Eli Dourado

Where are the broadband mutuals?

I’ve argued (here and here, for instance) against worrying too much about the monopolization of Internet access. Broadband is pretty clearly an industry in which there are increasing returns to scale, and when returns to scale are severe enough, that results in natural monopoly. There are not clear welfare gains from regulatory solutions to natural monopoly problems generally, and broadband in particular is a case where many of the problems associated with monopolization are ameliorated by price discrimination.

Nevertheless, I accept that most people are not persuaded by this logic. Let me try a different tack, explaining what I would expect to see if profit-centered monopolists were really as bad for consumers as their critics claim.

The answer can be summed up in one word: mutuals. Mutual companies are not especially common in today’s economy, but they are worth pondering at some length. Mutuals are firms in which customers, in virtue of their ongoing patronage of the firm, are also its owners. A mutual company generally has no other shareholders to please, and it does not typically distribute dividends. Instead, if it makes a profit it will distribute it to its customers in the form of lower prices in the future.

Managers at mutual companies have pretty cushy lives. They can’t earn multi-million dollar bonuses, and their salaries are capped by the firm’s charter or by state regulation. But the modest restrictions on compensation are made up for with quality of life. They don’t work too hard, maybe they spend a lot of the firm’s money on nice offices with plush carpet, and they don’t worry about squeezing every last penny out of the business.

The managers have weak incentives to maximize profit because of the firm’s distributed ownership. While in theory, customers could band together and oust the management team at the annual meeting, in practice it is hard to get 51 percent of the customers to sign and mail in their proxy forms. So instead of maximizing profit, the management team works hard to make sure the product works and nothing terrible goes wrong. As long as everything runs relatively smoothly, their jobs are secure and they can be out on the golf course at 3pm.

In some cases, weaker incentives to run the business efficiently are a feature, not a bug. As Eric Rasmusen pointed out in his excellent JLE article on mutual banks, the mutual form was popular in the financial sector before the New Deal, when federal deposit insurance largely displaced it. The reason is simple: a strong profit motive can lead to excess risk-taking, and depositors preferred that their banks be conservative. Managers at a mutual bank have an incentive to limit risk-taking because their profits are capped anyway. Why risk the assets of depositors when you have no upside? N.b., Washington Mutual, which collapsed in 2008, had actually demutualized in 1983, although it was allowed to keep its name.

Mutuals still exist today, but they are much less common. Vanguard is a familiar mutual company, though this fact is not to be confused with the product they sell, mutual funds. One reason the load on Vanguard funds is so low is that the managers have a very weak incentive to squeeze customers; instead, the firm focuses on basic, reliable service. Mutual companies are also common forms for utility companies in rural areas. Since utilities have increasing returns to scale and rural areas have low scale, the natural monopoly problem is particularly severe in this sector. Mutuals solve this problem by weakening the incentive to opportunistically charge a high price to rural consumers who have only one choice in service provider.

Incidentally, whenever someone challenges my extreme libertarianism by asking if I would privatize water service, I say yes: I would replace the regulated water monopoly with a mutual water company. Mutuals have some similarities to government-run firms, but also some important differences. They are similar in that the profit motive is weak, and that consumers frequently have to rely on voice more than exit to express their displeasure. However, if a mutual provides a truly horrific service, at some point a competing firm (perhaps a competing mutual) becomes a possibility. In that regard, mutuals are superior to government provision. Furthermore, mutuals don’t require me to bundle my purchases with a host of other products, whereas if I want to dump government provision of some good, I basically have to overthrow the state. Why should education spending be bundled with my water service?

My question, then, is predictable. If the state of broadband is so terrible, if broadband monopolists are engaging in harmful net neutrality violations, if infrastructure providers are using their market power to foreclose in the content market, where are the broadband mutuals? Why aren’t neighborhood associations setting up mutual companies to run high-speed local networks and buying transit from a competitive market of upstream providers? A little Googling shows that there are some broadband mutuals, but they operate mostly in rural areas, and they benefit from federal subsidies. Why don’t we see more of this corporate form?

Some possibilities:

  1. Economies of scale make it impossible to enter the market at all. I don’t believe this one. At a minimum, we would expect real estate developers to build new neighborhoods pre-wired for mutual Internet access if they believed that such an amenity would increase the value of the property.
  2. Regulatory barriers make it impossible in practice to enter the market. Maybe. To the extent such barriers exist, I favor removing them. But most of the critics of the broadband monopolies are not calling for deregulation; they are calling for additional regulation.
  3. The broadband monopolies are running their businesses in basically a socially efficient manner, and there is not much room for broadband mutuals to come in and provide a better product. Most observed net neutrality violations are welfare-enhancing, and most of the weird pricing schemes are forms of price discrimination used to underwrite the large fixed costs of running an ISP.

I still think the answer is #3. But if you don’t, you should be pushing to start a mutual broadband company in your neighborhood or city, not advocating for greater regulation or state-run broadband.