Paper LinkThere is general consensus that Best Effort Service has been an essential contributing factor in the Internet’s explosive growth and the corresponding growth in innovations, applications and creativity that has benefitted society and consumers. Users of the Best Effort service, notwithstanding the absence of guarantees, have enjoyed reasonable performance in quality of service features, such as latency, jitter, throughput and reliability, as well as unfettered connectivity to content and applications. Also, importantly, for a low flat subscription fee for broadband connection, usage has been free. Users have taken advantage by using the Internet as a platform for experiments on innovative ways of using the network, which has led to the creation of new applications that, in turn, has fueled growth.
In the current discussion on Net Neutrality, an important question is whether the Internet’s essential characteristics can be preserved if Internet Service Providers (ISPs) are allowed to offer Managed Service with guaranteed quality of service (QoS). The concern is that the flexibility of offering differentiated services may lead to the "damaged goods" strategy. That is, the ISPs will have the incentive to induce subscribers to pay a premium price to use Managed Service by withholding necessary provisioning and investments in bandwidth for Best Effort service. As a consequence Best Effort service will be offered with poor quality, which will reduce social welfare and consumer surplus in the short-term, and also hinder the creation of new applications and innovations, and thus undermine the long-term vitality of the Internet.
We study the above issues by developing a model-based approach for investigating equilibrium outcomes of allowing Managed Service. We consider a monopoly ISP which offers both Best Effort Service for free use and Managed Service with guaranteed QoS for a fee per use. Our analysis starts from modeling optimal choices of consumers regarding whether to subscribe to the broadband network, which service (Best Effort or Managed Service) to use, and the usage of the chosen service. These decisions depend on both the average delay of Best Effort service, which depends on bandwidth and users’ self-adjustment of usage in response to delay, and the usage fee of the Managed Service. The ISP selects the usage fee and makes decisions to rent bandwidth at a given unit price to provision for the two services. The ISP’s objective is profit maximization, under the constraint that it has to deliver sufficient surplus to induce consumers to subscribe to its network.
We follow a common premise that underlays many arguments for Net Neutrality in assuming that usage of Best Effort service leads to the generation of applications. We model the dynamics of the applications process as a "birth-death" process, where the number of new births per unit time is proportional to the usage level of Best Effort service and the death rate is proportional to the existing number of applications. The optimal solution for maximizing the immediate profit is to provide Best Effort service with the minimum quality that generates just enough consumer surplus to justify the subscription fee. However, we show that, on the contrary, forward-looking ISPs should never take this approach. To this end, we model a strategic ISP that perceives the connection between new applications generated from Best Effort service and the profitability of Managed Service. We show that the strategic view can lead to a profit-maximizing decision that is quite different from the myopic one. In many cases, it becomes optimal to offer bandwidth for Best Effort service that generates far more surplus for its users than the minimum amount.
Our research suggests that to preserve a robust offering of Best Effort service the regulator may not need to ban Managed Service. Instead, leveraging the power of usage-generated applications on long-term profit leads to the desired result.
