Net neutrality’s hollow promise to startups

Meet iHolo. This innovative (though hypothetical) startup sells a tiny cube that hooks into smartphones and projects a holographic image above the screen. Now we can see actual 3D holographic characters and movie explosions, hovering right in front of us! There’s just one problem: “Holovids” require an incredibly fast connection, and tons of bandwidth. The typical smartphone user has neither the speed nor the data capacity to use the new technology: after extended buffering waiting for the holovid to load, a user would exhaust his data plan within minutes. 

Worried that users won’t materialize, iHolo offers a deal to the big wireless carriers: To any carrier that will boost the speed of iHolo customers and exempt iHolo material from users’ data caps, iHolo will sell a minority interest in its fledgling company. 

It’s a potential win-win. iHolo gets access to much-needed capital, boosts demand for its product, and gains the stability that comes from having a big backer. That institutional support would mollify investors who would otherwise be wary of betting on an unproven technology. The carrier could differentiate itself in the wireless market, and the two companies could work together to figure out how to stream holovids efficiently.What’s not to love? Well, the business model that could make this innovation possible isn’t “neutral.” It could be banned if Net neutrality hardliners get their way. 

Net neutrality — the idea that all data should be treated the same as it zips over the Internet — sounds appealing in principle. Who wouldn’t want every competitor to have a fair shot, and for the best ideas to rise to the top? But in practice, rigid Net neutrality regulation could cripple the potential business arrangements that help launch new companies. 

To justify its proposed rules, the Federal Communications Commission warns that ISPs may have an “economic incentive to block or disadvantage” websites, and to charge providers for “prioritized access” to end users. Of particular concern, the agency wrote, “are threats to American innovation.” President Obama and The New York Times recently echoed the FCC’s fears, proclaiming that Net neutrality is necessary to enable “the next Google or the next Facebook.” 

But there is simply no benefit to startups for the FCC to scrutinize and regulate every deal made between every ISP and every content provider. Any complaint, no matter how frivolous, could spark a media frenzy, if not a formal investigation. And the threat of either could prevent the partnerships needed to drive innovative technologies. 

Moreover, it’s never been the case that all bits at all times have been treated “neutrally” on the Internet. Distinguishing between acceptable non-neutrality and the undefined “commercially unreasonable” conduct proposed by the FCC will be extremely difficult. And it will be arbitrary: Whether a transaction will be deemed to offend some yet-to-be-articulated principle of the public interest has less to do with rigorous analysis or the particulars of the transaction than with who’s sitting in judgment. 

The same goes for distinguishing between services subject to even stricter public-utility regulation under the provisions of Title II. This is an arbitrary distinction that further imperils content innovation and brings edge providers under Net neutrality’s most severe obligations. As Jeff Pulver, founder of Vonage, recently wrote, “I can attest I have no idea how to judge the difference between IP transmission and IP services for the purposes of my next startup. I will not be able to explain it to investors, because the line exists entirely in the mind of whoever happens to be Chairman of the FCC.” 

Indeed, it isn’t hard to imagine myriad business models that could be challenged or prohibited under a “pure” Net neutrality regime. 

A broadband provider might offer a sponsored content store, subsidized streaming music, or an exclusive partnership with an e-book seller to stream its books to its devices, for example. All of these are real examples offering clear benefits to consumers, and all would be threatened. But how about this one? An ISP offers a discount for each faster tier of access to consumers, as long as they don’t watch Netflix content more than a certain amount of time. 

It’s clear why Netflix would balk at such a proposal, but far less clear why startups and Net neutrality proponents support Netflix’s self-interested position. Contrary to the fears of Net neutrality proponents, this hypothetical arrangement would actually benefit new entrants, not established providers: It’s far more likely that an ISP would adopt policies that might limit the company responsible for 30% of broadband traffic rather than a startup that isn’t even a blip on an ISP’s radar. 

Established companies enjoy a host of advantages, ranging from name recognition to established revenue streams. Prioritization can be the difference between an unknown startup languishing in obscurity and a better product ousting an incumbent — banning prioritization in the name of protecting startup innovation is simply disingenuous. 

So, could our hypothetical iHolo be the “next Netflix”? Netflix wasn’t exactly a scrappy startup with no funds; its founder had just sold his first company for two-thirds of a billion dollars. Ironically, in a world where the Net is neutral, only the most prosperous and established companies would be able to secure the funding they need. Companies like iHolo would languish in the garage, unable to forge the partnerships needed to gain a foothold in a world dominated by big players.

If the FCC actually enacts its most extreme proposals, it may well become the very threat to innovation it fears. 

Geoffrey Manne is the founder and executive director of the International Center for Law and Economics (ICLE), based in Portland, Ore. Berin Szoka is the president of TechFreedom, based in Washington, DC.