Tug of War

Philip Krim, president and co-founder of online retailer The Merrick Group, is on a roll. His company doubled sales last year to about $9 million, and he expects to come close to doubling that amount this year. “We’ve been growing tremendously,” he says.

Merrick Group, with four web sites that sell bedding supplies, embodies the power of the Internet by figuring out how to capitalize on its open nature to meet specific needs of consumers and compete against more established and traditional retailers. With plenty of resources to support continued growth, the company entered a new market last year with the launch of window treatments site NationBlinds.com, and earlier this year it expanded into the tickets business with the acquisition of TonysTickets.com.

The niche e-retailer has no intention of slowing down. “We’re always looking for market opportunities,” Krim says, adding that Merrick Group has the skills and resources to operate additional sites. “We have plenty of room for growth.”

Paying for bandwidth

Plenty of room, that is, if the Internet maintains its “network neutrality” and remains the open highway of commerce that has fueled the growth of Merrick Group and countless other e-retailers over the past decade. Recent interest in a system of tiered Internet usage as expressed by major telecommunications companies—namely AT&T Inc. and Verizon Communications Inc.—threatens to eliminate network neutrality, forcing the Internet into a system more like cable TV, where retailers and other content providers compete—and pay—to operate with the best exposure to consumers, Krim and others say.

Under the telcos’ scenario, retailers or other site operators would pay for consumers to have faster and smoother access to their web sites. That, opponents contend, could lead to a drastic change in how the Internet operates by making it more difficult for consumers to get to the majority of web sites that would probably not be on a premium usage or access tier. As a result, those sites could suffer a severe slashing in their volume of online visitors. “The Internet has always been premised on the idea that consumers could reach whatever online businesses and services they want to,” says Brent Thompson, vice president of government affairs for multi-channel retailer IAC/InterActiveCorp, whose online retail properties include The Home Shopping Network’s HSN.com. “It’s easy to see how this could fundamentally change the Internet.”

Second-class citizens

For now, the issue involves the stated interest of the telecommunications companies to offer for a fee higher bandwidth to web sites that need to accommodate huge amounts of traffic or downloads of high-density items like music videos. The general understanding is that such offers would be made evenly to all sites within the same market, to prevent bandwidth providers from giving any favored sites an unfair advantage over their competition—keeping at least theoretically within the guidelines of network neutrality.

But those concerned about the loss of neutrality say there are at least two things wrong with that approach. In the near term, they say, retail competitors could wind up overpaying for bandwidth. “It’s conceivable that Kmart’s and Target’s online properties could get into a bidding war to see whose site loads fastest,” says Bill McClellan, director of government affairs for the Electronic Retailing Association, a trade group of infomercial and online retailers. And in the long term, the multi-tiered system could lead to a polarization of sites between those who can afford to pay a premium for higher bandwidth and those who cannot.

More important, once different tiers were created, there would be no telling how they would be used and what impact they’d have on the entire online retail community, experts say. If Kmart, Target and Amazon can each buy higher bandwidth because they’re in the same general merchandise market, that raises the question of what that means for the thousands of other merchandise retailers that compete with them on one level or another. “Maybe Amazon could pay higher fees for bandwidth, but what about the next Amazon or smaller retailers that could not afford to pay to insure that their content is delivered?” says Maura Corbett, partner with Qorvis Communications, a Washington-based public relations and lobbying firm representing online retailers.

Alarm bells

The prospect of a wholesale change in the Internet as a commerce channel has raised the alarm among a small but growing group of retail industry activists, who are desperate for broader backing from retailers as well as consumers. “We want to see the online marketplace continue to grow and expand with open architecture and few points of constriction, whether from broadband providers or any other restraint on the openness of the system,” says Krim, whose company has joined the Online Retailing Alliance, a group of more than 20 retailers and vendors involved in e-commerce—including eBay Inc., ShopNBC.com and IAC/InterActiveCorp—formed last fall to counteract the lobbying might of the telcos.

The group’s immediate goal is to win enough support from the U.S. Congress to put teeth into laws that would protect network neutrality, an issue that must be resolved soon before the telecommunications industry is able to establish a new status quo through legislation that could put them in more control of how the Internet works, says Corbett, whose firm represents the Online Retailing Alliance, which is a subgroup of the Electronic Retailing Association. “It’s unlikely any legislation will get through both chambers of Congress in this mid-term election year, but there’s a good chance it will next year,” Corbett says. “In the scheme of things, that’s not a lot of time.”

Indeed, retailers have already lost their first legislative battle. A subcommittee of the House Committee on Energy and Commerce last month voted down a measure that would strengthen the federal government’s hand in enforcing network neutrality.

“The train has already started to leave the station, and we’ve lost the first round,” says the ERA’s McClellan.

But the retail industry will press on with its fight, hoping to win broader industry support along the way, he says, adding: “I can’t think of any reason why every Internet retailer is not climbing over hill and dale to fight for network neutrality.”

Phantom problem?

Not surprisingly, the telecommunications industry takes a completely opposite view. Faced with a trillion-dollar-plus expense of expanding the Internet’s backbone in the U.S. with the latest fiber optic lines into homes as well as businesses, the industry is pressed to find new revenue streams, says David McClure, president and CEO of the U.S. Internet Industry Association, a trade group representing telecommunications companies and others involved in providing Internet services and equipment.

“Telecommunications companies need to build broadband Internet lines to connect to local addresses on top of what they’ve already spent and they need to find creative ways to fund that,” McClure says.

AT&T CEO Edward Whitacre suggests that telecommunications companies could a provide premium service for a higher rate, much the same as FedEx Corp. offers overnight deliveries at a higher fee than regular ground shipping.

It sounds harmless enough. Indeed, Whitacre and others in the telecommunications industry make no apologies for the suggestion, even after it caused an uproar among web site operators over the potential impact on network neutrality. “It’s not a bad idea, because e-commerce companies are now getting content distribution for free,” McClure says, echoing a statement by Whitacre. “They do nothing to help the network they depend on.”

Taking that argument a step further, McClure notes that consumers bear most of the cost of maintaining the public Internet through Internet access fees. “If we make business pay a little more, while even letting consumers pay less, we could more easily cover the cost of building more broadband,” he says.

But the idea of providing a special Internet pipe for transmitting preferred content for a higher price—while leaving lower-tier Internet content providers gasping for transmission speed—is too impractical to ever carry out, McClure says, adding that Whitacre was only speaking hypothetically.

“Nobody owns the Internet, which is a network of 1,000 networks that agree to work under a common set of protocols,” McClure says. “If I’m AT&T and want to create a system to give expedited transmissions for Amazon.com, I can possibly do that on my own network. But Amazon doesn’t just travel on my network; any transmission could travel over a hundred networks that AT&T has no control over. A packet of data traveling from Washington, D.C., to Richmond, Va., may go by way of Ukraine.”

Because the Internet is made up of hundreds of smaller networks, any Internet-wide system of setting usage fees would require cooperation among all of them, McClure says. “We don’t see any way to make that work, and we’ve been looking at it for a long time,” he says.

While the telcos need to devise new means of raising revenue, it’s unclear yet how they’ll do that, he says, adding: “Network neutrality is a phantom problem.”

Hornets’ nest

But Thompson and others working to protect network neutrality on behalf of retailers are unconvinced of the phantom argument. The fact that AT&T would raise the prospect of charging a fee for premium Internet usage, hypothetical or not, combined with the telcos’ need for new revenue streams, is reason to be wary of AT&T’s and Verizon’s long-term intentions, Thompson and others say. Throw in the fact that recent government action has reduced regulatory oversight of the telcos’ Internet role, and the phantom problem turns all too real, they say.

Moreover, the lack of clarity regarding the telcos’ plans for raising their Internet revenue is raising suspicion and turmoil among those out to guard network neutrality.

“The telecommunications companies have created a hornets’ nest, and the hornets are buzzing about,” Thompson says. “On the one hand, the telecommunication companies say they’d like to experiment with new business models and new revenue streams, but they then give no real insight into what value-added service they’d offer.”

Regardless of recent statements by Whitacre and other telco executives, there are other reasons retailers should be concerned, Thompson adds.

For one thing, the federal government has loosened oversight over telecommunications providers regarding the Internet. In its “Brand X” decision last year, the U.S. Supreme Court upheld a Federal Communications Commission finding that broadband cable companies providing cable modem Internet access were exempt from the common carrier regulation designed to support network neutrality by preventing telecommunications companies from restricting access to telephone lines. The FCC, to provide parity between cable and telecommunications companies regarding Internet access, then issued its “Wireline Broadband Internet Access Order,” which effectively deregulated broadband services offered by the telcos. “So cable modem and DSL are on an equal playing field as two deregulated monopolies,” Corbett says.

Further concerns

Those deregulatory actions have set the stage for further concerns. At a recent Congressional hearing, telecommunications executives were asked if they could guarantee that they would not block Internet services or in any way favor some users over others, Corbett says. “They did not promise,” she says.

Moreover, telcos, which stand to lose market share in their traditional telephone network markets to new Voice over Internet Protocol telephone services, have been clear about their interest in getting involved with providing content over the Internet, Corbett says, noting that Verizon is working with The Disney Co. to provide TV programming over its fiber optic lines.

With TV programming beginning to merge more with retail e-commerce—a trend expected to mushroom as the new IPTV television-over-web standard becomes common and makes it easier to let viewers click to a retail web site to purchase something featured in a TV program—the telcos could be in a position to control both TV and online retail content, experts say. “All roads lead to IPTV,” Corbett says. “The telecommunications companies want to get into the TV market.”

Reducing the Internet’s value

The importance of keeping the Internet open goes beyond the interests of any single retailer or group of companies, The Merrick Group’s Krim and others say. Indeed, if the issue were just whether some companies would have to pay more than others to use the highest levels of broadband, retailers like Amazon, eBay and IAC/InterActive might not have the same incentive to support network neutrality.

But the large retailers realize that network neutrality is more than a matter of keeping their own costs down, Thompson says. “IAC/InterActiveCorp is operating in a publicly spirited way about this,” he says. “We could throw our hands up and say, ‘We can pay extra for broadband and will pay to get a competitive advantage,’ and let that be the end of it.”

But if the telcos and cable companies control the Internet and somehow restrict the amount of content that consumers can readily access, that would bring down the overall value of the Internet for everyone, Thompson says.

David Fry, president and founder of web site design and e-commerce development firm Fry Inc., says that most retailers that do less than $100 million a year should not have to buy higher levels of bandwidth to maintain good content delivery speeds. But that could change as retailers offer more high-density items like videos, he says.

Power in numbers

For now, the extra competition between the telcos and cable companies in the way they serve the Internet suits Krim just fine. “I like the competition in broadband,” he says. “The quicker we can drive down prices and expand the availability of broadband, the sooner every retailer will benefit as more shoppers go online. We want to see the online marketplace continue to grow and expand.”

The greater the number of consumers and small, growing retailers that use broadband, the better chance Krim and other retailers will have to hold off any restrictive policies the telcos and cable companies may try to impose, Corbett says. “Keeping network neutrality is going to be a long battle and an uphill one,” she says. “But what we have that the other side does not is the power of consumers and small businesses.” l

paul@verticalwebmedia.com

Buttonholing the politicians

In Washington, lobbyists for the telecommunications industry outnumber retail industry lobbyists 10 to 1, says Brent Thompson, vice president of government affairs for IAC/InterActiveCorp.

But the voice of retailers is getting louder in the nation’s capital. More than 20 Internet retailers participating in the Online Retailing Alliance are pushing for clarification of “network neutrality” in a bill being considered by the House Committee on Energy and Commerce.

IRCE 2008 Conference Multi-Media CD-ROM

The bill, the Communications Opportunity, Promotion and Enhancement Act, sponsored by Rep. Joe Barton, a Texas Republican who chairs the House Energy and Commerce Committee, would open the door for telecommunications companies to provide Internet video services, effectively letting them compete with cable TV companies.

But retailers are concerned that the bill also includes a provision that ineffectively addresses network neutrality, the existing system of keeping the Internet free of rules by telecommunications providers on how Internet content can be transmitted, Thompson says.

The problem with Barton’s bill, he adds, is that its current provision on network neutrality removes the ability of the Federal Communications Commission to make rules regarding the openness of the Internet. “All we can say is that it’s an effort to diminish the ability of the government to enforce network neutrality,” he says.

Retail industry lobbyists will continue to press for inclusion of an effective network neutrality provision, even after a subcommittee of Barton’s committee voted down an amendment to his bill that would strengthen the FCC’s hand in enforcing network neutrality, says Bill McClellan, vice president of government affairs for the Electronic Retailing Association.

Retailers support another bill recently submitted in the U.S. Senate by Ron Wyden (D., Oregon), titled the Internet Non-Discrimination Act. Wyden’s bill, currently in committee, would give the FCC authority to bar telcos and cable providers from implementing unfair practices that could favor one company over another in use of the Internet.

“The growth of the Internet and its success are due in large part to the freedom that has always existed on the content and applications layer of the Internet,” Wyden’s bill says. “Innovation has thrived on this layer, as anyone with a good idea has the ability to access consumers. The continuation of this freedom is essential for future innovation.”

Members of the Online Retailing Alliance

(A lobbying group of the Electronic Retailing Association)

Adaptive Marketing LLC

Aegon Direct Marketing Services

American Telecast Corp.

Bloglines

Dave Petitto Direct

Downstream

Dresses.com

eBay Inc.

eBrands Commerce Group

Electronic Retailing Association

Hawthorne Direct

Iceland Health Inc.

iNest

InPulse Response

IAC/InterActiveCorp

• Ask.com

• CitySearch

• Cornerstone Brands (9 retail web sites)

• Entertainment Publications

• Evite

• Gifts.com

• Home Shopping Network/HSN.com

• LendingTree

• ServiceMagic and others

iWon

Jewelry Television

Livemercial

Match.com

Media Partners Worldwide

Mercury Media

Savvier

Shop At Home

ShopNBC

The Merrick Group

• AngelBeds.com

• Dreamsleep.com

• NationBlinds.com

• TonysTickets.com

• TranquilityMattress.com