internet ecosystem:

Richard T.B. Ma, Dahming Chiu, John C.S. Lui, Vishal Misra and Dan Rubenstein, On Cooperative Settlement Between Content, Transit and Eyeball Internet Service Providers, Proceedings of 2008 ACM Conference on Emerging network experiment and technology (CoNEXT 2008), Madrid, Spain, December, 2008

The associated talk we gave is here, but let me try to explain some numbers around competition that can explain the behavior we have observed.

An important concept of cooperative game theory is the Shapley value, which is the share that an individual gets of the value generated by the coalition it is part of. Shapley value incorporates various factors like the value an individual brings to the coalition, the value of the coalition without that individual etc. and the end formula gives guidance on what a rational individual would do to maximize it's share under all scenarios. Our work has the following formula of the “fair share” (the Shapley value) of the class of providers in the economic ecosystem of the Internet:

Let’s say there are m content providers and n ISPs. Then the share of the value generated (V) for the content providers is n/(m*(n+m)) and that of the ISPs is m/(n*(n+m)).

Let’s say Netflix is the sole content provider (m=1) at one end and there are 2 ISPs competing for customers (n = 2). Then Netflix’s share is 2/3 and each ISP is 1/6. So for every say 12 dollars a customer generates for Netflix every month, the ISPs have reason to believe that they deserve 2 dollars of it, because Netflix's business wouldn't exist without the ISPs (I am deliberately leaving out arguments of broadband being a utility that every consumer has the right to etc.).

If now the number of ISPs competing becomes 3, the Netflix share becomes 3/4 and the ISP share is 1/12 each. If you move to 4 ISPs, then Netflix share becomes 4/5, and each ISP is 1/20. Now for the 12 dollars that Netflix generates, the ISPs believe they deserve 60 cents from it.

So moving from 2 to 4 the “rightful share” of the value generated reduces to 1/20th from 1/6th - it is plausible that it is not worth it at that point to play hardball and extract that revenue from Netflix and instead the ISPs are more interested in winning and keeping customers. Maybe at 1/6th (2 ISPs competing) it is worth it to lose a few customers if you end up extracting more from the content provider but increasing the level of competition reduces the utility of that tactic. At some point the expected payoff (of toll) from the content provider falls below the expected loss (of customer revenue) to competing ISPs and at that point "competition is enough".

So more competition is better for consumers, and the cooperative game theory analysis provides some numbers to reason about how much better.


  1. Hmm, but look at what your model says about if there are multiple content providers. (Which is somewhat true, but Netflix has a dominant share in the US right now.) Set m=2 and n=4, and Netflix and its one competitor each have a 4/12 share, and the 4 ISPs each have a 1/12 share. If m=4 and n=4, then each ISP has a 1/8 share. Therefore, with more content providers competing, each ISP has a *greater* incentive to play hardball with each of the competing content providers, mutatis mutandis.

    Under the view that the sole consumer interest is avoiding the ISP having an interest in playing hardball, this would imply that it's not true that more competition is monotonically better for consumers either. (Presumably there are more factors going on, such as it being good for consumers in other ways if there's competition in streaming video platforms.)

    An ISP has an incentive to maximize net cash flow from content providers and networks regardless of whether the ISP is attempting to extract transit from the intervening networks *or* if the ISP is attempting to minimize transit payments that it must make to Level 3, Cogent, etc. Many of the smaller local and regional ISPs have to pay Level 3, Cogent, and others for transit, which is understandably why Cox and others (Cox pays Level 3 for transit) are willing to deal with Netflix's Open Connect at a price of free-- it's better than paying transit.

    Note that a desire to minimize transit payments can *also* give a regional ISP incentive to think it worth losing a few customers rather than upgrade one's interconnects. The additional revenue from keeping customers may not be worth the added IP transit payments to Tier 1 networks, and raising end-user prices to compensate may lose more customers than it keeps. Cf. the cable TV world, where disputes over carriage of TV networks persists despite the multichannel video programming distributor paying the content provider for content. MVPDs are willing to have disruption in programming and sometimes lose customers over that rather than the potential loss in revenue and/or customers from paying higher carriage fees for networks, and possibly passing that on in subscription fees.

    Of course, there's another set of players in this game as well-- the content owners, which are, despite Netflix's nascent efforts to produce their own shows, generally not the streaming video platform owners. They also have an interest in extracting as much rent as possible, and complicate the model.

    1. Hi John,

      Agree with the broader points you make, and in our paper we do look at more complicated models involving transit providers etc.

      On the issue of competition however, I stand by our conclusions.

      If there are more content providers, the share of each ISP relative to the content provide does increase, but if there are limited number of total dollars available (say the total consumer spending on streaming video sites), then the incentive to go for those dollars relative to the risk of losing your own broadband customers reduces. So increasing competition at either end is monotonically better for consumers.

      Transit prices have fallen by 2 orders of magnitude over the last decade, precisely due to this reason of competition increasing.

    2. Hi Vishal,

      Thanks for the response. I think in general it makes sense, but isn't the cable TV market marked by a large number of content providers? (Even given that content providers own many networks, there's still a lot more competition than Netflix vs. other online video platforms.) And yet we see MVPDs interested in reducing their payments to content providers even at the cost of carriage disputes. If anything, the competition sometimes makes them *more* likely to shut off network X, since viewers can still watch network Y and Z. In analogy, would an ISP be more willing to play hardball with Netflix if it knew that many customers, even if not all, would simply switch over to Amazon (or Hulu, or whatever)?

      Certainly a big difference between these models is that the consumer pays Netflix directly, rather than using the ISP as an intermediary. One exception is the Disney-owned ESPN3 service, which is a video streaming service where Disney/ESPN does not accept individual subscriptions, but instead makes the service available to all subscribers of ISPs that pay ESPN directly. (In other words, ESPN3 follows the cable TV model.)

      The closer analogy in the Netflix world to cable TV is thus when Netflix negotiations breakdown with a particular content owner, and Netflix loses access to a large amount of content, expecting consumers to shift to consuming other parts of Netflix's bundle.

  2. Hi John,

    Two points: One can argue that things like House of Cards and Orange is the New Black make Netflix less of a "commodity" that can swapped out for Amazon or Hulu. So it has less competition in that regards.
    On the flip side, people don't get Internet connections *only* to watch Netflix, they have a lot other uses for that bandwidth so in that sense there is a lot of competition.

    All these fights are really over video. Things will become a lot more interesting when 4K videos start proliferating and questions over who monetizes it and who pays for it will start getting heated.