FreedomWorks

While Washington and state regulators ponder the recent Court of Appeals decision rejecting the Federal Communications Commission’s rules governing the telecommunications market, trends within the sector suggest that current regulations have failed to achieve the competitive market required by the 1996 Telecommunications Act. In particular, the managed competition promoted by the FCC and state regulators has not generated the investments necessary to allow the widespread deployment of new technologies such as advanced broadband and the consumer applications that it enables. The Court was right to highlight the failures of the current system while calling on the FCC to develop rules that promote, rather than hinder, real competition.

Much of the debate hinges on the backwards-looking rules proposed after the 1996 Act to promote modern forms of competition on old copper wire networks. Today’s market has changed dramatically, with vigorous competition coming from sources that barely existed in 1996. Cable, satellite, and wireless providers, in particular, have made significant inroads in the telecommunications market, a trend that will only increase with the introduction of Internet telephony (VoIP). Copper is being slowly replaced by far more powerful fiber-optic networks. New forward-looking rules are required to encourage the investment and competition necessary to provide consumers access to these new technologies and services.

Source: FCC, Trends in Telephone Service, Table 8.3, August 2003.

The diagram above clarifies the problem facing today’s telecommunications providers. The new competitors envisioned in the Act, known as “competitive local exchange carriers” (CLECs) have three options when competing with local phone companies (also known as incumbent local exchange carriers, or ILECs). First, they can purchase services in the wholesale market to resell in the retail market. Second, they can build their own facilities and networks to compete with the existing network. Third, they can lease equipment at rates established by regulators according to pricing policies created by the FCC

The third option established a regime of forced access that required existing local phone companies to share their equipment with their competitors to promote entrance into the market. This was viewed as a stepping stone to real competition, with competitors eventually investing and building their own facilities to compete head-to-head with the existing phone companies. Under the rules established by the FCC, the local phone companies were to provide the switches and other equipment necessary to any new competitor who would be considered “impaired” without access.

The equipment that must be shared is known as the “unbundled network element” platform, or UNE-P. In practice, the definition of impairment has allowed state regulators wide discretion in defining what is included in the UNE-P. Things are made worse by the pricing policies created by the FCC, which set prices for the UNE-P based upon the hypothetical costs of a future state-of-the-art network rather than looking at what it actually to cost to build the system that is in place. These prices (known as total element long run incremental costs—TELRIC) are virtually always lower than existing costs, which creates deep discounts for the CLECs looking to rent equipment.

In practice, the regime of forced access has altered the incentives necessary to induce critical investment in our telecommunications infrastructure. The availability of mandated rates with large discounts has led CLECs to favor leasing over investments. As the chart above demonstrates, over time the CLECs have reduced new investments while ramping up their reliance on the existing lines, which are available at artificially low rates set by regulators. The UNE-P strategy has become dominant among CLECs, while investment in real facilities is declining.

This has made it difficult to upgrade the network to handle the latest technologies. First the UNE-P strategy adds little value to the network. The CLECs simply uses existing equipment to package and resell to customers. In addition, the increasing reliance on UNE-P over investment in new facilities suggests that CLECs are not investing in new infrastructure. At the same time, the local phone companies have little incentive to invest in upgrades that must be shared with their competitors.

As a result, nobody has strong incentives to invest in the “last mile,” which connects customers to the network and the high-speed backbone. Cable companies, which are not subject to such mandates have stepped into the void and now have a 2-to-1 margin over telephone companies in terms of broadband market share. With VoIP bringing voice communications to broadband, cable can expand even further, providing customers a low-cost alternative for voice communications.

The Court of Appeals carefully identifies the problems that the FCC’s rules have imposed on the telecommunications sector and calls for new rules that will allow more competition and investment in the marketplace. Many CLECs, comfortable in their world of discounted prices, are opposed to change and are requesting that the Supreme Court review the case. In the wake of the decision, the FCC has called upon phone companies and CLECs to negotiate their own rates, which is what should be expected in a competitive market. As a promising sign, one incumbent phone company, SBC, recently completed successful negotiations with a major CLEC, establishing market-based prices to replace regulated rates. Unfortunately, efforts to appeal the case to the Supreme Court will minimize opportunities for such deals while extending the uncertainty surrounding the market for telecommunications.

Eight years have passed since the Telecommunications Act was enacted, which is an eternity in the high-tech sector. Today, large parts of the telecommunications sector remain mired in the regulations of the past. The Court of Appeals recognized the failures of these policies and hopes to push the industry into the 21st century; additional appeals will only delay the transition, continue the uncertainty, and reduce the options available in the emerging market for broadband and advanced telecommunications services.