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Press Release

    Testimony of Dr. Jerry Ellig, Research Fellow, Citizens for a Sound Economy Foundation Before the U.S. House of Representatives

    05/25/2000

    Summary

    A pair of recent studies by Citizens for a Sound Economy Foundation holds two implications for broadband policy:

    Broadband access is not a monopoly; consumers can rely on competition, rather than economic regulation, for protection. Broadband access today is anything but a monopoly. Telephone companies, cable TV companies, electric utilities, satellite firms, and wireless vendors are all positioning themselves to offer broadband service to residential customers. It is unlikely any one technology or company will dominate. Therefore, there is no rationale for price regulation or forced unbundling in the broadband market.
    Allowing the Bell companies to carry data across Local Access and Transport Area (LATA) lines has the potential to create net benefits for consumers. Allowing the Bell Operating Companies to offer interLATA data services would expand the amount of high-speed data capacity available to serve an ever-growing demand. Current regulation prohibiting the Bells from entering this market increases the risk that several types of bottlenecks could slow data transmission speeds.
    The Bells could not use their control over local phone lines to thwart competition in the data market, because Internet interconnection agreements would not permit them to discriminate against their competitors. In addition, Bell companies lack dominance over broadband access, since cable modems serve three times as many customers and most homes will have broadband access via both cable and telephone lines. If there is no broadband access monopoly, there is no incentive to discriminate against competitors, and hence no reason to keep the Bells out of this market.

    Full Testimony

    Mr. Chairman and Members of the Subcommittee, thank you for the opportunity to appear today to discuss broadband issues. My name is Jerry Ellig, and I am a research fellow at Citizens for a Sound Economy Foundation. I am also a senior research fellow at the Mercatus Center at George Mason University. I am appearing here today on behalf of Citizens for a Sound Economy Foundation to summarize two of our recent studies that are relevant to the ongoing debate over broadband policy.1

    Citizens for a Sound Economy Foundation is a consumer education organization that promotes free market solutions to public policy problems. Our 250,000 members and supporters constantly remind us that decisions made in Washington, DC, are felt in places far away from here. Competition, consumer choice, and individual freedom have been CSE Foundation’s watchwords since our founding in 1984. These principles have continually informed our research and educational activity on telecommunications, which began in 1987.

    Our most recent pair of studies on the broadband market continue in this tradition. There are two key findings relevant to the topic of today’s hearing:

    Broadband is not a monopoly; consumers can rely on competition, rather than economic regulation, for protection.
    Allowing the Bell companies to carry data across Local Access and Transport Area (LATA) lines will likely create net benefits for consumers.
    Let me expand on each of these in greater detail.

    1. Broadband is not a monopoly, and so consumers can rely on competition rather than economic regulation for protection. Large business customers already have a wide variety of broadband options. Therefore, most policy discussion involves the “residential” broadband market, which serves both residences and small businesses.2

    Cable TV companies currently serve the majority of residential broadband customers. The Yankee Group estimated that there were 300,000 DSL subscribers in 1999, compared to 1.1 million cable modem subscribers. The Yankee Group also projects that 70 percent of U.S. households will have access to cable modems and DSL by 2004, and households with access to one will usually have access to the other.3

    In addition to cable and DSL, other options exist as well:

    Hughes Network Systems’ DirectPC offers high-speed download via satellite. Uplink is accomplished via phone lines. ·
    Multichannel Multipoint Distribution System (MMDS) transmits data via wireless spectrum. ·
    Local Multipoint Distribution Service (LMDS) also uses wireless spectrum. Unlike MMDS but like satellites, uplink occurs via phone lines.
    Cable and DSL currently have a lead in subscribers, but there is no guarantee that they will dominate the broadband market in the future. Experience shows that competitive telecommunications markets produce continuous productivity improvement and price reduction as well as new technologies. CSE Foundation estimates that, with plausible assumptions about cost trends, the current cost gap between technologies will narrow considerably. As the accompanying table shows, five years from now, four out of five broadband technologies could be available for $20-40/month – less than most Americans pay for cable TV today.4

    Cost of Residential Internet Access

    Method Speed (Kbps) Average Installation cost Customer equipment cost Monthly fees* Total monthly cost, 1998 Projected monthly cost, 2003
    Satellite 400 $50 $300 $30-50 $50.81 $25.68
    Terrestrial Wireless - MMDS 1000 $100 $400 $50-70 $75.44 $38.06
    Terrestrial Wireless - LMDS 1500 $200 $1000 $50 $87.06 $46.23
    ADSL 1500 $100 $200 $50-60 $64.26 $31.96
    CAble Modem 3000 $75-150 0** $40 $43.58 $21.35

    *Includes average monthly cost of basic hookup to the network plus Internet access fees, if any.
    **Included in installation fees.
    Source: Raw data are from Federal Communications Commission Broadband Report 1999, CC Docket No. 98-146 (January 28, 1999), Charts 2 and 3. Calculations are described in Jerry Ellig, “Broadband Open Access: An Idea Whose Time Has Gone,” CSE Foundation Issue Analysis No. 99 (December 16, 1999).

    In short, there are many different technological options, and multiple competitors are trying each. Some will succeed, and some will fail. But it is highly unlikely that a single firm will dominate the broadband market. With a market this far from monopoly, there is no justification for price regulation, mandated unbundling, or forced access to competitors’ facilities. The Federal Communications Commission’s refusal to impose forced access in cable, and H.R. 2420’s prohibition on forced unbundling of local phone companies’ advanced data networks, are both consistent with this conclusion.

    2. Allowing the Bell companies to carry data across Local Access and Transport Area (LATA) lines will likely create net benefits for consumers.

    Faster Internet Speeds

    It is a commonly-held belief that the relatively slow “last mile” of the telephone network is the only factor preventing many business and most household Internet users from enjoying fast data speeds. According to this theory, the “World Wide Wait” will disappear once all users have access to some type of broadband hookup.

    Although the “last mile” is an obvious constraint, there are other points in the data transmission system that could also slow performance. They include telephone company central offices, which were not designed to handle the traffic volumes generated by lengthy Internet sessions; Internet backbone providers’ points of presence, which are often connected to the backbone by T1 or other relatively slow transmission lines; and the backbone itself, whose speed can slow if too much data is sent at once. Growing demand for bandwidth could place pressure on some or all of these elements. Analysts at Morgan Stanley Dean Witter estimate that the number of consumers online will nearly double, from 30 million in 1999 to 58.5 million in 2004. About half of them will use high-speed, broadband Internet connections, primarily cable modems or DSL.5 Similarly, businesses will continue upgrading to faster Internet connections via fiber optics, DSL, and fixed wireless. The rest of the Internet will need to expand its capacity and speed in order to accommodate the increased demand for more and faster data transmission. As an executive from one startup backbone company noted, "The biggest problem for service providers that are providing high-speed access, whether over DSL or cable, is the difference between what customers expect in performance and what they get. The backbone-distribution bottlenecks only get worse when you add high-speed access, because people are pulling in more content at a faster rate than they did over dial-up lines.”6

    The Bell companies could mitigate data transmission bottlenecks by deploying more Internet backbone and building regional data networks.

    Bell-owned Internet backbones would ease congestion and perhaps lower the cost of data transmission by increasing the amount of backbone available in the market. The Bells would start with a dense concentration of fiber optic cable already in place within LATAs – an asset that would let them enter the backbone market at a low incremental cost.

    Regional data networks could bypass the telephone companies’ central offices, backbone companies’ points of presence, network access points, and leased lines. Such bypass would ease congestion and cut costs for many Internet Service Providers.

    The Bell companies can offer DSL, but some industry observers believe that they could be more effective competitors in DSL if they had their own regional data networks and backbones that could be configured to support the DSL offerings.7 Regulatory requirements that phone companies must sell “unbundled” elements of their DSL networks to competitors also deter the Bells from making the investments required to offer DSL.

    Arguments Against Bell Entry Into InterLATA Data Markets

    There are two principle arguments against allowing the Bell companies to engage in interLATA data transmission. One involves a potential threat to consumer welfare, and the other simply seeks to hold out entry into the data market as a “carrot” to induce the Bells to open their local telephone networks to competition.

    Threat to Consumers is Illusory

    A genuine threat to consumer welfare would occur if the Bell companies could use their control over the local phone lines to thwart competition in interLATA data transmission. This is the same type of reason that the Bells have been prohibited from offering long-distance phone service. Under that theory, a Bell company might degrade the quality or raise the cost of competitors’ long-distance services by giving them connections to the local network or contract terms for interconnection that are inferior to those enjoyed by the Bell’s own long-distance company.8 Would a Bell engage in discrimination to disadvantage Internet backbone firms and other competitors who carry data across LATA lines, in the hope that it would then capture some of their dissatisfied customers in its region?

    Fortunately for consumers, the nature of Internet interconnection neutralizes the danger of discrimination. The largest Internet companies interconnect and exchange traffic under “peering” agreements that essentially obligate each party to accept all traffic from the others at no charge. Such agreements give the companies the opportunity to offer their customers access to all other customers using the Internet. A Bell-owned interLATA data network would surely include enough subscribers to be an attractive peering partner, and the Bell company would receive large benefits from peering. But the peering agreement would require the Bell company to interconnect and accept traffic on the same terms as the other companies. Therefore, the terms of the agreement would prevent a Bell from discriminating in a way that disadvantages other Internet firms and harms consumers. Since peering is the most economical way to achieve interconnection, the Bells would have a strong incentive to abide by the peering agreements.

    If a Bell did not obtain peering and instead had to pay for interconnection with other backbone companies, it would still face incentives to offer high-quality interconnection to competitors. In this situation, the Bell is really providing the other Internet firms with two things: a cash payment, plus access to the Bell’s local customers. A Bell that offered its competitors inferior access to its local customers would thus have to pay more for interconnection to compensate for the fact that discriminatory interconnection is less valuable to the competitors. Bells lack a similar incentive to avoid discriminatory interconnection for long-distance voice competitors, because federal policy mandates that long-distance companies pay regulated access charges to local phone companies.

    Even without the incentives created by peering and interconnection agreements, the Bells have much less of an incentive to discriminate against data competitors than voice competitors. In either voice or data markets, the incentive to discriminate disappears if the local phone company lacks monopoly control over access to customers. Market share data show conclusively that the Bells do not dominate the broadband Internet access market in the same way that they dominate local phone service. Cable modem service is available to an estimated 25 percent of U.S. households now, and industry analysts project it will be available to half of all U.S. households by the end of 2001 and 70 percent by 2004.9 Where this directly competitive alternative is widely available, the Bells can gain nothing through discriminatory interconnection. Discriminatory interconnection would simply induce customers to switch to cable or other technologies for Internet access.

    The InterLATA Prohibition as a Carrot

    A second, distinct argument for maintaining the interLATA data restriction is that it gives the Bells a much stronger incentive to open up local telephone markets to competition. The idea is not that interLATA data transmission by the Bells poses any threat to consumer welfare, but rather that permission to enter this market should be held out as a carrot to prompt the Bells to do other things that benefit consumers.

    This “carrot” argument is creative but ignores the fact that the opportunity to offer long-distance service already gives the Bell companies a powerful incentive to open their local markets to competition. Removing the interLATA data prohibition would allow the Bell companies to compete in the wholesale Internet data transport market. Total revenues in this market were approximately $6 billion in 1999, compared to $105 billion for the retail long-distance market.10 The opportunity to participate in the large, high-margin long-distance market remains a strong incentive, even if permission to compete in a much smaller market is granted.

    The “carrot” argument also ignores the importance of bundling in today’s consumer market, which gives the Bells a strong incentive to open their local markets to competition. This incentive is especially attractive to the extent that customers want a single source for all of their communications needs. In the recent spate of merger filings before the FCC, both Bell and non-Bell companies have argued that the ability to offer all communications services in one package, with a single point of accountability, confers a significant competitive advantage.11 Even if a Bell can offer interLATA data services, its inability to offer long-distance phone service places the company at a competitive disadvantage with those customers who value one-stop shopping.

    Unfortunately, the “carrot” argument boils down to a gamble that depriving consumers of interLATA data competition now will make competition in local phone service occur more quickly. This is the same type of logic that underlies policies against “predatory pricing:” make consumers pay higher prices now to prevent the threat of a monopoly later. It’s also the logic underlying the use of international trade sanctions to open up foreign markets: make consumers pay more for imported goods and services now so that markets will be open to American exports later. Experience shows, however, that consumers usually end up losers when they are asked to give up vigorous competition today in exchange for a promise of other benefits at some future date.12

    Conclusion

    For residential and small business customers, the broadband access market is growing rapidly but still in its infancy. Two competing technologies – cable and DSL – already have strong footholds, but others could close the competitive gap over time. In such a competitive environment, neither price regulation nor forced unbundling is necessary to protect consumers.

    However, it takes more than a fast last mile to ensure that consumers receive high-speed, affordable Internet service that actually delivers its full promise. To mimimize the chance of bottlenecks developing in other parts of the system, public policy should leave all competitors free to enter the data transmission market, unless the entry of a particular competitor can be shown to harm consumers. Neither theory nor facts support the claim that Bell provision of interLATA data services can harm consumer welfare. Therefore, the costs of the prohibition on the Bells offering interLATA data services surely exceed the benefits.

    1 Jerry Ellig, “Broadband Open Access: An Idea Whose Time Has Gone,” CSE Foundation Issue Analysis No. 99 (December 16, 1999); Jerry Ellig, “Costs and Benefits of the Bells’ InterLATA Data Prohibition,” CSE Foundation Issue Analysis No. 104 (May 25, 2000).

    2 Federal Communications Commission, Broadband Report 1999, CC Docket No. 98-146 (January 28, 1999), para. 26.

    3 Federal Communications Commission Broadband Report 1999, para. 54; Yankee Group, “Cable Modems and DSL,” Media and Entertainment Strategies Report Vol. 3, No. 18, p. 6.

    4 The average cable bill is about $40. See “Comments of the Progress and Freedom Foundation” in FCC CC Docket No.98-146 (Sept. 14, 1998) at http://www.pff.org/pffdocket.html.

    5 Jeffrey Camp, Stephen Flynn, et. al., “The Internet Data Services Report,” Morgan Stanley Dean Witter (Aug. 11, 1999), pp. 17-19.

    6 Fred Watson, “Backbone Help on the Way, From Start-Ups Enron, Edgix,” Broadband Week (February 7, 2000).

    7 An article on Sprint’s broadband business noted, “Sprint is taking advantage of its high-speed IP (Internet protocol) backbone and its strategic positioning of local caching servers to facilitate delivery of content and applications at high speeds on an end-to-end basis…Bell companies, barred from the long-distance business, must rely on third parties for this kind of support, which most have been hesitant to do for cost concerns.” Fred Dawson, “Sprint's ION in Va. Sees Consumer DSL Launch,” Broadband Week (May 24, 1999).

    8 A Bell would have incentives to do this only if regulation constrained the price it could charge for local phone service. In that case, disadvantaging long-distance competitors would allow the Bell to charge a higher price for long-distance service, effectively reaping some of the monopoly profits that regulation of local service prevented it from capturing. If regulation does not constrain local service prices, then the Bell would be just as well off charging a monopoly price for local service and allowing all long-distance competitors to compete on an equal footing. See Robert Crandall, “Managed Competition in U.S. Telecommunications,” AEI-Brookings Joint Center for Regulatory Studies Working Paper 99-1 (March 1999).

    9 Camp, Flynn, et. al., “Internet Data Services Report,” p. 19; Yankee Group, “Cable Modems and DSL.”

    10 Yankee Group, "Wholesale Carrier Services: U.S. Market Supply and Demand,” Data Communications Series Vol. 14, No. 14 (September 1999), and Industry Analysis Division, Common Carrier Bureau, Federal Communications Commission, Trends in Telephone Service (March 2000), Table 11.2. The relevant comparison is between the wholesale data transport market and the retail long-distance market because the Bells are barred from the retail, interLATA long-distance market but permitted to offer retail Internet services, as long as those services do not cross LATA boundaries.

    11 AT&T Proxy Statement/Prospectus on the Merger of AT&T and TCI (Jan. 8, 1999), pp. 31, 35; Federal Communications Commission, In re Applications of Pacific Telesis and SBC, para. 71; WorldCom-MCI Public Interest Showing (Oct. 1, 1997), Sec. III.B.1; Kahan Affidavit in SBC-Ameritech, “Description of the Transaction, Public Interest Showing, and Related Demonstrations” (July 28, 1999), p. 12.

    12 Predatory pricing, for example, is often alleged but rarely found in practice; a vigorous and widespread campaign against predatory pricing would likely impose costs on consumers with no offsetting benefit. U.S. Seventh Circuit Court of Appeals Judge Frank Easterbrook noted, “Studies of many industries find little evidence of profitable predatory practices in the United States or abroad. These studies are consistent with the result of litigation; courts routinely find that there has been no predation.” See Frank H. Easterbrook, “Predatory Strategies and Counter-Strategies,” U. of Chicago Law Review 48 (1981), pp. 313-14. International trade sanctions, meanwhile, are often costly to consumers, but they rarely achieve their intended purposes. See Jerry Ellig, “One More Time: How Free Trade Benefits Americans,” CSE Foundation Issue Analysis (November 1999).