Innovation through discrimination!? A Formal Analysis of the Net Neutrality Debate

We model the main arguments of the net neutrality debate in a two-sided market framework with network congestion sensitive content providers and Internet consumers on each side, respectively. The platform is controlled by a monopolistic Internet service provider, who may choose to sell content providers prioritized access to its customers. We explicitly consider the adverse effects of traffic prioritization to the remaining best-effort class and find that network discrimination has overall positive effects on welfare, because congestion is better allocated to those content providers with congestion inelastic advertisement revenues. In the long-run, network discrimination leads to infrastructure investments in transmission capacity and encourages innovation on the content provider side. In the short-run, however, discrimination has no effect on innovation because the ISP expropriates the content providers’ increased surplus through the price for priority access. This is the downside of network discrimination: Albeit total welfare is increased, content providers will–at least in the short-run–be worse off than under network neutrality. Although price regulation can shift some of the congestion alleviation gains back to content providers, it is inapt as a policy instrument, because welfare is proportionally destroyed in the process.