But Netflix can’t succeed without a lot of help from its partners in the digital supply chain. The company is only as good as the programming it offers. And content owners are apparently inclined to drive a harder bargain these days: Netflix paid a whopping nine times as much for streaming rights in the second quarter of 2011 as it did the same quarter a year earlier.

More relevant here is Netflix’s rapid shift from being a supplier of rental DVDs by mail to video-streaming delivery on demand. The company last month separated its DVD-by-mail service from its streaming business by creating a DVD-only subscription and raising the base price for the combined service by nearly 60 percent, a move that raised the ire of many subscribers.

Netflix increasingly depends on the telephone companies and cable companies to deliver entertainment via broadband Internet to computers, TVs, and mobile devices such as the iPad. Indeed, at some periods of the day, Netflix video streaming constitutes almost 30 percent of all Internet traffic in the United States during peak periods. So it’s not surprising that the company is butting heads with Internet service providers—think everybody from Verizon Communications to Cox Communications to Time Warner Cable—over the issue of how the costs of streaming are covered.

To date, suppliers of wireline (as opposed to wireless) broadband have generally used the salad bar model: consumers pay a fixed monthly fee for all they choose to download. But that’s changing. AT&T and Comcast are now charging according to usage above monthly caps.

Netflix is crying foul: the last thing it wants is for subscribers, who buy their entertainment from a dozen vendors, to be counting bytes. But can the company make a case for regulatory intervention?

In principle, maybe. But it’s not easy to demonstrate that broadband caps are anticompetitive. More precisely, it is far from obvious that the shift away from flat-rate pricing reflects an attempt to increase revenues that would not be possible if there were more competition among Internet service providers.

Most of the cost of providing Internet services reflects the cost of building the massive networks of cables and switches that carry the digital traffic. When a network isn’t fully utilized, the cost of delivering another e-mail message—or, for that matter, all 86 episodes of “The Sopranos”—is next to nothing. Hence flat-rate pricing, in which users share the network costs with fixed monthly payments but pay nothing extra to watch another hour of James Gandolfini making mayhem, is easy to justify in economic terms.

Well, it’s not that simple. Internet providers must design their systems to deliver high-quality signals at peak-use periods. Indeed, no form of content is more sensitive to congestion slowdowns than streaming video. So the most efficient pricing system would be one that charged extra for service at periods of peak demand, reflecting the reality that a good portion of network capacity is only intermittently needed.

Internet providers haven’t tried peak-load pricing, most probably because they believe that residential customers would find it both confusing and unfair. In fact, they fear that alienating subscribers by using any approach to tying prices to how much system capacity is used (or when). And while we can’t say for sure why they’re just now moving toward “two-part” pricing in which customers pay a flat rate for the first big dollop of bytes and then pay extra for greater use, our best guess is that the alternatives look worse. They must somehow find ways to pay for explosive increases in use by some customers as they join the rush to entertainment via video streaming—but without increasing monthly bills for more modest users.

That’s not how David Hyman, Netflix’s general counsel, sees it. He argues that competition in Internet service is inadequate and that the providers are using the growing demand for video streaming as an excuse to raise total charges.

That’s a hard case to sell. If ISPs really have market power and are itching to exploit it, why switch to a pricing structure that’s sure to draw the attention (and ire) of a deep-pockets, high-profile company like Netflix?

A more plausible argument is that Netflix’s success has led the ISPs to covet a piece of their streaming-video business, and they’re using discriminatory pricing to gain a competitive advantage in selling entertainment. Hyman notes that the systems of AT&T and Comcast exempt their own video-streaming programming from bandwidth caps, giving users a financial incentive to avoid third- party vendors such as Netflix.

Should this be allowed? The policy debate about Internet discrimination has focused on access—allowing outside content providers to use the network without paying discriminatory fees to the service provider—which is not in question here. The issue is really whether a broadband provider should be permitted to charge users by the byte but waive the fee for viewing content it is selling in competition with Netflix (or Hulu, You Tube, or others.).

Much, we think, turns on the practical impact on competitors and consumers, which under current pricing schemes doesn’t appear large. For example, AT&T is charging $10 for 50GB, which amounts to less than 20 cents for a typical standard-definition movie. And that cost only kicks in beyond the 150GB cap per month, which is enough for roughly 300 hours of programming via the Internet. (High-definition programming uses more bandwidth; just how much more depends on the degree of digital-code compression.)

Of course, caps could be reduced, and fees for use above the cap could be raised, which would have a greater impact on competitors. So it makes sense for the Federal Communications Commission to keep an eye on Internet providers’ pricing schemes. But there’s a cost to intervention—at best, the hourly fees for battalions of regulatory lawyers, at worst deterrence to innovation. Therefore, we think that the bar should be set pretty high. In particular, price discrimination should only be the government’s business, if other content providers are put at a significant disadvantage, and consumers (as opposed to content providers) suffer as a result.

Netflix, we’re rooting for you—but not at the expense of hobbling innovation on the Internet.

(This post was also published on CNET.com.)

Nonetheless, three prominent public-interest lawyers from across the ideological spectrum (Richard Epstein, Alan Morrison and Kathleen Sullivan) have submitted a “friend of the court” brief in just such a challenge by the Competitive Enterprise Institute. The amici take no position on the settlement itself. What’s being challenged is the fact that the states cut the deal without the blessing of Congress in violation of the Compact Clause of the U.S. Constitution.

The notion that an agreement among a group of States that authorizes price fixing and market share divisions…can stop federal enforcement of antitrust laws in its tracks, is almost unthinkable… But the Compact Clause takes that possibility from the unthinkable to the unconstitutional because the MSA is precisely the kind of joint state interference with federal laws that the Clause was designed to preclude.

We don’t claim expertise on the constitutional issue. But it sure would be nice to give the Justice Department’s antitrust division a chance to question the outrageous consequences of the MSA.

Now it appears to be Google’s turn in regulators’ klieg lights. Google, you probably don’t remember, epitomized the New Age company, adopting “Do No Evil” as its mantra and plunging into visionary enterprises including the preservation of every book ever published in digital form. But Google’s current dominance of some information technology niches (and the undisguised ambition to its reach) has made the company a prime target for antitrust authorities around the world.

Google managed to convince U.S. trustbusters to bless its purchases of DoubleClick (digital marketing technology) and AdMob (mobile advertising) – though it was apparently a close call. And the company still faces complaints about its dominance of web-based advertising in Europe, whose competition authority way too casually equates market share to monopoly.

Antitrust scrutiny is often called for, particularly when large firms acquire others in related fields. But scrutiny for the right reasons. Regulators need to recognize that in markets driven by rapidly changing technology and huge economies of scale, it’s natural for one firm or another to be king of the hill – albeit temporarily. So market share alone is no indicator of anticompetitive behavior or of the difficulty a newcomer with a better idea would have in competing for the business.

This tendency toward winner-take-all market outcomes explains why Google is following the explosive growth of Facebook with interest — and, we suspect apprehension. The number of Facebook users exceeds half a billion, and Google has already fallen flat with an attempt to use its highly successful web-based e-mail technology to counter the juggernaut.

So will Facebook, with its massive lead in social networking, bury Google? Probably not. After all, successful competition in a variety of market niches left Microsoft standing (and profitable). But, if Google fails to slow Facebook’s relentless growth in social networking, the search behemoth might find itself struggling in a lot of arenas it now dominates – notably online advertising.

Neither Google nor Facebook will last forever (or even necessarily a long time). Very little related to the Internet manages to survive the Next Big Thing – even companies whose names become verbs. Whether the winners du jour make it or not, though, what ought to matter from the competition regulators’ perspective is whether their behavior is aimed at preserving market power and stifling innovation. The short but eventful history of digital technology suggests that consumers will be better off if these behemoths are given the benefit of a doubt.

Remember why the Antitrust Division brought an antitrust case against Microsoft in 1998? In a nutshell, the feds contended that Bill Gates’ monster so dominated the market for key information technology (the PC operating system) that rivals couldn’t compete without a little help from Uncle Sam.

Fast forward to June 2010. Microsoft has lost 40% of the market in Internet browser use — Google‘s Chrome browser and the “open source” Mozilla Firefox browser control one-third of the market along with 100% of the media buzz. And in spite of years of effort, Microsoft owns a mere 3% of the search market worldwide, compared with 84% for Google. Indeed, the notion that Microsoft can use its dominance in operating systems as leverage to push other software makers off their own turf is such a non-starter (to everyone but regulators) that the world barely noticed when the company started giving away terrific anti-malware software to Windows users.

Microsoft isn’t killing on other fronts, either. It barely qualifies as a major presence in smartphone platforms or in music players. (Remember the Zune: Someday, it will be a show stopper on trivia quizzes). And even Microsoft’s near-monopoly in office productivity software is finally being challenged, as Google and others offer free applications that live entirely on “the cloud.” The move has forced Microsoft to match their free Web offerings, accelerating the erosion of the traditional market for Office.

So now that the king is dead, should we be worrying about the anticompetitive behavior of the pretender to the throne? The Federal Trade Commission thinks so: It is investigating Apple for its efforts to leverage its market power in digital music and mobile devices to other services. But look more closely and Apple’s quasi-monopoly begins to resemble that of Microsoft’s a decade ago. Practically since the introduction of the iPhone, it’s been conventional wisdom that Apple had a hammerlock on high-end smartphones because it had created an incontestable lead in mobile apps. Yet, in a matter of months, Google’s Android managed to build an online store with 70,000 apps, and one forecaster thinks Android devices have a good shot at passing iPhone sales in the next few years. Arguably more ominous from Apple’s perspective, Android users are already clicking on more mobile ads than their iPhone counterparts.

So what does that mean? The markets for information technology products are, often as not, highly concentrated. But concentration doesn’t equal true market power the way it does in, say, steel or air travel because IT is changing so rapidly. Indeed, a competition policy that uses share of total sales as the cue for antitrust investigation in any technology-driven market may actually undermine competition. For without the prospect of huge profits associated with temporary market dominance, investment in expensive, long-shot technologies would surely diminish.

To be clear, there’s a place for antitrust regulation in protecting consumers from the abusive practices of companies that gain and keep market power by what the law calls “restraint of trade.” But where market power follows from innovation, the burden of proof ought to be on those who argue that dominance will endure.

(This blog post was published earlier on Forbes.)

The most significant changes in the market last year were (a) the disappearance of Alltel, the fifth largest carrier, through merger with Verizon and (b) the explosive growth of MetroPCS and Leap, the number six and seven carriers respectively, which both specialize in all-you-can-talk-text-surf plans. All told, the FCC notes that the market is a bit more concentrated than it was last year, and significantly more concentrated than in 2003.

No argument there: The Herfindahl-Hirschman Index has risen from 2141 to 2858 in five years. The dispute is over what that implies. Commissioner Michael Copps concluded that “competition has been dramatically eroded and is continually endangered.” We think concentration is just one factor is assessing the state of competition in this and other industries characterized by rapid technological change and service quality.

According to the report, prices are stable – evidence that the carriers either face direct competition or fear entry. Indeed, Leap and MetroPCS have had great success in using their image as discounters to compete for younger, less affluent customers. Note, too, that all the major carriers are running scared. All are promoting slews of new devices and investing heavily in the high speed, 4G networks needed to get the best out of bandwidth-hungry smartphones.

Then there’s the question of international comparisons. The average price of a minute of airtime in the United States is far, far lower than in other rich countries. In Japan, for example, the typical customer talks 139 minutes a month at a hefty 26 cents per minute, compared to the typical American’s 829 minutes at 5 cents a minute.

Don’t get us wrong. Somebody – preferably the Department of Justice or the Federal Trade Commission – needs to keep an eye peeled for signs of market power in the wireless industry. But the bigger risk at this point is that, in their enthusiasm to protect consumers, the FCC will attempt to manage market share – say by giving a helping hand to smaller carriers or by barring marketing practices that make it costly to switch carriers before the end of a handset contract. The industry has done very well on its own, thank you, in containing costs while fostering a technological revolution in wireless communications.

Comcast, America’s largest cable company, ran afoul of the FCC in 2007 when it chose to discriminate among Internet users by providing slower service for peer-to-peer networking, which was hogging disproportionate amounts of bandwidth. In disciplining Comcast, the FCC both asserted jurisdiction over the Internet and its right to adjudicate the issue without a formal rulemaking.

The court, for its part, decided that the FCC overreached its statutory authority. But that begs the more fundamental question: should there be rules prohibiting discrimination of this sort by Internet service providers? One could imagine other ways in which Comcast could have discouraged excessive use of bandwidth by peer-to-peer users. It might, for example, have charged everybody by the byte rather than by the month. But for competitive reasons, Internet service providers have thus far been reluctant to go this route. Do we really want the government rather than the marketplace to make this call?

It may, in the end, serve the public interest to bar some forms of discrimination by Internet providers. But the Comcast case illustrates how problematic it will be to draw hard and fast lines. The antitrust agencies already have authority to regulate the competitive practices of the industry. Congress should think long and hard before delegating power to the FCC in the Internet arena – and, if it does, should insist that the agency use its new authority solely to advance consumer welfare and efficiency, not as a catch-all rationale for enforcing the agency’s views on net neutrality.