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The recent Google/Verizon framework stoked fears of internet service providers (ISPs) suppressing disruptive and innovative consumer services and tiering traffic. Like water and energy distribution, ISPs face the same high last mile costs which engender natural monopolies. Broadly speaking, monopolies concentrate market power, centralize customer bases, reduce innovation and increase prices.  

However, the ISP market is competitive enough today to ensure that “additional online services” carved out by the Google-Verizon framework will not subjugate new or existing internet services and may enable startups to drive their services into the homes of millions. After all, 84% of US households are served by at 2 or more ISPs, typically one DSL and one cable provider and market share is generally split 60/40 in those environments according to the FCC. 

As a result, the ISP market exhibits some characteristics of competition: rapidly improving service levels, price stability and significant network investment. Advertised download speeds have grown at a 20% annual rate for the past ten years. Faster networks reach an more of the population. In two years’ time, 45% of the population will have access to the Docsis 3.0 and either Fiber-to-the-Home or Fiber-to-the-Node, some of the fastest technologies available.   

To drive increases in speed and penetration, ISPs have invested a steady $18-20B annually in wireline network capex. Recent studies have demonstrated that this spend is concentrated in areas where ISPs compete for customers. Although there isn’t sufficient data to compare the service level and price combination, the significant capex investment in key markets serves as some measure of the level of competition.  Despite these performance increases, internet access fees for both standalone and bundled service internet access fees have been stable since 2006 according to recent surveys. 

In addition to wireline competitors, ISPs increasingly face competition from their nascent wireless brethren invigorated both by private and government efforts. Today, 77% of Americans are served by 3 or more 3G networks. Additionally, faster fixed wireless networks like Clearwire will be serve up to 120M users by the beginning of 2011. The US Government is also fostering competition by promising to auction 500MHz more spectrum, doubling current available capacity. Lastly, two new satellite ISPs, Hughes and WildBlue, will launch in 2012 offering additional service options for those in rural areas. Though wireless speeds are slower, upcoming deployments of 4G technologies should offer a viable, albeit more expensive, alternative to wired broadband. 

On another front, ISPs are fending off threats from over-the-top (OTP) video providers including Netflix, XBox Live and Hulu. A conundrum for ISPs, the millions of OTP users upgrade to more profitable, faster data plans but threaten cannibalization of the ISP’s cable TV service. Reluctant to cede market share, most ISPs accept these customers.  

Much as restricting traffic to OTP services causes attrition in the customer base, so would impeding unfettered access to innovative web applications. Consumers have enough alternatives to make an informed decision about network access. This is precisely why the transparency provision in the Google/Verizon agreement is critical. 

As a result of the competition in the market, ISPs are differentiating themselves with access to exclusive television content evident in the cases of Comcast/NBC merger, DirectTV’s Sunday Ticket  and the massive investment in video-on-demand libraries. Over time, content will become the primary differentiator between ISPs, hence  the carve-out for “additional online services” in the Google/Verizon framework.

This “additional online services” carve-out presents opportunities for startups to provide innovative services and content. Unlike selling to the mobile carrier market, where there are 4 key players in the US, no single ISP has greater than 16% share of subscribers. 

In this  ecosystem, ISPs do not possess the market power to demand, enforce or impose degradation of the public internet in favor of newer, proprietary services. Additionally, these ISPs must differentiate on content and services – an encouraging conclusion for new and disruptive startups. 

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