In a monumental court case with far-reaching consequences, Verizon (NYSE:VZ) successfully challenged the Federal Communications Commission's rules on Internet fairness. Before I get to why this is awesome for the company and horrible for the Internet, here's everything you need to know about "net neutrality."
A brief history
Aside from being the newest alliteration-happy sound bite, net neutrality happens to be a bedrock principle of Internet usage. It means that Internet service providers (ISPs) can't charge you different rates or change the speed of your Internet depending on what you happen to be doing at that moment.
For instance, I may check up on Twitter after finishing this article, but I expect my Internet speed to remain constant. Even though I'm moving from a content management system to a microblogging platform, Internet performance does not cross my mind. Sure, waiting for a video to buffer can cause you to curse your ISP, but the reasons it happens are fairly innocent. It depends on the quality of the Internet package (low mb/sec, maybe), how old the router is, or if distance is weakening the signal. In any case, the causes are not deliberate.
But that's about to change.
Verizon managed to convince three judges on an appellate court that the FCC's mandate, as outlined in the 1996 Communications Act, does not extend to regulating the Internet. In the decision, Judge David Tatel wrote, "Given that the Commission has chosen to classify broadband providers in a manner that exempts them from treatment as common carriers, the Communications Act expressly prohibits the Commission from nonetheless regulating them as such."
What does that mean, you ask? Translated into plain English, it means that Verizon found a gaping loophole. Back in 1996, the only way for end users to browse the web was through dial-up … yeah, I'd rather forget that existed too, but it's relevant to the story. Anyways, dial-up fell under the FCC's most stringent regulations – known as Title II restrictions for common carriers -- for the exact same reason we all hated it. Answering a phone call would disconnect your Internet (oh, the painful memories!), because telephone wires were the common infrastructure for both activities.
Why integrated information is bad
Regulating the Internet might be contentious, but transmission of those signals through telephone lines kept it squarely within the FCC's ballpark. This meant that the FCC had full authority to regulate them as before. And then came broadband.
With broadband, the FCC chose not to distinguish the "transmission and processing of information as distinct services," opting instead to think of it as "a single, integrated information service."
According to Judge Tatel, "because cable broadband providers were thus not telecommunications carriers at all, they were entirely exempt from Title II regulation." It's important to note the awkwardness and ambiguity of this classification, because it's caused countless headaches for the FCC. Like when complaints began pouring in about Comcast's (NASDAQ:CMCSA) interference with certain peer-to-peer networking applications. In keeping with its commitment to maintain a free and open Internet, the FCC did try to rein the providers in, but the court of appeals ruled it outside their jurisdiction. Sound familiar? The problem is that broadband providers aren't technically held to Title II standards, but neither can the FCC let them run wild.
In response to the Comcast decision came an Open Internet Order to establish ground rules for Internet fairness, but it was far too late. The loophole had been exposed and Verzion was quick to challenge any proposed restrictions.
Fast-forward to today.
The D.C. Circuit Court sides with Verizon, nullifying any real effect of the Open Internet Order and dealing a hammer blow to the idea of net neutrality. It's no surprise, really. The FCC had backed itself into a corner. Short of reclassifying broadband providers in line with common carriers, or Congress expanding the FCC's mandate, the commission's legal reasoning was on thin ice.
Some eternal optimists believe that a permanent fix is on the horizon, but I doubt it it'll come soon enough. The FCC has continuously shied away from redefining ISPs and a Republican House remains insurmountable for Internet advocates.
What it means for investors
The effects of this ruling can't be overstated. It quite literally gives ISPs the authority to impair or improve your access to a website depending on how it benefits them.
Here's some food for thought: if Verizon decides to challenge Netflix (NASDAQ:NFLX) by expanding its FiOS TV programming, what's to stop Verizon from skewing end-user access in its favor? Assuming Verizon can beef up its selection of shows and movies, it makes sense for consumers to go where the streaming is smoothest.
Netflix's problem is that the integrity of its product -- entertainment on demand -- can now be controlled by a potential competitor. That may not be fair, but it is legal for now.
A price war among the telecom giants starts right after net neutrality is struck down? That can't be coincidence. By luring subscribers with ultra-low data plans, you can sell them more of your other products. Everyone knows that. It's business school 101.
But what's at play here is a little more subtle -- Verizon, AT&T, and their counterparts all realize that a wider subscriber base doesn't just translate to higher cross-selling revenues. The real gold mine is the greater leverage they have when negotiating deals with content creators. It means that ISPs can demand that Netflix pay a premium to ensure smooth delivery of its product. And the bigger the subscriber base, the bigger the premiums.
So, ignore the bears and understand that ISPs are now running the table. The corporatization of the Internet has begun.