ESPN360.Com Locks Up It's Content — Let The Fragmentation Games Begin!

There’s been a lot of back and forth over whether letting broadband providers lock up content, or content providers lock out ISPs, is a good thing or a bad thing. And now, ESPN360.Com is going to kick off the fragmentation games and let us all find out.

It is a fine old Republican free market anti-deregulatory tradition to deregulate critical infrastructure and hope for the best, pooh-poohing doomsday predictions as ignorant exaggerations and fear mongering by business-hating regulation-loving quasi-commies. And since this philosophy worked so well with our financial sector, we have now moved it to the next major engine of the economy — broadband.

I am so excited! For those who have developed a taste for Lehman Bros-type thrill rides, the ESPN360.com deal will bring back fine memories of your first subprime derivative. You (and the rest of us along for the ride) can look forward to the thrill, the excitement, the dramatic highs and lows of playing high stakes roulette with our digital future. True we’ve lost our mortgage money (literally and metaphorically) playing “follow the Subprime queen.” But don’t worry. As any economist will tell you, the combination of a lack of information, high transaction costs, complex interrelated markets, and poorly understood network effects is just tailor made for that wild west anything goes atmosphere that made all them miners rich in the Sacramento gold fields!

Bet our critical infrastructure? How can we afford NOT TOO!!!

Details below . . .

I’ve written in the past about my general concern over allowing ISPs to charge third parties for “premium” treatment or for exclusivities, as well as why I think it is a bad idea for Democracy and why it stinks for deployment to minority communities and rural communities. The ESPN360.com helps puts some flesh on those theoretical bones and also helps show that it does not rely on the current competitive state of the market so much as the hideously complex state of telecommunications markets.

First, the details of the deal. ESPN360.com will let you watch all manner of exclusive international content via streaming video if you subscribe to one of their “partner” ISPs (such as AT&T DSL or Verizon FIOS), or are accessing through the U.S. military or through a college or university system (support the troops and build your customer base). If you belong to a disfavored ISP (such as Comcast or Cox), then you are screwed. You cannot independently buy access to the content or subscribe to it.

As a start, I can’t help but be mildly bewildered why the article’s author, Chris Soghoian, is at once so incensed by this deal and so disdainful of the idea of network neutrality. The ESPN360.com is a logical outcome of the ability of parties to cut exclusive deals. It makes little difference from an economic standpoint whether it is a high-value content provider cutting an exclusive with an ISP, or an ISP with market power cutting a deal with a content provider, the effect is the same. Which is why I believe the ESPN360.com deal may be the beginning of a new fragmentation of the internet which has serious negative long term consequences for all of us — including the ISPs.

Control of content and streaming is nothing new, of course. Indeed, as discussed in this AdWeek piece, sports content producers in particular are trying to figure out how to make this pay. But the ESPN360.com represents a new level of exclusivity. Unless you subscribe to an ISP acceptable to ESPN360, you can’t get the content no matter how much you wish to pay.

Traditionally, those who wished to control content found that exclusivity with any particular provider would cut them off from too large a segment of the market. Even when AOL had 22 million subscribers and was clearly the dominant ISP, it found that it did itself more harm than good by excluding visitors from its content. Since then, every business plan of every internet start up relies on the basic principle that it can reach any willing customer.

ESPN360.com tries to change that. It is trying, in essence, to recreate the cable/DBS competition model online. This worked very well for ESPN and its parent, Disney which — as part of the insane complexity of this market — also negotiate with both Comcast and Verizon and AT&T on the video side of things. While I have no idea what unit of ESPN or Disney negotiated this, big content providers like Disney have increasingly had total integration of its content and content delivery when it negotiates for platform access. In plain English, when Disney negotiates “retransmission rights” with cable companies, telcos, or satellite providers, Disney negotiates for access to the local ABC-owned television signal (if it has one in the local market) and all its cable programs. Disney leverages the “must have” parts of its package, e.g., local broadcast, ESPN, to require bundling and placement of less popular channels on basic tier.

Again, big whoop. Disney is a big boy and can take care of itself just fine. It wants to cut a deal with some ISPs for a subset of content to see if that will attract subscribers. Given that Verizon and AT&T are the new entrants in video and seriously lagging behind the cable boys in broadband, I bet ESPN got good terms. Why not let them all experiment with who gets to monetize what rather than require ESPN360 to make its content available to any willing buyer?

Ans: Because if this works out, Comcast and the other cable ISPs will retaliate by getting exclusive content of their own, then access to exclusive functionalities. For the big boys and at the early stages of the market, it’ll look great. We will have a total free-for-all where everyone is cutting their best deals and trying to find a partner to maximize their revenue. It’ll be just like the cell phone market was before that market matured into fixed carriers with fixed dancing partners or, if you prefer, it’ll be just like the good old days when we figured that everyone who wanted to lend money should be able to do so, and if someone else wanted to buy that paper or buy a security based on that paper, who were we to stop them.

But the interconnected nature of all this makes me worry a great deal about how this works out down the road after the free-for-all is over. Players with massive resources across different markets, like Disney or Google, will probably make out quite well. But if the cable market gives us any warning, the difficulty in getting subscribers to switch from one system to another, combined with the need to own eyeballs to attract the best content and demand the best terms, will gradually concentrate the market into a handful of players among ISPs and content and application providers. Any new content provider will need to find a partner ISP, and be prepared to sell itself to that ISP as the price of getting to a customer. Any small ISP will find itself unable to negotiate deals and, based on the filings of small cable companies and small programmers in the FCC’s “wholesale unbundling docket,” that means getting squeezed or trampled by the largest providers and largest carriers. Similarly, based on the Petition to ban exclusive handset deals filed at the FCC by the Rural Carrier Association, it would appear that smaller rural systems with “less desirable” customers will find themselves locked out of the market.

But even these are poor guides to the total extent to which this rewriting of business models may bite us all in the rear end down the road. The sheer complexity and cost of deal making at every level for the “new economy” will act to stifle innovation and job generation. The cost of developing content or applications and getting them online to customers will increase exponentially, but without any rise in economic activity. The size to which a company can hope to grow online will shrink dramatically, limited by the scope of its exclusivity arrangements with other providers. This increasing fragmentation will impact not only commercial speech, but non-commercial speech. Your campaign website may not want to negotiate an exclusive, but what about trying to leverage your content across other platforms. You Youtube videos will only reach some people, your Yahoo! videos another subset.

Or maybe you will be able to negotiate yourself a special exception for a campaign website. But when someone creates the next “maccaca” video, or even the next “series of tubes” video, it will be accessible only to those people who can access the particular platform hosting it.

I know, I know, crazy paranoid fantasies. Starting at shadows. Trust the market. Government shouldn’t pick winners, shouldn’t mandate business models, etc.. etc. OTOH, having written my first blog post on the coming economic meltdown in January 2006, I’m used to being told I’m a crazy paranoid Socialist who hates the free market and doesn’t understand how economics works.

So why not roll the dice with another piece of critical infrastructure with a complicated, interrelated market structure? After all, what could possibly go wrong?

Stay tuned . . . .

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4 Comments

  1. Ben Byrne says:

    I can’t wait til the day I can tell my kids how cool the web used to be when I was their age.

  2. Matt says:

    How is this any different than an ISP developing it’s own exclusive content and then outsourcing production of it?

    Some content producers charge individual users for content, like MLB.com.
    Some content producers show ads to users and give it away for free, google.com.
    Some content producers show new content for free and archives are charged for, or the reverse.

    The ESPN deal is similar to the first, only with a collective bargaining agreement to an entire ISP. Not all of the users probably agree, but the per user cost is probably lower. It sucks if a user is in a group that didn’t sign up and they want to. Also for users in groups that did sign up and they didn’t want to. But, it sucks for people who work in a union shop and don’t like the union or for people who want to unionize but can’t get enough others to agree.

    Or, how about web sites that only work with Internet Explorer and aren’t available to everyone who might use something else.
    It’s very different from an ISP limiting consumers only to exclusive content.
    No matter how many content providers decide to charge ISPs for content and be exclusive to just those ISPs it has no impact on any content producer that wants to be available to everyone. That campaign website has no obligation to negotiate with anyone.

    Who charges who is extremely important. True, in both cases, the user suffers.

    But, when the content provider charges, they have made a conscious decision to only offer their content to some consumers and to exclude others. That’s their business model and it’s no different than only having stores in big cities and not in small towns.

    When the ISP charges, it’s the communication pipeline that is restricted. Neither the content producer or consumer has any choice in the matter, it’s a third party restriction.

    I’m all in favor of regulating the communication channel to be neutral to the parties on both ends of the communication, since they’re providing a communication channel. Regulating the content providers to only provide content a certain way doesn’t make any sense. Otherwise, next we’ll need to regulate the consumers too so they can all consume the content.

  3. Harold says:

    Matt:

    What concerns me is that allowing outside content producers and ISPs to do their deals in this fashion is that it leads ultimately to fragmentation of all content and applications because large ISPs are able to force smaller content providers to “chose sides,” and larger content/application providers do the same thing with smaller ISPs. This is different from an ISP developing its own content or applications because it does not prevent new entrants into the market or impact pre-existing entrants. Also, traditionally, ISPs seeking to make money from content found that isolating that content from a significant market share did them more harm than good.

    Your argument about the danger of over-regulation is the natural retort. My response is that we can either build some simple principles into the underlying architecture now, or wait until everything has gone to Hell first. Who knows, maybe it won’t go to Hell and the costs of regulation will be thus wisely avoided.

    But analogies to retail outlets fail for three fairly straightforward reasons: a) we understand retail markets, they are uncomplicated compared to the current telecommunications market. These are interconnected markets with significant barriers to entry at some levels; b) retail markets are not critical infrastructure (well, in the aggregate you need some way to move products, but we do not have nearly as much riding on the success or failure of any retail model as we do on the success or failure of our broadband policy); and, c) switching cost, network effects, and the exclusivity of access have enormous impacts on consumer behavior substantively different from retail markets. If I shop at WalMart, nothing stops me from going to Costco or even local specialty store if I don’t find what I want. But no one is going to subscribe to both Comcast and FIOS. They will get one or the other and thus be excluded from the entire content of the one they do not select.

    In short, the differences in markets really matter. It is not enough to say “it works for retail, so it should work for telecom.”

  4. Matt says:

    How does this allow large ISPs to force smaller content providers to “chose sides,”?

    A small content provider can choose an ISP to be exclusive with or be open to all. There isn’t any requirement for them to pick one or any ISPs at all. If they feel they can make more money selling to the ISP than to the end users directly or by selling advertising that’s their option. The fragmentation happens at the Content Providers decision not an external entity.

    As you said, “traditionally, ISPs seeking to make money from content found that isolating that content from a significant market share did them more harm than good.”

    There’s no reason to think that this will be any different for a content provider choosing the same isolation themselves.

    In the current scenario, ESPN admits that some ISPs will NEVER pay, schools and the military. So, they’re giving it away. Smaller ISPs are likely to never pay because it’s to expensive. Very Large ISPs are likey to never pay on the idea that ESPN will want that market of users more than the ISPs want to pay ESPN. The only ISPs that are likely to pay (and this seems to be the case) are moderate sized that are trying to become large and are using it as a marketing tool to try and get new customers. At some point, they’ll get big enough and tell ESPN they aren’t going to pay any more and ESPN can either find a way to charge the impacted users directly or just loose those consumers and revenue. And just to make it more interesting, the ISP can do this and still be neutral, since they’re not limiting access to ESPN, just not paying ESPN to keep access.
    If an ISP doesn’t have to be neutral and can reject content on it’s own, that creates the problem. But, the ESPN example is an example of a content provider restricting the market, not the delivery mechanism.

    There isn’t anyway for this process to force anyone to pay ESPN for access to it. The only way this isn’t true, is if the content is so valuable that a majority of ISPs subscribe to it, effectively isolating the smaller ISPs. But, that isn’t likely to happen, because we would be back at very large ISPs refusing to pay and holding the fact that none of their huge consumer base will have access through no restriction of the ISP but solely because of the content provider.

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