UCSC-SOE-09-08: A Two-Sided Market Analysis of Provider Investment Incentives With an Application to the Net-Neutrality Issue

John Musacchio, Galina Schwartz, Jean Walrand
03/02/2009 09:00 AM
We address whether providers of last-mile access (local ISPs) to end users should be allowed to charge content providers, who derive advertising revenue, for the right to access end users. This question is part of the larger debate on network neutrality. We compare two-sided pricing where these charges are allowed to one-sided pricing where such charges are prohibited by possible network neutrality regulations. We find the equilibrium levels of investment of content and access providers in both regimes, which allows us to compare the welfare of the regimes as a function of a few key parameters. Our results indicate that two-sided pricing (corresponding to a "non-neutral" network) is more favorable in terms of social welfare when the ratio between parameters characterizing advertising rates and end user price sensitivity is either low or high. When the ratio is in the intermediate range, one-sided pricing (a "neutral'' network) can be preferable. The degree by which one-sided pricing is preferable increases with the number of ISPs.

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