In a 16 page letter sent by Phil Corwin  the Internet Commerce Association (ICA)  to the U.S. Department of Commerce (DOC) and the Department of Justice (DOJ), the ICA urges the DOC & the DOJ not to approve the renewal of the Verisign contract to operate the .com registry unless Verisign rolls back wholesale prices of .com domain names to the same price it charges for .net domain registrations and to limit price increases in the future to the increase in the Consumer Price Index (CPI).

Verisign (VRSN) reported during their earnings call about a month ago, that the contract to mange the  Com registry is still under review by the Department of Commerce and Department of Justice.

In its letter, the ICA took a very strong position that the contract should only be renewed if price adjustments are made to the contract in both the base price and the price increases.

The argument is pretty simple.

Verisign operates the .net registry for a wholesale price of $5.86 per domain yet its charging $7.85 to manage the .com registry using the same facilities, staff, equipment and infrastructure.

There is no logical reason Verisign can operate the much smaller .net registry which has less than 15 million registrations for $2 less than the .Com registry which has around 105 Million domain registrations.

The second point is equally direct.

Verisign has a monopoly on the .com and .net registries and operates like a traditional utility company in that  you cannot register a .com or a .net domain without Verisign getting paid as you can’t get electricity without paying your local electric company.

The difference is if your electric company wants a rate increase it has to go to the relevant commission that oversees it and show that its costs have increased and profits decreased and get approval for each and every rate increase.

Verisign on the other hand is entitled to a 7% rate increase in every 4 out of 6 years, without a showing of additional cost all the while when the company is operating at a greater than 50% profit margin.

Here is the highlights of letter which makes me proud to be a silver member of the ICA:

As the Department of Commerce (DOC) continues its review of the .com Registry Agreement in consultation with the Department of Justice, it is the view of the ICA that approval of its renewal with VeriSign should be approved as being in the public interest only if:

• The wholesale base price for .com domains is reduced from its present level of $7.85 to at least the same $5.86 price currently in effect for .net domains
• Future increases in the wholesale price of .com domains are limited during the six-year term of the new agreement to the increase in the Consumer Price Index (CPI) unless VeriSign submits additional information that provides sufficient documented justification to the satisfaction DOC that such higher pricing is required for the continued operation of the .com registry in a safe, stable, and secure manner.

VeriSign Continues to Dominate the gTLD Marketplace

VeriSign continues to exercise quasi-monopolistic control over the marketplace for generic top level domains (GTLDs) through its operation of the .com and .net registries under contracts with the Internet Corporation for Assigned Names and Numbers (ICANN) that require approval of the Department of Commerce. As of June 30, 2012 total combined .com and .net domain registrations totaled 118.5 million domains, of which 103.7 million were in .com and 14.8 million in .net.

These two dominant gTLD registries, both operated by VeriSign, constituted nearly fifty percent of the 240 million domains registered as of that date.

Their combined total of 118.5 million domains exceeds the 100.3 million total for all of the country code top level domains (ccTLDs) operated by all the nations of the world. It is also more than five times greater than combined total registrations of approximately 22 million for all other existing gTLDs.

“The term “dot com” is now the world’s biggest brand and it is used and respected globally as the gold standard of the internet.”

“The monopolistic position occupied by VeriSign is openly recognized by market analysts. Here is how one technology sector analyst characterized the benefits of VeriSign’s monopoly DNS position in late 2009, while also correctly forecasting the massive “special dividends” and stock buyback program that we discuss later in this letter:

We are attracted to VRSN primarily for stock-specific reasons. VRSN holds a legal monopoly on the DNS industry…We touched on VRSN’s monopoly position in DNS… As a result, VRSN holds one of the stronger competitive positions of any stock in our portfolio. The DNS contracts for managing the dot.com and dot.net domain naming registries were granted by ICANN in 2006 and 2005, respectively. The agreements expire in 2012 and 2011, respectively, but call for a “presumptive right of renewal,” i.e., the contracts should automatically renew with similar terms for another six years as long as VRSN meets its contractual obligations. Under the contracts, VRSN is allowed to take price increases of up to 7% and 10% (for dot.com and dot.net, respectively) in as many as four of the six years in the term…VRSN has spent more than $100mm over the past couple of years to build out its DNS infrastructure. With this spending program mostly finished, management is free to redeploy this cash flow into more shareholder friendly initiatives, like a large share buyback or perhaps the initiation of a dividend.

Absent existing pricing restraints in the .com and .net registry agreements, VeriSign could exploit this market dominance through substantially higher wholesale pricing.

We believe that VeriSign should be fairly compensated for the technical function of operating these registries, but should not be allowed to abuse its quasi-monopolistic control to overcharge for those services based upon the secondary market value of the domains and the enterprise value of the businesses that have utilized them as a virtual foundation for speech and commerce.

.Net Pricing is the Appropriate Benchmark for .Com

The current .Com registry agreement was forged as the settlement of litigation brought against ICANN by VeriSign in the middle of the last decade, after ICANN attempted to put the renewal contract out for competitive rebid. One year earlier, a similar competitive rebid process had reduced the wholesale price for .net registrations from $6.00 to $3.50 – yet the .Com settlement set a wholesale domain base price for the much larger registry at $6.00.

When the terms of the settlement were announced they set off substantial opposition from a bipartisan group of members of the U.S. Senate and House.  They also generated intense debate and division among members of ICANN’s Board and after the Board’s split 9-5 February  2006 vote to approve the contract its approval by DOC was opposed by  almost all major domain registrars and other members of the ICANN community. One contemporary press release captures the outcry over the badly flawed contract now being considered for renewal:

GoDaddy.com, the No. 1 registrar of domain names worldwide, is outraged by the Internet Corporation for Assigned Names and Numbers’ (ICANN) 9-5 vote last night to approve a new .COM registry agreement with VeriSign. The agreement grants VeriSign uncontested price increases and perpetual monopoly power, which will lead to exorbitant profits at the expense of the Internet community.

ICANN, the governing body of the Internet, has been working to settle a lawsuit with VeriSign, which manages .COM and .NET domain name extensions. The proposed settlement agreement would allow VeriSign to raise registration fees by seven percent annually in four of the next six years without cost-based justification. It also would give VeriSign control of the .COM registry indefinitely, as it extends VeriSign’s “presumptive renewal” right when the proposed settlement agreement expires in 2012.

“We are bitterly disappointed, but we’re not giving up yet. It’s simply a bad deal for the industry and registrants everywhere,” said Bob Parsons, CEO and Founder of GoDaddy.com. “The fact that this monopolistic deal was approved is a loud signal that major changes are needed at ICANN.”

GoDaddy.com joined other top registrars, representing approximately 57 percent of all registered .COM names, in petitioning ICANN to address concerns with the proposed settlement. The ICANN board vote came only one week after the close of the public comment period, and without modifications to any of the raised issues.[5]

The principal objections to what was broadly viewed as a “sweetheart deal” were:

• ICANN’s lack of adequate transparency and accountability in reaching this agreement behind closed doors and its presentation to the community as for all practical purposes a fait accompli.
• The presumptive renewal provisions of the agreement, which in fact amount to perpetual renewal and effectively grant VeriSign an endless monopoly to operate the .Com registry.
• The pricing provisions, which permit increases of 7 percent in four out of the six years of the contract absent any substantive justification.

In the ensuing years, VeriSign has exercised all four of its upward pricing options, resulting in an increase from the $6 contract base price to the current $7.85 wholesale price. VeriSign can likewise be expected to exercise all of the price increase opportunities permitted under the pending Agreement.

We believe that a minimum $2 reduction, which would align .Com and .Net wholesale pricing, would be in the public interest and therefore should be required as a condition of DOC approval. As noted above, a competitive rebid of the .Net contract in the year preceding the .Com litigation settlement set a wholesale base price of $3.50 for that .net contract. That is the only market testing that has been performed in the past decade for the operation of these two dominant gTLD registries and thus the only reliable wholesale pricing benchmark.

Rather than being viewed as harsh treatment of VeriSign, a reduction in .Com pricing of only $2 is in fact generous. First, had the .Com contract been competitively rebid in the year following the .Net pricing competition there is a substantial probability that the base wholesale price would have been set at less than $3.50, not at the settlement benchmark of $6, due to the fact than the number of registered domains is more than seven times larger with resulting efficiencies of scale. Second, under its own overly generous contract pricing provisions, .Net wholesale prices were permitted to increase by up to ten percent annually absent any justification commencing on January 1, 2007, and that pricing power carried into the new .Net agreement approved by ICANN in 2011[6] — so the current $5.86 .Net wholesale price may itself be unjustifiably generous.

Indeed, registry operation services consist of commodity technical services that are widely available from a large number of well-qualified potential providers.

It is widely acknowledged that the price of commodity technical services tends to fall, not rise, over time – particularly in the database management field, given that prices for data storage continue to decrease dramatically in accordance with Moore’s Law – so there is no reason for the DOC to permit unjustified price hikes for such services.

It is absolutely not in the public interest for .Com wholesale prices to be at least $2 more than they would be if the .Com registry contract was competitively rebid on a regular basis. That excess price level, multiplied across a .Com domain base of at least 100 million, results in excess and unjustifiable revenues of more than $200 million per annum. Across the entire six-year span of the renewal contract, this will result in excess revenues to VeriSign totaling at least $1.2 billion.

Of course, for the average registrant holding only one or a few registrations for business or personal use, the difference in pricing may appear negligible.

But for the overall public the aggregate difference is quite substantial.

And there are distinct segments of the public who suffer a disproportionate impact from an unjustifiably high .com price.

One of those segments is, admittedly, the non-infringing domain investor and developer portfolio owners and managers who comprise the membership of the ICA.

But another large and significant segment is comprised of the large brand interests who are compelled to maintain substantial “defensive” portfolios of infringing, primarily .com domains with no intent to use them but solely to keep them out of the hands of infringing “cybersquatters”.

Maintaining these mostly useless domains is a continuing annual cost drain on U.S. businesses, as such defensive portfolios probably total many tens of millions of domains in the aggregate – one leading brand protection company reported that a recent survey “revealed that over 90% of corporate portfolios currently consist of defensive registrations”.

Allowing VeriSign to price .Com domains in excess of competitive market levels leads to an unjustified transfer of wealth from the shareholders of large brand entities to those of  VeriSign.

VeriSign also operates the .Name registry, and its wholesale pricing level currently is $6.00, again indicating that wholesale .Com prices are unjustifiably high.

In any event, there can be no justification for a $2 price differential between .Net and .Com wholesale domain prices given that VeriSign performs the exact same registry functions for all these gTLDs, as well as back end services for other TLDs, at the exact same technical facilities:

Registry Services operates the authoritative directory of all .com, .net, .cc, .tv, and .name domain names and the back-end systems for all .gov, .jobs and .edu domain names…

We are the exclusive registry of domain names within the .com, .net and .name generic top-level domains (“gTLDs”) under agreements with the Internet Corporation for Assigned Names and Numbers (“ICANN”) and the U.S. Department of Commerce (“DOC”). As a registry, we maintain the master directory of all second-level domain names in these top-level domains (e.g., johndoe.com and janedoe.net). These top-level domains are supported by our global constellation of domain name servers. In addition, we own and maintain the shared registration system that allows all registrars to enter new second-level domain names into the master directory and to submit modifications, transfers, re-registrations and deletions for existing second-level domain names (“Shared Registration System”).

Separate from our agreements with ICANN, we have agreements to be the exclusive registry for the .tv and .cc country code top-level domains (“ccTLDs”) and to operate the back-end registry systems for the .gov , .jobs and .edu gTLDs. These top-level domains are also supported by our global constellation of domain name servers and Shared Registration System. (Emphasis added)

What is the justification for .Com registry services being priced at $7.85 when the exact same functions performed at the exact same technical facilities for .Net domains are priced at only $5.86? We submit that there is no reasonable justification and that permitting this price differential to persist is not in the public interest.

A $2 price wholesale reduction is also less harsh treatment than submitting the .Com registry contract for competitive rebid.

We believe that DOC could justify such a rebid on the basis of VeriSign experiencing substantial security breaches in 2010 that were not reported to senior management until more than a year later.

We are confident that if such a bidding process was initiated that well-qualified DNS providers would be willing to operate the .Com registry at a wholesale price of $5.86 – or less.

.Com Pricing Will Rise Inordinately and Unjustifiably if DOC Fails to Protect the Public Interest

If the DOC approves the .Com renewal contract in the form approved by ICANN’s Board of Directors in June, .Com wholesale prices will rise inordinately and unjustifiably over its six year term. We must assume that VeriSign will again exercise all four upward pricing options if they are available.

This is what the compounded effect of four seven percent increases would result in starting from the current base price of $7.85:

1. $8.40
2. $8.99
3. $9.62
4. $10.29

An ICANN fee and a registrar markup are added to these wholesale prices, resulting in a retail price that is more than $3.00 higher than the above wholesale prices (and, depending on the registrar, in some case substantially higher).

Thus, if the contract currently being reviewed by DOC is approved, retail prices for .Com domain registrations and renewals can be expected to reach $13.50 or higher by the end of its term – and that would be the starting base price for the next perpetually renewed contract.

In addition, for those remaining two years in which VeriSign is not entitled to exercise a seven percent price increased absent justification, its ICANN-approved renewal contract permits two additional price increases of up to seven percent each as follows:

In any year, however, where a price increase does not occur, Registry Operator shall be entitled to increase the Maximum price by an amount sufficient to cover any additional incremental costs incurred during the term of the Agreement due to the imposition of any new Consensus Policy or documented extraordinary expense resulting from an attack or threat of attack on the Security or Stability of the DNS…

In short, even without the ability to levy unjustified price hikes, VeriSign retains the freedom to increase prices to account for the costs of implementing any new ICANN consensus policies or to deal with even the threat of cyberattacks. Any contract ultimately approved by DOC should preserve necessary pricing flexibility that can be justified for these and other salient reasons.

What would be endangered by a .Com price reduction are extremely generous dividend distributions to VeriSign shareholders as well as a large share buyback program. As the company’s most recent 10-K filing discloses:

In April 2011, we declared and in May 2011 paid a special dividend of $2.75 per share of our common stock totaling $463.5 million.

Similarly, the 2010 10-K reports a similar act of extraordinary financial generosity to VeriSign shareholders:

In December 2010, we declared and paid a special dividend of $3.00 per share of our common stock totaling $518.2 million.  Lastly, VeriSign’s enviable profitability has allowed it to engage in a continuing stock buyback program resulting in increased share prices, with more than three quarters of a $billion still in reserve for future buybacks:      During the first quarter, Verisign repurchased approximately 1.8 million shares of  the company’s common stock for a cost of $68 million. At March 31, 2012, approximately $763 million remained available and authorized under the current share repurchase program.

In other words, over the past two years VeriSign determined that a total of $981.7 million was not required for R&D and cybersecurity purposes and could be readily transferred to its shareholders – and still leave it with about $1.4 billion in cash and equivalents, with about half of that reserved for future stock buybacks rather than investment in operations.

While these distributions in part represented cash received for sales of six separate and less profitable operating units over the past three years, the fact remains that VeriSign determined that retention of these funds was not required for future R&D and cybersecurity expenditures for its remaining core registry operations business.  Further, those divestitures resulted in a fifty percent increase in operating margins, from a quite healthy 33% to an enviable 52%. While official 2011 earnings were $249 million on revenues of $772 million, earnings per share (EPS) are on track to jump 27% in 2012 alone, and VeriSign is projected to generate $368 million in free cash in 2012 and $409 million in 2013. 

This company would remain highly profitable even in the wake of a .Com wholesale price reduction.

Overall, the transfer of nearly $1 billion through special dividends constitutes significant evidence that VeriSign revenues are substantially in excess of what is required for the continued secure operation of the .Com registry.

Its fifty percent-plus operating margin, surging EPS, and escalating free cash generation is  a direct result of having perpetual monopoly control  of the most important and valuable gTLD, along with the government-sanctioned ability to repeatedly raise domain prices absent any justification.

Only DOC Has the Power to Restrain .Com Pricing

Section 3.1 (b) (v) of the draft renewal agreement between VeriSign and ICANN states that any adopted ICANN Consensus Policies shall not:

(A) prescribe or limit the price of Registry Services; …

(C) modify the terms or conditions for the renewal or termination of this Agreement; …

(G) modify the terms of Sections 7.2 and 7.3 below

Section 5 of the Agreement requires that disputes arising under it shall be resolved by binding arbitration.

Section 6.1 of the Agreement relates to termination by ICANN, stating:

Section 6.1 Termination by ICANN. ICANN may terminate this Agreement if and only if: (i) Registry Operator fails to cure any fundamental and material breach of Registry Operator’s obligations set forth in Sections 3.1(a), (b), (d) or (e); Section 5.2 or Section 7.3 within thirty calendar days after ICANN gives Registry Operator written notice of the breach, which notice shall include with specificity the details of the alleged breach; and (ii) (a) an arbitrator or court has finally determined that Registry Operator is, or was, in fundamental and material breach and failed to cure such breach within the prescribed time period and (b) following the decision of such arbitrator or court, Registry Operator has failed to comply with the decision of the arbitrator or court.

In other words, VeriSign can fail to cure fundamental and material breaches of the Agreement for which it has received notice from ICANN, can be found to have been in fundamental and material breach by an arbitrator or court, and even after losing the judgment in such forum can retain the right to continue operating the .Com registry if it then complies with the decision of the arbitrator or court. Only a willful refusal to comply with such a decision could provide ICANN with the power to terminate the Agreement and make it available for competitive rebid, a provision which has drawn stern criticism from the Department of Justice.

These are collectively the provisions of the Agreement that prompted charges of a “sweetheart deal” in 2005-6 and that preclude ICANN from ever subjecting the Agreement to market price testing except in the extraordinary and very unlikely circumstances that would allow a termination, as well as from negotiating any changes in its domain registration pricing provisions.

ICANN conceded its own impotence in this regard in the very text of the Public Notice that accompanied the draft .com renewal Agreement, noting that any breach of the renewal provisions would expose it to legal liability:

The registry agreement precludes a competitive bidding process to provide .com registry services. The renewal provisions in the current .com Registry Agreement are consistent with all the other ICANN gTLD agreements. All ICANN’s gTLD registry agreements essentially provide that they will be renewed absent a serious breach of the agreement. These renewal provisions encourage long-term investment in robust TLD operations, and this has benefitted the community in the form of reliable operation of the registry infrastructure. ICANN does not have the right under the current .com Registry Agreement to unilaterally refuse to renew the agreement or to bifurcate registry functions. Breaching the renewal provision would expose ICANN to liability under the contract… Both the current .com registry agreement and the proposed renewal agreement permit Verisign to increase the price it charges registrars for domain names registrations four times during the six-year term with each increase being no greater than 7%. This provision was substantially negotiated between Verisign on the one hand, and the U.S. Department of Justice and the U.S. Department of Commerce, on the other. The current agreement (Section 4.2) specifies that the pricing and renewal provisions (among others) are not subject to change through the agreement renewal process. (Emphasis added)

Given ICANN’s self-imposed legal impotence, rendering it unable to negotiate any alteration in the presumptive renewal or registration pricing provisions of the proposed .Com  Agreement, only the Department of Commerce – acting in concert with the Department of Justice – can protect the overall public interest by compelling .Com pricing changes as a condition for government approval.

Further, while we believe that antitrust analysis is relevant, we also feel that the operative concept of “public interest” in this situation is broader than antitrust law. Given the .Com dominance, its operation is in essence a public trust.

Finally, DOC has a particular duty to protect U.S. domain registrants because of the particular dominance of .com domains in the U.S. marketplace. Unlike the European Union, where many businesses utilize ccTLDs for their main website (e.g., .uk, .fr, .de, etc.), as well as many other nations where the same situation exists (such as .au for Australia and .cn for China) the .us ccTLD has never gained significant market share in the United States. As a result, Alexa reports that 23 of the top 25 U.S. websites, and 94 of the top 100, are hosted on .com domains.

VeriSign Shareholders Will Have Ample Opportunity to Benefit and Profit from New Initiatives in Fully Competitive Markets

If DOC acts in accordance with our request it will likely have some negative short-term impact on the overall price of VeriSign stock, which at the moment undoubtedly prices in the unwarranted benefits of  both perpetual renewal and guaranteed price increases notwithstanding overall consumer price levels, technology-based productivity gains,  or any need for substantive justification.

However, DOC should act in the public interest of resetting .Com pricing at a level more consistent with the market testing expressed in current .Net pricing.

Such action would in no way preclude VeriSign and its shareholders from reaping additional profits in markets in which its .Com monopoly cannot be leveraged and it is not subject to ICANN-imposed price restrictions.

The current and proposed renewal .Com contract both allow VeriSign to engage in activities that do not constitute core “Registry Services” and to charge whatever the competitive market will bear.

For example, VeriSign is the exclusive registry for the .tv and .cc ccTLDs, and operates the back end registry systems for the .gov, .jobs, and .edu gTLDs. It also provides Network Intelligence and Availability Services (NIA) comprised of its iDefense, Managed DNS, and DDoS Protection Services, each of which generates separate fees from customers.

VeriSign also stands to generate substantial new revenues through participation in ICANN’s New gTLD program.

It has applied for 14 new gTLDs, including twelve International Domain Name (IDN) transliterations of .Com and .Net, none of which will be subject to pricing restrictions. In addition, applicants for about 220 new gTLDs have selected VeriSign to provide their back-end technical registry services, which also have been negotiated at competitive market prices.

In regard to new gTLDs, we would note that additional new gTLDs established over the past decade have failed to dislodge .Com and .Net from their dominant gTLD positions, and at this point in time the competitive impact of the introduction of hundreds of new gTLDs is entirely speculative. Therefore, ICANN’s new gTLD program cannot be used as a rationale for abrogating DOC’s responsibility to safeguard the public interest through restraint of exorbitant .Com pricing as there is no assurance that any new gTLDs, either individually or in the aggregate, will effectively exercise market price competition against .Com over the term of the pending Agreement.

Overall, DOC can act to protect the public interest in reasonable .Com pricing levels while leaving VeriSign and its shareholders free to reap the financial benefit of an array of existing and new services that do not benefit from the natural monopoly conferred by the .Com and .Net registry contracts.

Conclusion

Operation of each TLD registry is a “natural monopoly” because only a single entity may exercise control over registry operations. Natural monopolies in the public utility sector traditionally require the monopoly operator to submit a request accompanied by extensive documentation and justification, and receive affirmative permission from its oversight regulator, before any price increase can be put into effect.

The possibility of excessive price increases is even more pronounced for .Com domains, given the registry’s massively dominant position in the overall TLD marketplace — .Com registrations constitute nearly half of all domain registrations, and the secondary marketplace as well as  consumer behavior conclusively demonstrates that .Com domains are by far the most valuable.

A registrant which believes it has been subject to excessive price increases has no practical alternative at the present time, as moving their domain location to another TLD would mean significant sacrifices in overall traffic and marketplace recognition and credibility.

Given these realities, we implore the Department of Commerce to act to protect the public interest by mandating a reduction of wholesale .Com domain prices to at least the same level as current .Net prices, and to prohibit future .Com price increases other than adjustments in concert with CPI increases, or those for which VeriSign provides substantial and convincing justification as being necessary for the continued reliable and secure provision of .Com registry services.