Free vs. Google: Bad Economics

French fixed and mobile network operator Free (owned by parent company Iliad) recently began blocking online advertising sent to its fixed network subscribers. Although the move was quickly reversed after complaints by local advertisers on net neutrality grounds, the initiative raises interesting questions. Google ads in particular have been targeted and there has also been talk of YouTube traffic degrading. At the same time, there have been reports that Free, like many operators in the past (France Telecom, Telecom Italia, Vodafone), is trying to claim some share of Google’s and other over the top service providers’ revenue (see: Internet Monies) to compensate the network provider for carrying traffic.

Why target advertising? What about subscription services? Netflix is probably the most visible of many subscription video services that can cause network operators headaches by congesting networks and increasing CAPEX. There is an ongoing discussion about how to deal with carriage issues (e.g. Comcast vs. L3, 2010), but the obvious solution is for network operators to charge for traffic or bandwidth incrementally – thus consumers pay for what they get. This puts operators in a tricky spot because, in competitive markets, they seem always to decide they are better off selling effectively unlimited access and attracting more customers. This is the basis of the market economy; competition and demand set margins.

That challenge for operators leads us back to online advertising (distinguished in this case from video ads embedded in content). Low bandwidth web services generate revenue through ads without loading networks. A subscription funded low bandwidth service would probably be targeted similarly if any had sufficient scale. In this low bandwidth case, there is no direct link with operator costs so no incremental, transparent, competition exists. Unless service providers like Google are willing to deny their services to users, operators don’t have a competitive downside to blocking ads or degrading service. The assumption must be that Google would accept lower margins rather than fewer potential users.

However weak the economic sense for an operator to claim a share of the revenue, is it a prize too rich to ignore? Google certainly does have the largest market share in online advertising. IAB estimates that Google has 55% of the US market. Borrowing that market share and applying it to a population weighted revenue base of the European market, online advertising in France is likely worth a bit less than €2B annually (2011). To what share does Free believe it’s entitled? For comparison, fixed and mobile network operators in France took in roughly €37B in 2011. Of course, any extra revenue would go straight to the bottom line (because operators did nothing to earn it). In this comparison, Google is a minnow beside the €1T global telecom whale and can’t make more than a footnote in operators’ financial results.

Net neutrality is most often raised by proponents of a democratic internet where companies like Google cannot buy themselves preferred connectivity and stifle innovative, but less well funded, competitors. In this case net neutrality has a more mundane purpose – to keep complacent operators competing with each other rather than charging economic rents to third party service providers. Operators should be focused on how to increase their own service revenues and margins. Unfortunately, there are not many signs of such focus, not in France and maybe not elsewhere in Europe either, but it would be a big step backwards for innovation if an operator stands firm (with the regulator on its side) and fixes its revenue problems by forcing Google (or Facebook, Amazon or anybody else) to pay up or cut services.

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