Investment in Two-Sided Markets and the Net Neutrality Debate

Abstract

This paper develops a game-theoretic model based on a two-sided market framework to compare Internet service providers’ (ISPs) investment incentives, content providers’ (CPs) participation, and social welfare between neutral and non-neutral network regimes. We find that ISPs’ investments are driven by the trade-off between softening consumer price competition and increasing revenues from CPs. Specifically, investments are higher in the non-neutral regime because it is easier to extract revenue through appropriate CP pricing. On the other hand, participation of CPs may be reduced in a non-neutral network due to higher prices. The net impact of non-neutrality on social welfare is determined by which of these two effects is dominant. Overall, we find that the non-neutral network is always welfare superior in a “walled-gardens” model, while the neutral network is superior in a “priority lanes” model when CP-quality heterogeneity is large. These results provide useful insights that inform the net-neutrality debate.