Haas Newsroom

Two UC Berkeley Haas School of Business Professors Negative on Network Neutrality

Sept. 19, 2006

Media Contacts:
Ute S. Frey
UC Berkeley Haas School of Business

Ronna Kelly
UC Berkeley Haas School of Business

With Congress returning from recess, lawmakers are expected to revisit several initiatives collectively known under the banner of “network neutrality.” One of the central issues in the net neutrality debate is whether providers of “last mile” Internet access services – typically phone or cable companies – should be allowed to offer more than one grade of service, similar to how cable companies offer different programming packages or software companies sell standard and professional versions of their product.

Some proponents of network neutrality have suggested legislation is necessary to prevent creating a two-tier Internet for the haves and have-nots. But new research by Professors Michael Katz and Benjamin Hermalin at the University of California, Berkeley’s Haas School of Business shows that legislating a single tier of service – as some network neutrality proponents are seeking – could prove harmful, leaving low-end customers completely un-served and high-end customers to consume a lower quality product. That’s because a firm is likely to choose to sell a product that is too expensive for a low-end customer and of lower quality than some high-end customers would otherwise have purchased if they had a choice of several products

“There are benefits of variety and these network neutrality regulations would just get rid of them,” says Katz, who holds the Sarin Chair in Strategy and Leadership at the Haas School. “The notion that everyone gets the best possible product is just wrong.”

Katz and Hermalin, the Willis H. Booth Professor of Banking and Finance, reached that conclusion in a recently released working paper titled “The Economics of Product-Line Restrictions with an Application to the Net Neutrality Debate.”

In their paper, the professors formally modeled the effects of restricting product lines such as those sought by some proponents of network neutrality regulation. Their model uncovered several consequences of restricting a firm to offering only a single product:

* Consumers who would otherwise have consumed a low-quality variant are priced out of the market. Consumers at the bottom of the market – the ones that a single-product restriction is typically intended to aid – are almost always harmed by the restriction.

* Consumers in the “middle” market consume a higher quality product than they would have consumed if a firm offered multiple products.

* Consumers at the top of the market consume a lower quality product than they would have consumed if a firm offered multiple products.

In a duopoly model – such as a local telephone company and a cable company in the network neutrality debate – a new dynamic comes into play, Katz and Hermalin found. Their model showed that restricting the number of products that two firms can offer may lead the firms to choose non-overlapping products where they would have otherwise engaged in head-to-head competition across all product variants. “The resulting loss of competition can harm consumers,” Hermalin and Katz concluded.

“There are all sorts of unintended effects of these proposed network neutrality policies,” Katz concludes. “We’re hoping we can advise the rigor of the debate.”

For a copy of the working paper “The Economics of Product-Line Restrictions with an Application to the Net Neutrality Debate,” please contact the Haas School of Business.