**2. Zero-rating, net neutrality and competitive harms**

Calls for the banning of zero-rating offers have arisen in the context of wider advocacy for increased regulation of ISPs to impose a particular view of an internet where ISPs are required to treat every data packet equally—in regard to both technical and financial characteristics. Calls for ISPs (but not the providers of content and applications used on the infrastructure) to operate in this neutral, non-discriminatory manner—so-called net neutrality—derived from Wu's [12] seminal paper.

Particular concerns have been voiced about ISPs charging some content and applications providers (CAPs) but not others to deliver their traffic to end consumers, even when those payments are not associated with traffic prioritisation (so fall outside the so-called 'hard' network neutrality regulations [13] precluding such behaviour). ISPs, however, are continually looking for new revenues in order to finance the newer, more capable networks required to transport a burgeoning volume of content and application data between CAPs and end users, in addition to winning new customers and amortising general network costs.

Some neutral internet proponents (e.g., [14, 15, 28]) have argued that 'zero-rated' internet access plans, frequently offered by mobile providers, should be prohibited.

These plans do not count data used for selected ('zero-rated') applications against the data downloading 'cap' specified within the monthly access fee. End users face a lower effective price for using the selected application than for other applications that are not 'zero-rated'. The ISP may or may not charge the selected CAPs to recover the costs of delivering their data to end users. 'Zero-rated' plans are seen by net neutrality proponents as a form of unfair price discrimination1 against those internet users who do not access the selected content. It is also argued that when ISPs selectively zero-rate data relating to large established CAPs, smaller and newer rivals will be foreclosed, thereby harming incentives for application innovation, regardless of whether or not ISPs charge CAPs. A further argument is that application variety will be harmed because smaller, newer providers may not have the resources to pay ISPs to zero-rate their traffic, leading to their applications being eschewed by end users preferring the zero-rated options.

Others, however (e.g., [10, 16, 17, 25, 27]), contend that preventing all instances of zero-rating will necessarily rule out some cases (e.g., those analogous to advertising in newspapers) where payments on both sides of a two-sided market may be necessary for both an application and the additional infrastructure needed to service demand for it to be commercially viable in the first place. They also suggest that zero-rating will facilitate higher internet use in total (and therefore higher welfare) than if payments were restricted to only one 'side' of the internet platform. The potential welfare gains from higher internet use may be especially valuable in developing countries where the ability to pay for additional data use is very low [18]. They argue for a more nuanced approach, where each case is considered on its merits, so that the interests of all participants in highly complex internet-enabled ecosystems can be assessed [9, 19, 29, 30].

To date, no consistent view has emerged amongst regulators and competition authorities of what constitutes anti-competitive use of zero-rating. In the United States, much press has been directed at T-Mobile's zero-rating of its Binge-On application, but the FCC has found no harm. In Europe, the Belgian regulator found Proximus use acceptable according to the BEREC guidelines [31], and two National Regulatory Authorities (NRAs)—Austria and Croatia—found zero-rating acceptable when assessed against BEREC's commercial criteria. However, the Dutch NRA found Deutsche Telecom had infringed in zero-rating its free music service. The decision was struck down on appeal, but on grounds that the NRA decision exceeded EU law, rather than on its commercial merits.2

#### **3. The internet ecosystem and zero-rating**

Zero-rating offers take place in a complex internet-enabled ecosystem consisting of multiple intertwined two-sided platforms, of which ISPs are just one of many in the commercial chain linking senders and receivers of data [20, 21, 32]. **Figure 1** illustrates how in this ecosystem, payment flows need not necessarily follow data flows. The systemic interaction of payments and data flows means that actions at any one segment of the ecosystem can have material consequences at any other part.

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*Strategic Use of Zero-rating of Mobile Data DOI: http://dx.doi.org/10.5772/intechopen.84130*

**3.1 Complex interactions**

*The internet-enabled ecosystem.*

**Figure 1.**

Net neutrality advocates assert that innovation at the CAP 'edge' of the ecosystem unconditionally dominates innovation at the ISP core. In this view, ISPs' sole commercial functions are to serve the internet data transmission requirements of their end users. ISPs should not have commercial interactions with CAPs—thereby precluding any possibility that selected CAPs can pay ISPs to prioritise (i.e., discriminate against) traffic related to their applications over that of their rivals. By extension, any arrangements whereby ISPs discount the charges relating to specific applications (i.e., zero-rating) are seen as price discrimination. Both practices are seen to discriminate amongst CAPs, so are antithetic to the objective of promoting the internet ecosystem as an engine of innovation [22]. Van Schewick [15] uses this argument to question the efficacy of T-Mobile's zero-rating of content on Binge-On, as do critics of Facebook's Free Basics. Indeed, Lemley and Lessig go so far as to suggest that ISPs should not charge CAPs for data delivery as a form of subsidy for application development activities. In contrast, ISPs claim that they have been required to build ever-more-capable networks (for example, from 2G to 3G, 4G and now 5G mobile, and fixed fibre and wireless) to serve the vastly increased demands placed on them to deliver ever-larger amounts of data at ever-faster speeds to meet the demands of specific applications [26]. A handful of application types—notably audio and video streaming—require vastly more sophisticated network capabilities than others—for example, simple websites. As not all consumers use these applications equally, and some applications—for example, those relating to time-critical bilateral interactions—need to be treated differently from others—e.g., one-way streamed data then some degree of discrimination (both in terms of traffic management and pricing, such as charging CAPs in some instances as well as ends users) is essential if

their networks are to be operated efficiently and effectively.

<sup>1</sup> A distinction needs to be made between legal definitions of discrimination—where two people with observable differences are treated differently (e.g., racial or gender discrimination) and economic discrimination—where two people with different economic characteristics are treated differently (e.g., where those with low willingness-to-pay are charged a low price and those with high willingness-to-pay a high price). The latter case may frequently lead to a more efficient outcome. However, in the former, the individuals may have identical economic characteristics, so charging different prices is not welfare-enhancing. <sup>2</sup> Autoriteit Consument & Markt, "ACM Not to Appeal Ruling on Net Neutrality | ACM.Nl," News, May 23, 2017, /en/publications/publication/17267/ACM-not-to-appeal-ruling-on-net-neutrality.

*Strategic Use of Zero-rating of Mobile Data DOI: http://dx.doi.org/10.5772/intechopen.84130*

*Strategy and Behaviors in the Digital Economy*

nents as a form of unfair price discrimination1

exceeded EU law, rather than on its commercial merits.2

Zero-rating offers take place in a complex internet-enabled ecosystem consisting of multiple intertwined two-sided platforms, of which ISPs are just one of many in the commercial chain linking senders and receivers of data [20, 21, 32]. **Figure 1** illustrates how in this ecosystem, payment flows need not necessarily follow data flows. The systemic interaction of payments and data flows means that actions at any one segment of the ecosystem can have material consequences at any other part.

<sup>1</sup> A distinction needs to be made between legal definitions of discrimination—where two people with observable differences are treated differently (e.g., racial or gender discrimination) and economic discrimination—where two people with different economic characteristics are treated differently (e.g., where those with low willingness-to-pay are charged a low price and those with high willingness-to-pay a high price). The latter case may frequently lead to a more efficient outcome. However, in the former, the individuals may have identical economic characteristics, so charging different prices is not welfare-enhancing. <sup>2</sup> Autoriteit Consument & Markt, "ACM Not to Appeal Ruling on Net Neutrality | ACM.Nl," News, May

23, 2017, /en/publications/publication/17267/ACM-not-to-appeal-ruling-on-net-neutrality.

**3. The internet ecosystem and zero-rating**

These plans do not count data used for selected ('zero-rated') applications against the data downloading 'cap' specified within the monthly access fee. End users face a lower effective price for using the selected application than for other applications that are not 'zero-rated'. The ISP may or may not charge the selected CAPs to recover the costs of delivering their data to end users. 'Zero-rated' plans are seen by net neutrality propo-

access the selected content. It is also argued that when ISPs selectively zero-rate data relating to large established CAPs, smaller and newer rivals will be foreclosed, thereby harming incentives for application innovation, regardless of whether or not ISPs charge CAPs. A further argument is that application variety will be harmed because smaller, newer providers may not have the resources to pay ISPs to zero-rate their traffic, leading to their applications being eschewed by end users preferring the zero-rated options. Others, however (e.g., [10, 16, 17, 25, 27]), contend that preventing all instances of zero-rating will necessarily rule out some cases (e.g., those analogous to advertising in newspapers) where payments on both sides of a two-sided market may be necessary for both an application and the additional infrastructure needed to service demand for it to be commercially viable in the first place. They also suggest that zero-rating will facilitate higher internet use in total (and therefore higher welfare) than if payments were restricted to only one 'side' of the internet platform. The potential welfare gains from higher internet use may be especially valuable in developing countries where the ability to pay for additional data use is very low [18]. They argue for a more nuanced approach, where each case is considered on its merits, so that the interests of all participants in highly complex internet-enabled ecosystems can be assessed [9, 19, 29, 30]. To date, no consistent view has emerged amongst regulators and competition authorities of what constitutes anti-competitive use of zero-rating. In the United States, much press has been directed at T-Mobile's zero-rating of its Binge-On application, but the FCC has found no harm. In Europe, the Belgian regulator found Proximus use acceptable according to the BEREC guidelines [31], and two National Regulatory Authorities (NRAs)—Austria and Croatia—found zero-rating acceptable when assessed against BEREC's commercial criteria. However, the Dutch NRA found Deutsche Telecom had infringed in zero-rating its free music service. The decision was struck down on appeal, but on grounds that the NRA decision

against those internet users who do not

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**Figure 1.** *The internet-enabled ecosystem.*

#### **3.1 Complex interactions**

Net neutrality advocates assert that innovation at the CAP 'edge' of the ecosystem unconditionally dominates innovation at the ISP core. In this view, ISPs' sole commercial functions are to serve the internet data transmission requirements of their end users. ISPs should not have commercial interactions with CAPs—thereby precluding any possibility that selected CAPs can pay ISPs to prioritise (i.e., discriminate against) traffic related to their applications over that of their rivals. By extension, any arrangements whereby ISPs discount the charges relating to specific applications (i.e., zero-rating) are seen as price discrimination. Both practices are seen to discriminate amongst CAPs, so are antithetic to the objective of promoting the internet ecosystem as an engine of innovation [22]. Van Schewick [15] uses this argument to question the efficacy of T-Mobile's zero-rating of content on Binge-On, as do critics of Facebook's Free Basics. Indeed, Lemley and Lessig go so far as to suggest that ISPs should not charge CAPs for data delivery as a form of subsidy for application development activities.

In contrast, ISPs claim that they have been required to build ever-more-capable networks (for example, from 2G to 3G, 4G and now 5G mobile, and fixed fibre and wireless) to serve the vastly increased demands placed on them to deliver ever-larger amounts of data at ever-faster speeds to meet the demands of specific applications [26]. A handful of application types—notably audio and video streaming—require vastly more sophisticated network capabilities than others—for example, simple websites. As not all consumers use these applications equally, and some applications—for example, those relating to time-critical bilateral interactions—need to be treated differently from others—e.g., one-way streamed data then some degree of discrimination (both in terms of traffic management and pricing, such as charging CAPs in some instances as well as ends users) is essential if their networks are to be operated efficiently and effectively.

Regulators and competition authorities are charged with promoting competition in each of the relevant markets in order to protect the long-term interests of consumers. This dynamic welfare criterion is predicated upon the assumption that the long-term interests of consumers in each of these markets are a suitable proxy for the long-term interests of the ecosystem as a whole. Thus, balance is required between short-term and long-term factors. Furthermore, what is optimal at one time of the ecosystem lifecycle may not be optimal at another [33, 34]. To the extent that social preferences may override the economic considerations, then the costs of imposing those preferences must be recognised in both the total welfare foregone, and the transfers that those preferences engender between ecosystem stakeholders. Moreover, a single stakeholder may participate in the ecosystem in multiple capacities, and these may vary over the ecosystem lifecycle. The dilemma for regulators and policy-makers is to decide what to take into account when developing a framework for assessing cases of zero-rating, and deciding how and when to intervene.

#### **3.2 Derived demands**

The dilemma is exacerbated because end-users' demands for ISP services are not determined solely by their own interaction. An ISP connection is of no value to an end user if it is not used to access internet applications. ISPs operate two-sided platforms connecting CAPs and end users. The relevant products for any zerorating inquiry are the complex bundles of internet access and application use that end users consume. Internet connection value cannot be considered in isolation—it is dependent upon the value the consumer places on the applications accessed. The ISP may supply some of these applications, but for the most part, consumers' value of the connection is contingent upon being able to access a vast range of applications provided by third-party CAPs.

A nontrivial observation arising is that, for the most part, ISPs do not have strong incentives to impede their consumers' access to the preferred applications, for fear of losing them—and their revenues—to rival ISPs [21]. If favouring one application harms access to or use of another, then likewise this will likely reduce both the number of ISP customers and the ability of the relevant CAP to earn subscription and advertising revenues. Ipso facto, this reduces the incentives for ISPs to use pricing to strategically foreclose selected third-party applications—especially those consumers valued highly—unless they are compensated by the CAP. However, as the market power (measured by the consumer base) of highly valued CAPs vastly exceeds that of any individual ISP, and they have very wide (global) reach whereas ISPs are geographically specific, it is most unlikely that they will engage in contracting in each of the vast number of local geographic ISP markets in order to foreclose their CAP rivals. It cannot be discounted that locally specific CAPs might find such a strategy advantageous with regard to a rival facing the same geographic limitations.

#### **3.3 Complex tariffs**

ISPs can charge consumers a flat fee, a usage-based fee or a combination of the two for internet access. Consumers' internet access purchases are determined by trading off the fixed price paid for access and any usage charge against the benefits of accessing and utilising applications. Menus of two-part tariffs bundling access and usage charges are generally welfare enhancing relative to a single flat-rate or solely usage-based tariff as they allow users with different valuations associated with different usage levels of even a single application to self-select the tariff that gives them most surplus [35].

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quality for all users).

**3.4 Heterogeneous end users**

to pay for the connection.

wishes to remain solvent.

Costs remain unchanged, but revenues will fall.

**4. Competition: relaxing the assumptions**

A zero-rated tariff applied to a specific application is simply a tariff with no usage-based component—that is, a flat fee. Flat fees are most advantageous for those with the highest expected usage, (e.g., video gaming) as they will utilise it up to the point where no further benefits will be obtained. This is necessarily more than if usage is charged at marginal cost (noting that network congestion is a significant externality proportional to utilisation that is imposed by users when utilising applications). If the higher costs associated with higher usage levels are to be recovered in user fees, a single flat-rate tariff will be higher where usage is higher that when it is lower. Metered tariffs (including plans with flat-rates within a given data cap, that rise as the data cap increases) are an efficient means by which ISPs may recover revenues from each consumer rising in proportion with the costs that usage imposes on the ISP (including the costs of congestion that lower service

However, metered tariffs will arise in practice only if consumers are heterogeneous in their valuations of application usage. If all consumers value their connections identically, then there will be one tariff that is efficient for all users, and there will be no incentive for ISPs to offer any other tariff. Consumers' valuations of internet application usage are inherently heterogeneous because different users will prefer to use different applications for different purposes. Some will prefer applications requiring high usage (e.g., video streaming) while others will prefer applications with lower resource demands (e.g., web browsing, email). Even consumers preferring a single application will vary in their use of it due to personal preferences and resource constraints—for example, time to watch streamed video and the cash

Consequently, internet access as sold by ISPs is not a homogeneous good—it varies with the application preferences of the consumers using it. Consumers with higher valuations for a single application will consume more resources than those with lower valuations. If metered tariffs are intended to recover higher revenues from higher-using consumers of a single application, then offering a zero-rated tariff for that application is inconsistent with the ISP's objective to recover its costs in usage fees. Assuming that the ISP does not recover the revenues lost from zerorating application usage from the application provider, and it costs the same to deliver a unit of each application to the end user, then it is strategically illogical for the ISP to charge for the usage of one application and zero-rate usage of the other.

Hence, in the simplest case, as zero-rating by an ISP discounts revenues received from selected end users on the consumer side of the ISP platform, it must necessarily be associated with compensatory revenue streams—for example, higher fees charged to non-selected users, charges on the CAP side of the platform, or revenues from other sources, such as taxation or advertising—if in the long run the ISP

The principal arguments against zero-rating promulgated by net neutrality advocates rest on the one-sided logic that all end users should pay the same price for internet access, regardless of whether the market for the product in question conforms to the assumptions of perfect competition. In this model, the marginal unit supplied will be sold at its marginal cost of production, and this cost will determine

#### *Strategic Use of Zero-rating of Mobile Data DOI: http://dx.doi.org/10.5772/intechopen.84130*

*Strategy and Behaviors in the Digital Economy*

**3.2 Derived demands**

tions provided by third-party CAPs.

Regulators and competition authorities are charged with promoting competition in each of the relevant markets in order to protect the long-term interests of consumers. This dynamic welfare criterion is predicated upon the assumption that the long-term interests of consumers in each of these markets are a suitable proxy for the long-term interests of the ecosystem as a whole. Thus, balance is required between short-term and long-term factors. Furthermore, what is optimal at one time of the ecosystem lifecycle may not be optimal at another [33, 34]. To the extent that social preferences may override the economic considerations, then the costs of imposing those preferences must be recognised in both the total welfare foregone, and the transfers that those preferences engender between ecosystem stakeholders. Moreover, a single stakeholder may participate in the ecosystem in multiple capacities, and these may vary over the ecosystem lifecycle. The dilemma for regulators and policy-makers is to decide what to take into account when developing a framework for assessing cases of zero-rating, and deciding how and when to intervene.

The dilemma is exacerbated because end-users' demands for ISP services are not determined solely by their own interaction. An ISP connection is of no value to an end user if it is not used to access internet applications. ISPs operate two-sided platforms connecting CAPs and end users. The relevant products for any zerorating inquiry are the complex bundles of internet access and application use that end users consume. Internet connection value cannot be considered in isolation—it is dependent upon the value the consumer places on the applications accessed. The ISP may supply some of these applications, but for the most part, consumers' value of the connection is contingent upon being able to access a vast range of applica-

A nontrivial observation arising is that, for the most part, ISPs do not have strong incentives to impede their consumers' access to the preferred applications, for fear of losing them—and their revenues—to rival ISPs [21]. If favouring one application harms access to or use of another, then likewise this will likely reduce both the number of ISP customers and the ability of the relevant CAP to earn subscription and advertising revenues. Ipso facto, this reduces the incentives for ISPs to use pricing to strategically foreclose selected third-party applications—especially those consumers valued highly—unless they are compensated by the CAP. However, as the market power (measured by the consumer base) of highly valued CAPs vastly exceeds that of any individual ISP, and they have very wide (global) reach whereas ISPs are geographically specific, it is most unlikely that they will engage in contracting in each of the vast number of local geographic ISP markets in order to foreclose their CAP rivals. It cannot be discounted that locally specific CAPs might find such a strategy advantageous with regard to a rival facing the same geographic

ISPs can charge consumers a flat fee, a usage-based fee or a combination of the two for internet access. Consumers' internet access purchases are determined by trading off the fixed price paid for access and any usage charge against the benefits of accessing and utilising applications. Menus of two-part tariffs bundling access and usage charges are generally welfare enhancing relative to a single flat-rate or solely usage-based tariff as they allow users with different valuations associated with different usage levels of even a single application to self-select the tariff that

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limitations.

**3.3 Complex tariffs**

gives them most surplus [35].

A zero-rated tariff applied to a specific application is simply a tariff with no usage-based component—that is, a flat fee. Flat fees are most advantageous for those with the highest expected usage, (e.g., video gaming) as they will utilise it up to the point where no further benefits will be obtained. This is necessarily more than if usage is charged at marginal cost (noting that network congestion is a significant externality proportional to utilisation that is imposed by users when utilising applications). If the higher costs associated with higher usage levels are to be recovered in user fees, a single flat-rate tariff will be higher where usage is higher that when it is lower. Metered tariffs (including plans with flat-rates within a given data cap, that rise as the data cap increases) are an efficient means by which ISPs may recover revenues from each consumer rising in proportion with the costs that usage imposes on the ISP (including the costs of congestion that lower service quality for all users).

#### **3.4 Heterogeneous end users**

However, metered tariffs will arise in practice only if consumers are heterogeneous in their valuations of application usage. If all consumers value their connections identically, then there will be one tariff that is efficient for all users, and there will be no incentive for ISPs to offer any other tariff. Consumers' valuations of internet application usage are inherently heterogeneous because different users will prefer to use different applications for different purposes. Some will prefer applications requiring high usage (e.g., video streaming) while others will prefer applications with lower resource demands (e.g., web browsing, email). Even consumers preferring a single application will vary in their use of it due to personal preferences and resource constraints—for example, time to watch streamed video and the cash to pay for the connection.

Consequently, internet access as sold by ISPs is not a homogeneous good—it varies with the application preferences of the consumers using it. Consumers with higher valuations for a single application will consume more resources than those with lower valuations. If metered tariffs are intended to recover higher revenues from higher-using consumers of a single application, then offering a zero-rated tariff for that application is inconsistent with the ISP's objective to recover its costs in usage fees. Assuming that the ISP does not recover the revenues lost from zerorating application usage from the application provider, and it costs the same to deliver a unit of each application to the end user, then it is strategically illogical for the ISP to charge for the usage of one application and zero-rate usage of the other. Costs remain unchanged, but revenues will fall.

Hence, in the simplest case, as zero-rating by an ISP discounts revenues received from selected end users on the consumer side of the ISP platform, it must necessarily be associated with compensatory revenue streams—for example, higher fees charged to non-selected users, charges on the CAP side of the platform, or revenues from other sources, such as taxation or advertising—if in the long run the ISP wishes to remain solvent.

#### **4. Competition: relaxing the assumptions**

The principal arguments against zero-rating promulgated by net neutrality advocates rest on the one-sided logic that all end users should pay the same price for internet access, regardless of whether the market for the product in question conforms to the assumptions of perfect competition. In this model, the marginal unit supplied will be sold at its marginal cost of production, and this cost will determine

the price paid for all other units sold. This leads to a statically efficient outcome, with maximum total welfare.

However, for this to be achieved, other specific market conditions must be met. Importantly, the product sold must be perfectly homogeneous, there must be perfect information, no transaction costs, no externalities, and no barriers to firms entering or leaving the market. There must be perfectly divisible output (i.e., no scale economies). All participants are price-takers—that is, no firm can charge more than the efficient price and remain in the market, and consumers must pay that price if they value the product at that price or above.

Requiring all units to be sold at the same price does not of itself make a market more competitive (i.e., render the perfectly competitive outcome) unless all of the other conditions are met. In this section, we will demonstrate that as practically none of these assumptions prevail in the complex market for internet access discussed in the previous section, simplistic calls to prevent zero-rating are insufficient to guide decision-making.

First, we show that when the assumption of homogeneous goods is relaxed, it is most unlikely that zero-rated tariffs can be used to foreclose rival applications. Instead, we demonstrate that requiring the same price to be charged for accessing products costing different amounts to produce obscures crucial underlying differences in costs on the supply side and user preferences on the demand side. This leads to our first three questions to be posed by those undertaking case-by-case assessments of zero-rating examples. Next, we relax the assumptions of perfect information and absence of transaction costs in the exchanges between ISPs and their end consumers, and their effects on barriers to entry for new CAPs and ISPs. This leads us to question the competitive positioning of the party objecting to an ISP using zero-rating prices—and our fourth question for assessors. It also leads to our final consideration—how the presence of transaction costs creates barriers to entry that lead to entrants and not incumbents favouring zero-rating policies. This leads to our fifth question, regarding the strategic options available to CAPs and ISPs that render financial transactions between them an adjunct to zero-rating that makes the strategy not only pro-competitive but also welfare-enhancing.

We note that in this analysis we are considering only instances of pricing of data transfer as a strategy for zero-rating. We do not consider cases of payments for data prioritisation. The examples we consider therefore have the appearance of the price discrimination to which Wu [12] and Van Schewick [15] raise objections, rather than being artefacts of paid data management, which are considered in other literature.

#### **4.1 Relaxing the constraints: homogeneous products and heterogeneous users**

In net neutrality discourse, ISPs could strategically zero-rate a selected application to steer end users away from using another application and towards the favoured one. This could occur if the ISP is also the CAP for the favoured application, whereby it could foreclose another ISP offering a similar application, or to foreclose a rival stand-alone CAP. However, such foreclosure can only occur only if the end users perceive the applications as perfect substitutes: that is, the applications are homogeneous.

If the two applications offer materially different value propositions to end consumers (i.e., the assumption of homogeneous products in the perfect competition model is relaxed), then the zero-priced application will not be able to force the positive-priced one from the market so long as there are consumers who prefer the positive-priced one over the zero-rated one by more than the discount embedded in the zero-rating offer [11]. As demonstrated above, as end users are also

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and sports reports) and advertisers.

on the discriminating ISP's network.

more likely it is that foreclosure will occur.

*zero-rated application(s)?*

indistinguishable.

inherently heterogeneous in their content preferences, it is quite unlikely that the requisite conditions for foreclosure will occur unless the applications concerned are

The inability for 'free' offerings to foreclose those with a positive price is observed with broadcast television and newspaper providers. Free-to-air television and free newspapers have not foreclosed pay television and newspaper subscriptions. Indeed, some consumers willingly consume both, even when some of the content overlaps, because the additional value offered by the pay version is sufficiently high enough that it overcomes the price differential. Arguably, the presence of the two different newspaper forms has led to greater content variety, with subscriber newspapers providing a professional journalist-based news service, and free newspapers relying more upon content generated by readers (e.g., local school

This leads to our first question to be posed about zero-rating offers.

*Question 1. What very close or perfectly substitute applications accessible over the ISP's connection, costing the same to deliver, are likely to be foreclosed by the* 

The closer are the non-zero-rated application(s) to the zero-rated one(s) in the perception of the end users, then the more likely it is that the non-zero-rated applications will be crowded out. However, there are very few applications meeting this requirement that are truly close substitutes. For the most part, CAPs such as Netflix and Hulu are not close or perfect substitutes for each other because they contain different bundles of content for which end users have distinct preferences. The applications themselves are differentiated; even if it costs the ISP the same to deliver a Hulu movie and a Netflix one of equivalent specifications. If a consumer preferring Netflix is not prevented from paying the higher usage fee to watch Hulu content if the content available only on Hulu is sufficiently highly valued, then Hulu will not be foreclosed, even in respect of the subset of Hulu-preferring consumers

It might be a concern, however, if the applications in consideration were, for example, two identical cloud storage applications. The zero-rated application will have an unequivocal advantage over the non-zero-rated one, leading to all consumers with a non-zero valuation of using cloud storage opting for the lower-cost one. However, for foreclosure to occur, it is necessary for the applications to be undifferentiated—that is, homogeneous products. Foreclosure of differentiated products will be a function of the degree of differentiation—the more similar they are, the

The logic applied in this simple illustration leads to the conclusion that without some non-neutral pricing signals, over-much (inefficient) investment in CAP variety is possible if equalising the prices faced by consumers and application providers

conceals underlying real differences in costs and user preferences.

**4.2 Equalising prices conceals underlying cost and valuation differences**

Assume now that the two applications are perfectly homogeneous, but one actually costs less to deliver than the other. This could be because the ISP has been able to customise the delivery of one application within its own networks so that it costs less (or causes less congestion) than an otherwise-equivalent one that has not been customised. It could also be that one class of applications can be processed via a different operational process that is less costly, as occurred in Australia and New Zealand in the mid-1990s, when the internet was first becoming popular. At the time, international bandwidth capacity on the PACNET sub-oceanic cable was constrained. Due to asymmetric data flows, Australian and New Zealand ISPs

#### *Strategic Use of Zero-rating of Mobile Data DOI: http://dx.doi.org/10.5772/intechopen.84130*

*Strategy and Behaviors in the Digital Economy*

that price if they value the product at that price or above.

strategy not only pro-competitive but also welfare-enhancing.

with maximum total welfare.

to guide decision-making.

the price paid for all other units sold. This leads to a statically efficient outcome,

However, for this to be achieved, other specific market conditions must be met. Importantly, the product sold must be perfectly homogeneous, there must be perfect information, no transaction costs, no externalities, and no barriers to firms entering or leaving the market. There must be perfectly divisible output (i.e., no scale economies). All participants are price-takers—that is, no firm can charge more than the efficient price and remain in the market, and consumers must pay

Requiring all units to be sold at the same price does not of itself make a market more competitive (i.e., render the perfectly competitive outcome) unless all of the other conditions are met. In this section, we will demonstrate that as practically none of these assumptions prevail in the complex market for internet access discussed in the previous section, simplistic calls to prevent zero-rating are insufficient

First, we show that when the assumption of homogeneous goods is relaxed, it is most unlikely that zero-rated tariffs can be used to foreclose rival applications. Instead, we demonstrate that requiring the same price to be charged for accessing products costing different amounts to produce obscures crucial underlying differences in costs on the supply side and user preferences on the demand side. This leads to our first three questions to be posed by those undertaking case-by-case assessments of zero-rating examples. Next, we relax the assumptions of perfect information and absence of transaction costs in the exchanges between ISPs and their end consumers, and their effects on barriers to entry for new CAPs and ISPs. This leads us to question the competitive positioning of the party objecting to an ISP using zero-rating prices—and our fourth question for assessors. It also leads to our final consideration—how the presence of transaction costs creates barriers to entry that lead to entrants and not incumbents favouring zero-rating policies. This leads to our fifth question, regarding the strategic options available to CAPs and ISPs that render financial transactions between them an adjunct to zero-rating that makes the

We note that in this analysis we are considering only instances of pricing of data transfer as a strategy for zero-rating. We do not consider cases of payments for data prioritisation. The examples we consider therefore have the appearance of the price discrimination to which Wu [12] and Van Schewick [15] raise objections, rather than being artefacts of paid data management, which are considered in other

**4.1 Relaxing the constraints: homogeneous products and heterogeneous users**

In net neutrality discourse, ISPs could strategically zero-rate a selected application to steer end users away from using another application and towards the favoured one. This could occur if the ISP is also the CAP for the favoured application, whereby it could foreclose another ISP offering a similar application, or to foreclose a rival stand-alone CAP. However, such foreclosure can only occur only if the end users perceive the applications as perfect substitutes: that is, the applica-

If the two applications offer materially different value propositions to end consumers (i.e., the assumption of homogeneous products in the perfect competition model is relaxed), then the zero-priced application will not be able to force the positive-priced one from the market so long as there are consumers who prefer the positive-priced one over the zero-rated one by more than the discount embedded in the zero-rating offer [11]. As demonstrated above, as end users are also

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tions are homogeneous.

inherently heterogeneous in their content preferences, it is quite unlikely that the requisite conditions for foreclosure will occur unless the applications concerned are indistinguishable.

The inability for 'free' offerings to foreclose those with a positive price is observed with broadcast television and newspaper providers. Free-to-air television and free newspapers have not foreclosed pay television and newspaper subscriptions. Indeed, some consumers willingly consume both, even when some of the content overlaps, because the additional value offered by the pay version is sufficiently high enough that it overcomes the price differential. Arguably, the presence of the two different newspaper forms has led to greater content variety, with subscriber newspapers providing a professional journalist-based news service, and free newspapers relying more upon content generated by readers (e.g., local school and sports reports) and advertisers.

This leads to our first question to be posed about zero-rating offers.
