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Some venture capitalists at the cutting edge of Internet innovation say they will shun startups requiring fast connections for video, audio, or other services, mindful that the U.S. Federal Communications Commission may let ISPs charge extra fees to major content providers.

Proposed rules being drafted by the FCC’s chairman, Tom Wheeler, would allow ISPs to charge content providers like Netflix to ensure speedy service, so long as those charges are “commercially reasonable.” The rules are scheduled to be released for public comment May 15.

In the absence of clear rules, some ISPs have already begun requesting—and receiving—access fees. Netflix recently agreed to pay big ISPs like Comcast interconnection fees to ensure a high quality of service, but Netflix CEO Reed Hastings then wrote in a blog post that the United States needs a strict form of net neutrality, with no such tolls, because users who are already paying high prices for fast service should be able to get what content they want.

The cable industry says such charges are sensible, especially when a few large content providers like Netflix can take up a large fraction of traffic. But if deep-pocketed players can pay for a faster, more reliable service, then small startups face a crushing disadvantage, says Brad Burnham, managing partner at Union Square Ventures, a VC firm based in New York City. “This is absolutely part of our calculus now,” he says.

Burnham says his firm will now “stay away from” startups working on video and media businesses. It will also avoid investing in payment systems or in mobile wallets, which require ultrafast transaction times to make sense. “This is a bad scene for innovation in those areas,” Burnham says of the FCC proposal.

This will be the third time the FCC has tried to impose regulations on discrimination in data delivery, following two losses on earlier versions in federal court (see “Net Neutrality Quashed: New Pricing, Throttling, and Business Models to Follow”). The latest proposal has been interpreted as a reversal, in that it would allow carriers to charge extra for certain services.

Wheeler said in a blog post last week that he was being misunderstood. “There has been a great deal of discussion about how our proposal to follow the court’s roadmap will result in a so-called ‘fast lane’ and Internet ‘haves’ and ‘have-nots.’ This misses the point,” he wrote.

Wheeler said the rules are designed to “to ensure that everyone has access to an Internet that is sufficiently robust to enable consumers to access the content, services and applications they demand, as well as an Internet that offers innovators and edge providers the ability to offer new products and services.”

History shows that some Web-based products and services are most likely to take root when access to Internet users is free. The founders of Foursquare, as an example, were able to set up their mobile social-networking service and reach 100,000 users with a mere $25,000 budget, Burnham says. “The thing that has been so remarkable about the Internet is that it’s been possible for a small startup to reach a global audience at no cost,” he adds. “An entrepreneur can get a product in the market, demonstrate real interest, and then go to talk to investors.”

Other VCs, particularly those who fund broadband providers, have another view. They say the explosion of video service has triggered massive costs that far exceed the growth in subscribers. Gillis Cashman, a managing partner at MC Partners in Boston, says it makes sense to charge extra to big content providers like Netflix, whose services at peak hours can sometimes consume more than 30 percent of total Internet traffic. Video is “significantly congesting these networks, and causing real issues for carriers where they have to spend a lot of money upgrading networks, and pushing fiber deeper into their networks,” he says. “There is currently no model for monetizing that required investment.”

Some less financially invested observers have little sympathy for this argument. Rob Faris, research director at the Berkman Center for Internet & Society at Harvard University, notes that broadband providers typically have had very high profit margins and often charge tiered rates based on the speeds consumers desire. “You can’t credibly argue that consumers aren’t paying enough for access to maintain higher-bandwidth services,” he says.

Not all the costs of network upgrades are high, either. While it’s true that digging trenches to install fiber-optic cables is always going to be expensive, improvements in electronics and software also boost speeds. “One reason why there isn’t more investment in new fiber-optic networks by the carriers is simply that boosting speeds on existing networks is more profitable for them,” Faris says.

If the FCC does let ISPs impose access fees, new business models and technologies for imposing those charges will emerge. Wireless carriers like Verizon are also working out “fast lane” technology, as are Web optimization companies like Akamai, which did not return a request for comment for this story (see “Akamai’s Plan for a Wireless Data Fast Lane” and “Verizon Plans a Fast Lane for Some Apps”). And AT&T offers so-called sponsored data that allows a broadcaster to subsidize its bits so can you watch shows (and ads) free on your phone, while other streams of data will count against your monthly caps.

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Tagged: Computing, Communications, Web, Verizon, Netflix, AT&T, net neutrality, Comcast, FCC, ISPs

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