Zero Rating, Content Quality and Network Capacity

We consider a departure from net neutrality by an Internet service provider (ISP) that financially discriminates among content providers through bilateral zero rating contracts. Zero rating is an instrument to distort competition between content providers and the way in which consumers value content. We analyze its implications for the incentives to provide quality in the market for content and to invest in broadband infrastructure. Zero rating makes content more expensive for consumers to access and implies a downward distortion of quality by increasing downward vertical differentiation. Content providers move from a minimal differentiation equilibrium to a downward vertical differentiation outcome. Next, we find that while zero rating happens to reduce congestion, a profit-maximizing ISP always underinvests in the broadband infrastructure in the discriminatory network. We highlight that this under provision comes from a standard rent-extraction argument and a new cost-alleviation channel, which relates to the complementarity between network capacity and content quality. Finally, the ISP always implements zero rating, which is welfare reducing and detrimental to consumers.