Interesting/disappointing article about the obstacles to the next paradigm shift being looked for by the VC community....
MICHAEL POWELL V. THE ECONOMY
Cable Access
by John B. Judis
Post date: 08.27.02
Issue date: 09.02.02
Telecommunications was the driving force behind the great economic boom of the late '90s. Between 1996 and 2000 the telecom industry grew at twice the rate of the national economy. By March of last year telecom companies had reached a market value of $3 trillion, and their share of the national GDP had risen to almost 6 percent. The Internet, and wireless and other telecom services, spurred investment in information technology, which by 1999 accounted for 43 percent of private, nonresidential investment. To a great extent, the boom of the late '90s was a telecommunications boom.
By the same token, the bust of the early 2000s is being driven largely by a collapse in telecom. The industry has lost an estimated $2 trillion in paper value on the stock market--more than eight times what it cost to bail out the savings and loan industry a decade ago. New investment capital, vital for innovation, has dried up. In the first six months of this year (i.e., before WorldCom's bankruptcy) telecom lost 225,000 jobs, one-fifth of the total jobs lost in the country. And with thousands of miles of excess capacity in fiber-optic cable, and as much as $500 billion in questionable debt, the industry may continue to hemorrhage value and jobs for the foreseeable future--potentially imperiling the country's overall recovery. Says former Federal Communications Commission (FCC) chairman Reed Hundt, "If the communications sector doesn't start attracting investment again, it's going to be hard for business investment in general to increase. And if that doesn't happen soon, the whole economy will begin to shrink again."
The government official most responsible for turning telecom around is the current FCC chair, Michael Powell, son of Colin. Articulate and well-liked on Capitol Hill, Powell was the first choice for the FCC job of former Senator Commerce Committee chair John McCain and House Commerce Committee chair Billy Tauzin. But Powell has proven a disaster. He has equivocated, frustrating even ardent supporters like Tauzin; and when he has finally acted, it has been to prolong rather than shorten the telecom slump. Like Harvey Pitt, the chairman of the Securities and Exchange Commission (SEC), Powell would be ripe for replacement--if his feckless, ideological approach didn't so perfectly reflect the president he serves.
y Powell's own admission, the key to reviving the telecom industry is stimulating the growth and improvement of broadband--the high-speed Internet connections that are widespread in business but have only incrementally made their way into consumers' homes. High-speed Internet connections--carried either over cable TV lines or phone lines (called DSL, for "digital subscriber line")--could speed the technological convergence between the phone, the computer, and the television and spark new investment in hardware, software, and infrastructure. As Powell himself stated in testimony last month before the Senate Commerce, Science, and Transportation Committee, "Broadband very likely holds the key for the long-term recovery of the telecommunication industry, and indeed our nation's long-term economic growth and its ability to compete on the global stage."
But the growth of broadband is lagging. Eighty percent of businesses connected to the Internet use broadband, but only 12 percent of homes with Internet service do--not nearly enough to spark widespread new investment. The reason is largely that prices for residential broadband remain high. While other kinds of telecom prices--from long-distance and wireless-phone rates to super-high-speed oc-3 lines--have fallen, prices for high-speed cable and DSL connections have actually risen. It costs between $40 and $50 per month for residential broadband, compared with just $10 or $20 for slower, dial-up modem connections.
Why have broadband prices risen while other telecom services are getting cheaper? The answer can be found in the first chapter of most economic textbooks: There is little or no competition among broadband providers. In most areas, the cable company connects residences to the Internet through the TV cable, and the regional Bell company connects businesses through DSL lines. Cable and phone companies rarely compete with one another, and both have effectively discouraged independent service providers (ISPs) like MindSpring or EarthLink from using their connections. Cable companies have often blocked other providers outright, while phone companies have used a variety of tactics--from getting local or state commissions to set prohibitively high rental prices for their lines to sabotaging rival systems by deceiving them about whether Internet addresses were available. In Virginia, when one small town, Bristol, wanted to set up its own broadband system, Verizon lobbyists persuaded the pliant, Republican-controlled state legislature to pass a law prohibiting any town from doing so.
In the older dial-up market, where prices have fallen, there are 15 ISPs for every 100,000 subscribers--everything from AOL to MSN to the small start-up. These ISPs have been the source of innovations like instant messaging. In the high-speed market, by contrast, there are fewer than two ISPs for every 100,000 subscribers. Affiliates of cable and phone companies have a 95 percent share of the broadband market. That lack of competition keeps prices up, demand down, and innovation at bay.
That's the short-run problem limiting broadband's expansion. The long-run problem is that the high-speed services offered by the cable and phone companies are still fairly primitive. During the late '90s fledgling companies laid down high-capacity fiber-optic lines between large cities and even across oceans, but phone companies continued transmitting the "last mile" of connections--i.e., from local hubs to individual residences or businesses--through slower, lower-capacity copper wires. This isn't a problem for telephone conversations, which transmit a relatively small amount of information at a slow speed. But it's a major problem for broadband, which transmits huge bundles of information and can be greatly slowed down by copper wires. Nor is widespread broadband access over cable lines a solution: Like copper phone lines, cable is a relatively low-capacity conductor, and the speed of delivery slows dramatically as the number of users grows. (If you subscribe to broadband through your local cable system, cross your fingers that your neighbors don't follow suit.) To achieve its potential, broadband providers need to "uncork the last mile," extending fiber-optic connections to office buildings and residences. But so far, the Baby Bells, which own the wires, have proved reluctant to replace them. And why should they? Lacking competition, they have little incentive to improve or innovate.
here are solutions to these problems, some fairly obvious. As Americans first learned a century ago, the way to encourage competition in an industry that tends toward natural monopoly is through strong government regulation. That is the long-standing purpose of antitrust laws. In this case, the FCC has the power to force the cable and phone companies to open their lines--for a reasonable price, of course--to the competing Internet providers trying to enter the high-speed market. The problem of wiring the last mile is a trickier one; but here, too, the government could adopt measures like those it has traditionally used to encourage new industries. Just as it helped develop the railroad, automobile, and airline industries by subsidizing the construction of rail, roads, and airports, the government could subsidize the last mile of the information highway, either through tax breaks or outright grants. (Former FCC chair Hundt and others have urged exactly this.) By so doing, the government would also preserve its right to demand open access to the broadband infrastructure it had helped create.
But Powell, backed by the Baby Bells and the cable companies, has rejected these forward-looking solutions in favor of a simplistic mantra of "deregulation." "Deregulation is a critical ingredient to facilitate competition," Powell announced when he was nominated last year. But Powell's brand of deregulation protects the Baby Bells and cable companies from competition in the illogical hope that they will invest in new technology to improve transmission. Far from increasing competition, it will reinforce the trend toward monopoly.
t first, Powell's deregulatory crusade was largely rhetorical, but this year he began to take action. In February, Powell, who enjoys a three-to-one majority on the FCC, announced a "proposed rulemaking" on "telephone-based broadband." According to the FCC's decision, telephone-based broadband services are "information services, with a telecommunications component, rather than telecommunications services." The distinction sounds semantic, but it has profound legal implications. According to the Telecommunications Act of 1996, telecommunications services have to grant open access to their facilities, but information services do not. By defining telephone broadband as an information service--a designation originally intended for content providers like LexisNexis--the FCC removed it from regulation, allowing the Baby Bells to ban other ISPs from transmitting over their lines.
The next month Powell struck again--getting his majority to declare that cable-based broadband was "an interstate information service" and not either a "telecommunication service" or a "cable service." Here again, by defining cable broadband as an information rather than a telecommunication service, Powell permitted cable to ban other providers from using their lines. Moreover, by defining cable as an "interstate" information service rather than a "cable service," he removed it from any local regulation over prices and service. Michael J. Copps, the sole dissenter on Powell's FCC, said of the March decision, "Make no mistake--today's decision places these services outside any viable and predictable regulatory framework." Or as Governing magazine put it, the decision means "local governments won't be able to enforce customer service standards."
Lately, as deregulation has been discredited by scandal, Powell has openly espoused the end to which deregulation was the means. In an interview last month with The Wall Street Journal, Powell admitted that he favored major (supposedly innovation-spurring) consolidations in the telecommunications industry along the same lines of those the defense industry underwent in the '90s. During the '90s the defense industry was reduced from about a dozen to three giant firms: Lockheed Martin, Raytheon, and Boeing. By that logic, the telecommunications industry would consolidate into a handful of firms based on the Baby Bells. But as Mark Cooper of the Consumer Federation of America has noted, the two industries are hardly analogous. Defense firms contract primarily with a single buyer, the U.S. government, which enjoys substantial leverage over them. They are thus intrinsically subject to government oversight. Phone and cable monopolies, by contrast, contract with millions of unorganized consumers who, in the absence of a vigilant FCC, can't exert much influence over them.
If you want an analogy for what Powell is trying to do, you have to look at the Bell system before the breakup of AT&T in 1982 or to the French telecommunication monopoly in the '90s. AT&T was broken up partly because its monopoly was stunting innovation and removing competition. Long-distance prices fell 40 percent in the decade after AT&T's breakup. Similarly, French Telecom once boasted about its Minitel network, which since 1981 provided text-based, monochrome information services. But by the mid-'90s its monopoly held back the introduction of the Internet, a far better medium for conveying information. The U.S. telecom industry could eventually suffer similar obsolescence under Powell's plans for new consolidated regional monopolies.
Indeed, U.S. failure to wire the last mile is already undermining its telecom industry in relation to competitors in South Korea and Canada. South Koreans, for instance, are currently four times more likely to have broadband than are Americans; and South Korean telecom companies are now in a position to leapfrog their American competitors in Internet technology in much the same way American telecom firms leapfrogged the once-formidable Japanese during the '90s. (This, too, was largely because the Japanese were held back by a national monopoly, NTT.) Falling behind in telecom technology won't just mean American consumers have to wait for affordable broadband service. It will mean, as Powell himself argues, that the telecom industry will likely remain in the doldrums--and perhaps keep the overall economy there with it.
In June, when the Los Angeles Times asked Powell what he considered his greatest accomplishment at the FCC, he responded, "I'm still here." It was a joke that could just as easily have been made by Paul O'Neill at Treasury, Harvey Pitt at the SEC, or Lawrence Lindsey in the White House. Powell is yet another Bush administration appointee who has not measured up to the daunting challenge of a downturn that has swept away many of the gains American industry made in the late '90s. Powell may indeed survive. Sadly, the American telecom industry--and with it, hopes for a near-term economic recovery--may not.
John B. Judis is a senior editor at TNR.
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