**Abstract**

The digital economy, characterised by goods exhibiting high instantiation and low reproduction costs frequently created and distributed over multisided platforms, poses challenges for the pricing of products and services. As convergence occurs between applications and transport, flexible ways of pricing internet access and content are being developed. One frequently used pricing strategy is 'zerorating'—where traffic for specific applications is not counted against the 'cap' in an internet user's monthly access plan. This pricing strategy has drawn much criticism from net neutrality advocates, but it is far from clear that the policy is harmful. Using an economic analysis based upon relaxing assumptions in the simple model of perfect competition, so that it more closely reflects the complex internet ecosystem, we assess the extent to which it is plausible for zero-rating to be used to harm competition, consumer welfare and incentives for application innovation. We develop five questions to assist inquiry into the potential harm or benefits arising, which can be applied by competition authorities, regulators and the firms concerned to assist in sorting the cases less likely to be harmful from those that warrant further investigation.

**Keywords:** zero-rating, economic analysis, regulation, competition, strategic interaction

### **1. Introduction**

The digital economy, characterised by goods exhibiting high instantiation and low reproduction costs frequently created and distributed over multisided platforms, poses challenges for the pricing of products and services. Unlike for most physical goods, it no longer follows that the optimal price for any individual item will be a simple function of its cost of production, or even that the individual consuming the product or service should be the one that pays for it [1].

Information goods providers are increasingly adopting strategies subsidising the consumption of information goods by bundling them with other goods, or by utilising multisided platforms whereby revenues in excess of costs raised in transactions with customers of one product type (or side of the platform) are used to subsidise below-cost purchases by consumers of another product type (or side of the platform). For example, consumers receive 'free' (or discounted) newspapers, television and radio channels when advertising revenues offset the costs of providing the printing and broadcasting infrastructure required for the content to reach consumers. 'Virtuous cycles' arise as advertising revenues subsidise the costs of

readers or viewers accessing content, thereby increasing consumer welfare, at the same time as having more readers and viewers increases the value to advertisers and hence the price that platform operators can charge them [2]. So long as there is careful balancing of demand elasticities on both sides of the platform, having prices varying from marginal cost on both sides can be both profit- and welfare enhancing [3, 4, 24].

Such practices have, however, proved particularly challenging for regulators and competition authorities entrusted with the pursuit and protection of competitive markets for the long-term benefits of consumers. Successfully engaging in abovecost pricing in at least one market requires the firm to have some degree of market power, while using the surpluses to subsidise another potentially alters the competitive dynamics in that market as well [5]. Inevitably, the interests of consumers of one product must be traded off against those of another. Furthermore, in the context of increasing disintermediation of once-integrated firms and their replacement by complex contractually co-ordinated supply chains for the relevant products and services, it is no longer obvious that one specific firm or even one market is the appropriate focus for attention. While a mandate clearly exists for competition authorities and regulators to be interested, it is far less clear that their historic precedents and inquiry methods based on historic structure-conduct-performance (SCP) models of industrial organisation established to deal with single firm or markets and non-information goods are suitable for governing commercial interactions in the new context.

The complexities are highlighted by 'zero-rating'. This occurs when internet service providers (ISPs) do not count the data traffic used to service specific applications (supplied typically by third-party content and application providers— CAPs—who may also be using advertising revenues to subsidise production costs) against the data traffic 'cap' allowed in an internet user's access (subscription) plan. Data transmissions for these applications are effectively 'free to the user', whereas data transmissions serving other applications incur an effective positive price. Regulators and telecommunication authorities in many jurisdictions have been required to adjudicate allegations of the use of zero-rating to harm competition in both the ISP and CAP markets, and thereby to cause harm to consumers collectively, and disproportionately to different consumer groups. Telecommunications regulators have been lobbied to impose rules prohibiting its use entirely, or at least permitting it only in very restricted circumstances.

To date, regulators and competition authorities have generally responded cautiously, by eschewing outright prohibition of zero-rating in favour of case-by-case analysis, as was explicitly required in the United States Federal Communications Commission's (FCC) subsequently repealed 2015 Open Internet Rule [6]. Following repeal, case-by-case jurisdiction has persisted under generic competition law overseen by the Federal Trade Commission, as occurred prior to 2015, and has always prevailed in countries such as Australia and New Zealand, where no specific net neutrality regulations have been introduced. In contrast, the European Union's approach, encapsulated in its 2016 Net Neutrality Regulation, is more prescriptive.

Nonetheless, even with case-by-case evaluation, regulators and competition authorities face many difficulties in assessing economic harms and benefits. Not least is defining the relevant market(s). Benefits and harms may accrue in multiple markets, many of which may be far-removed from both that in which the firm engaging in the pricing practice is deemed to be operating (e.g., in CAP markets not ISP markets) and the territory over which the relevant authority has jurisdiction (e.g., a CAP operating from a different country to the ISP). Further decisionmaking complications exist due to extensive use of bundling of internet and content access with other products and services (e.g., with fixed and mobile voice applications, and pay television, in classic 'triple' and 'quadruple' play subscriptions), and

**111**

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

tions market to which the commission aspires [9].

the fact that little may yet be known about consumer valuations and preferences in markets for products that are comparatively new [7]. While the Body of European Regulators for Electronic Communications (BEREC) has endeavoured to address this complexity by issuing a set of guidelines for member state regulators to assist in implementing the European Net Neutrality Regulation [8], they have proven problematic. Their focus on legal compliance with the directive rather than detailed assessment of the economic harms and benefits in different circumstances has resulted in considerable variation between member state regulators' interpretation and application of the rule, creating both controversy and uncertainty about the acceptability of zero-rating pricing strategies across the notional single communica-

Given the levels of economic complexity invoked by zero-rating, and the lack of theoretical and empirical evidence to date to inform both firms seeking to adopt the practice and regulators and competition authorities seeking to maintain fair and competitive markets (on balance, most that has been produced finds the practice NOT harmful), the development of some general economic principles for evaluating its effects is indicated. This chapter represents a first step in this direction. The contribution is five questions, which can be used as a preliminary filter to assess the likelihood of a specific instance of zero-rating being harmful to total welfare, thereby necessitating either caution on the part of a firm potentially implementing it, or justification on the part of competition authorities and regulators contemplat-

We begin by outlining the general arguments for and against the use of zerorating. Next, we summarise key economic characteristics of the internet ecosystem in which zero-rating offers are being made. Then, beginning with the models of perfect competition upon which theories of competitive harm were developed in classical SCP thinking, we demonstrate how successively relaxing the model assumptions when it is applied to the commercial interaction between ISPs and end users leads to the identification of circumstances where zero-rating may be more or less harmful to total welfare. The theoretical economic methodology used for this inquiry draws upon and extends the similar approach used by Greenstein et al. [21] and Gans and Katz [10, 11] in their inquiries into specific examples of zero-rating.

ing expending their scarce resources on a more intensive investigation.

The result is the five questions, which are summarised in our conclusion.

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

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.

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

winning new customers and amortising general network costs.

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

*Strategy and Behaviors in the Digital Economy*

permitting it only in very restricted circumstances.

enhancing [3, 4, 24].

readers or viewers accessing content, thereby increasing consumer welfare, at the same time as having more readers and viewers increases the value to advertisers and hence the price that platform operators can charge them [2]. So long as there is careful balancing of demand elasticities on both sides of the platform, having prices varying from marginal cost on both sides can be both profit- and welfare

Such practices have, however, proved particularly challenging for regulators and competition authorities entrusted with the pursuit and protection of competitive markets for the long-term benefits of consumers. Successfully engaging in abovecost pricing in at least one market requires the firm to have some degree of market power, while using the surpluses to subsidise another potentially alters the competitive dynamics in that market as well [5]. Inevitably, the interests of consumers of one product must be traded off against those of another. Furthermore, in the context of increasing disintermediation of once-integrated firms and their replacement by complex contractually co-ordinated supply chains for the relevant products and services, it is no longer obvious that one specific firm or even one market is the appropriate focus for attention. While a mandate clearly exists for competition authorities and regulators to be interested, it is far less clear that their historic precedents and inquiry methods based on historic structure-conduct-performance (SCP) models of industrial organisation established to deal with single firm or markets and non-information goods are suitable for governing commercial interactions in the new context. The complexities are highlighted by 'zero-rating'. This occurs when internet service providers (ISPs) do not count the data traffic used to service specific applications (supplied typically by third-party content and application providers— CAPs—who may also be using advertising revenues to subsidise production costs) against the data traffic 'cap' allowed in an internet user's access (subscription) plan. Data transmissions for these applications are effectively 'free to the user', whereas data transmissions serving other applications incur an effective positive price. Regulators and telecommunication authorities in many jurisdictions have been required to adjudicate allegations of the use of zero-rating to harm competition in both the ISP and CAP markets, and thereby to cause harm to consumers collectively, and disproportionately to different consumer groups. Telecommunications regulators have been lobbied to impose rules prohibiting its use entirely, or at least

To date, regulators and competition authorities have generally responded cautiously, by eschewing outright prohibition of zero-rating in favour of case-by-case analysis, as was explicitly required in the United States Federal Communications Commission's (FCC) subsequently repealed 2015 Open Internet Rule [6]. Following repeal, case-by-case jurisdiction has persisted under generic competition law overseen by the Federal Trade Commission, as occurred prior to 2015, and has always prevailed in countries such as Australia and New Zealand, where no specific net neutrality regulations have been introduced. In contrast, the European Union's approach, encapsulated in its 2016 Net Neutrality Regulation, is more prescriptive. Nonetheless, even with case-by-case evaluation, regulators and competition authorities face many difficulties in assessing economic harms and benefits. Not least is defining the relevant market(s). Benefits and harms may accrue in multiple markets, many of which may be far-removed from both that in which the firm engaging in the pricing practice is deemed to be operating (e.g., in CAP markets not ISP markets) and the territory over which the relevant authority has jurisdiction (e.g., a CAP operating from a different country to the ISP). Further decisionmaking complications exist due to extensive use of bundling of internet and content access with other products and services (e.g., with fixed and mobile voice applications, and pay television, in classic 'triple' and 'quadruple' play subscriptions), and

**110**

the fact that little may yet be known about consumer valuations and preferences in markets for products that are comparatively new [7]. While the Body of European Regulators for Electronic Communications (BEREC) has endeavoured to address this complexity by issuing a set of guidelines for member state regulators to assist in implementing the European Net Neutrality Regulation [8], they have proven problematic. Their focus on legal compliance with the directive rather than detailed assessment of the economic harms and benefits in different circumstances has resulted in considerable variation between member state regulators' interpretation and application of the rule, creating both controversy and uncertainty about the acceptability of zero-rating pricing strategies across the notional single communications market to which the commission aspires [9].

Given the levels of economic complexity invoked by zero-rating, and the lack of theoretical and empirical evidence to date to inform both firms seeking to adopt the practice and regulators and competition authorities seeking to maintain fair and competitive markets (on balance, most that has been produced finds the practice NOT harmful), the development of some general economic principles for evaluating its effects is indicated. This chapter represents a first step in this direction. The contribution is five questions, which can be used as a preliminary filter to assess the likelihood of a specific instance of zero-rating being harmful to total welfare, thereby necessitating either caution on the part of a firm potentially implementing it, or justification on the part of competition authorities and regulators contemplating expending their scarce resources on a more intensive investigation.

We begin by outlining the general arguments for and against the use of zerorating. Next, we summarise key economic characteristics of the internet ecosystem in which zero-rating offers are being made. Then, beginning with the models of perfect competition upon which theories of competitive harm were developed in classical SCP thinking, we demonstrate how successively relaxing the model assumptions when it is applied to the commercial interaction between ISPs and end users leads to the identification of circumstances where zero-rating may be more or less harmful to total welfare. The theoretical economic methodology used for this inquiry draws upon and extends the similar approach used by Greenstein et al. [21] and Gans and Katz [10, 11] in their inquiries into specific examples of zero-rating. The result is the five questions, which are summarised in our conclusion.
