There's been a lot of back and forth over whether letting broadband providers lock up content, or content providers lock out ISPs, is a good thing or a bad thing. And now, ESPN360.Com is going to kick off the fragmentation games and let us all find out.

It is a fine old Republican free market anti-deregulatory tradition to deregulate critical infrastructure and hope for the best, pooh-poohing doomsday predictions as ignorant exaggerations and fear mongering by business-hating regulation-loving quasi-commies. And since this philosophy worked so well with our financial sector, we have now moved it to the next major engine of the economy — broadband.

I am so excited! For those who have developed a taste for Lehman Bros-type thrill rides, the ESPN360.com deal will bring back fine memories of your first subprime derivative. You (and the rest of us along for the ride) can look forward to the thrill, the excitement, the dramatic highs and lows of playing high stakes roulette with our digital future. True we've lost our mortgage money (literally and metaphorically) playing “follow the Subprime queen.” But don't worry. As any economist will tell you, the combination of a lack of information, high transaction costs, complex interrelated markets, and poorly understood network effects is just tailor made for that wild west anything goes atmosphere that made all them miners rich in the Sacramento gold fields!

Bet our critical infrastructure? How can we afford NOT TOO!!!

Details below . . .

I've written in the past about my general concern over allowing ISPs to charge third parties for “premium” treatment or for exclusivities, as well as why I think it is a bad idea for Democracy and why it stinks for deployment to minority communities and rural communities. The ESPN360.com helps puts some flesh on those theoretical bones and also helps show that it does not rely on the current competitive state of the market so much as the hideously complex state of telecommunications markets.

First, the details of the deal. ESPN360.com will let you watch all manner of exclusive international content via streaming video if you subscribe to one of their “partner” ISPs (such as AT&T DSL or Verizon FIOS), or are accessing through the U.S. military or through a college or university system (support the troops and build your customer base). If you belong to a disfavored ISP (such as Comcast or Cox), then you are screwed. You cannot independently buy access to the content or subscribe to it.

As a start, I can't help but be mildly bewildered why the article's author, Chris Soghoian, is at once so incensed by this deal and so disdainful of the idea of network neutrality. The ESPN360.com is a logical outcome of the ability of parties to cut exclusive deals. It makes little difference from an economic standpoint whether it is a high-value content provider cutting an exclusive with an ISP, or an ISP with market power cutting a deal with a content provider, the effect is the same. Which is why I believe the ESPN360.com deal may be the beginning of a new fragmentation of the internet which has serious negative long term consequences for all of us — including the ISPs.

Control of content and streaming is nothing new, of course. Indeed, as discussed in this AdWeek piece, sports content producers in particular are trying to figure out how to make this pay. But the ESPN360.com represents a new level of exclusivity. Unless you subscribe to an ISP acceptable to ESPN360, you can't get the content no matter how much you wish to pay.

Traditionally, those who wished to control content found that exclusivity with any particular provider would cut them off from too large a segment of the market. Even when AOL had 22 million subscribers and was clearly the dominant ISP, it found that it did itself more harm than good by excluding visitors from its content. Since then, every business plan of every internet start up relies on the basic principle that it can reach any willing customer.

ESPN360.com tries to change that. It is trying, in essence, to recreate the cable/DBS competition model online. This worked very well for ESPN and its parent, Disney which — as part of the insane complexity of this market — also negotiate with both Comcast and Verizon and AT&T on the video side of things. While I have no idea what unit of ESPN or Disney negotiated this, big content providers like Disney have increasingly had total integration of its content and content delivery when it negotiates for platform access. In plain English, when Disney negotiates “retransmission rights” with cable companies, telcos, or satellite providers, Disney negotiates for access to the local ABC-owned television signal (if it has one in the local market) and all its cable programs. Disney leverages the “must have” parts of its package, e.g., local broadcast, ESPN, to require bundling and placement of less popular channels on basic tier.

Again, big whoop. Disney is a big boy and can take care of itself just fine. It wants to cut a deal with some ISPs for a subset of content to see if that will attract subscribers. Given that Verizon and AT&T are the new entrants in video and seriously lagging behind the cable boys in broadband, I bet ESPN got good terms. Why not let them all experiment with who gets to monetize what rather than require ESPN360 to make its content available to any willing buyer?

Ans: Because if this works out, Comcast and the other cable ISPs will retaliate by getting exclusive content of their own, then access to exclusive functionalities. For the big boys and at the early stages of the market, it'll look great. We will have a total free-for-all where everyone is cutting their best deals and trying to find a partner to maximize their revenue. It'll be just like the cell phone market was before that market matured into fixed carriers with fixed dancing partners or, if you prefer, it'll be just like the good old days when we figured that everyone who wanted to lend money should be able to do so, and if someone else wanted to buy that paper or buy a security based on that paper, who were we to stop them.

But the interconnected nature of all this makes me worry a great deal about how this works out down the road after the free-for-all is over. Players with massive resources across different markets, like Disney or Google, will probably make out quite well. But if the cable market gives us any warning, the difficulty in getting subscribers to switch from one system to another, combined with the need to own eyeballs to attract the best content and demand the best terms, will gradually concentrate the market into a handful of players among ISPs and content and application providers. Any new content provider will need to find a partner ISP, and be prepared to sell itself to that ISP as the price of getting to a customer. Any small ISP will find itself unable to negotiate deals and, based on the filings of small cable companies and small programmers in the FCC's “wholesale unbundling docket,” that means getting squeezed or trampled by the largest providers and largest carriers. Similarly, based on the Petition to ban exclusive handset deals filed at the FCC by the Rural Carrier Association, it would appear that smaller rural systems with “less desirable” customers will find themselves locked out of the market.

But even these are poor guides to the total extent to which this rewriting of business models may bite us all in the rear end down the road. The sheer complexity and cost of deal making at every level for the “new economy” will act to stifle innovation and job generation. The cost of developing content or applications and getting them online to customers will increase exponentially, but without any rise in economic activity. The size to which a company can hope to grow online will shrink dramatically, limited by the scope of its exclusivity arrangements with other providers. This increasing fragmentation will impact not only commercial speech, but non-commercial speech. Your campaign website may not want to negotiate an exclusive, but what about trying to leverage your content across other platforms. You Youtube videos will only reach some people, your Yahoo! videos another subset.

Or maybe you will be able to negotiate yourself a special exception for a campaign website. But when someone creates the next “maccaca” video, or even the next “series of tubes” video, it will be accessible only to those people who can access the particular platform hosting it.

I know, I know, crazy paranoid fantasies. Starting at shadows. Trust the market. Government shouldn't pick winners, shouldn't mandate business models, etc.. etc. OTOH, having written my first blog post on the coming economic meltdown in January 2006, I'm used to being told I'm a crazy paranoid Socialist who hates the free market and doesn't understand how economics works.

So why not roll the dice with another piece of critical infrastructure with a complicated, interrelated market structure? After all, what could possibly go wrong?

Stay tuned . . . .