Net neutrality refers to a range of principles ensuring non-discriminatory access to the internet.  A particularly contentious principle urges prohibition of “managed” or “tiered” internet service wherein your internet service provider is permitted to restrict or degrade service.  ISPs argue that without such permission they are unable to earn sufficient return on investment in network capacity and would be deterred from making such improvements.

One argument is based on congestion.  Managed service controls congestion, raising the value to users and allowing providers to capture some of this value with access fees.  This is a logical argument and one I will take up in a later post, but here I want to discuss another aspect of managed service:  price discrimination.

Enabling providers to limit access, say by bandwidth caps, opens the door to “tiered” service where users can buy additional bandwidth at higher prices.  This generally raises profits and so we should expect tiered service if net neutrality is abandoned.  What effect does the ability to price discriminate have on an ISP’s incentive to invest in capacity?

It can easily reduce that incentive and this undermines the industry argument against net neutrality.  Here is a simple example to illustrate why.  Suppose there is a small subset of users who have a high willingness to pay for additional bandwidth.  Under net neutrality, all users are charged the same price for access, and none have bandwidth restrictions.  An ISP then has only two choices.  Set a high price and sell only to the high-end users, or set a low price and sell to all users.  When the high-end users are relatively few, profits are maximized with low prices and wide access.  It is reasonable to think of this as describing the present situation.

Suppose tiered access is now allowed.  This gives the ISP a new range of pricing schemes.  The ISP can offer a low-price service plan with a bandwidth cap alongside a high-priced unrestricted plan.  As we vary the cap associated with the low-end plan, we can move along a continuum from no cap at all to a 100% cap.  These two extremes are equivalent to the two price systems available under net neutrality.

Often one of these in-between solutions will be more profitable than either of the two extremes.  The reason is simple.  The bandwidth cap makes the low-end plan less attractive to high-end users and as a result the ISP can raise the price of un-capped access to high-end users.  It’s true that low-end users will pay less for capped service but often the trade-off is favorable to the ISP and total profits increase.

The upshot of this is that total bandwidth is lower, not higher, when an ISP unconstrained by net-neutrality uses the profit-maximizing tiered-service plan.  Couched in the industry’s usual terms, the ISP’s incentive to increase network capacity is in fact reduced by moving away from net neutrality.

(Of course it can just as easily go the other way.  For example, it may be that presently only the high-end users are being served because to lower price enough to attract the low end users, the ISP would lose too much profit from the high-end.  In that case, allowing tiered service would induce the ISP to raise capacity and offer a capped service to previously excluded low-end users without significantly reducing profits from the high-end.  Note however, this is not typically how industry lobbyists frame their argument.)