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 exclusive zero-rating contracts. Zero-rating is an instrument to distort competition between content providers and the manner 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 use and imply a downward distortion of content quality. Content providers switch from minimal differentiation to a downward vertical differentiation outcome. Next, we find that zero-rating implies underprovision in the broadband infrastructure, which comes from a standard rent-extraction argument and a cost-alleviation channel related to the complementarity between network capacity and content quality. Finally, when implemented, zero-rating is found to be welfare reducing and detrimental to consumers.