Telecom Time Warp

Calls for non-discrimination rules in telecom arise periodically from disadvantaged groups of rivals. In the late 1960s, the call for regulation came from equipment providers; in the early 1980s, it came from long-distance providers. In the mid-1990s, it was local exchange carriers and Internet service providers. Today Internet telephone, or “VoIP,” providers want help, but to obfuscate their role, they couch it in a deceptive, overused phrase: “network neutrality.”

Unfortunately, some lawmakers and regulators are seriously entertaining these pleas for greater regulation. The FCC is considering service rules for the upcoming 700 MHz-auction sponsored by Frontline, a firm headed by former FCC chairman Reed Hundt, which would impose, among other onerous requirements, a net neutrality requirement on the winning bidder. And today Rep. Edward Markey (D., Mass.), chairman of the House Subcommittee on Telecommunications and the Internet, will hold a hearing on the subject of “wireless net neutrality.”

When the government decided to impose nondiscrimination rules on (the old) AT&T in the late 1960s, AT&T and its local operating companies controlled virtually the entire telecommunications sector. There were no local competitors, no cable companies offering phone service, not even any wireless companies. AT&T was also vertically integrated into the manufacture of telephone equipment through its ownership of Western Electric. Before its breakup, AT&T had both the incentive (due to its vertical integration) and the ability (due to its market power in voice service) to engage in anticompetitive conduct in complementary markets (equipment).

The telecom environment could not be more different today. There are three survivors of the breakup of AT&T’s fixed-wire business, each of which offers phone and high-speed Internet service and is spending billions of dollars upgrading its network to offer video services. Cable television companies have also upgraded their networks so they can offer these services. And the five largest wireless carriers — AT&T, Verizon, Sprint, T-Mobile and Alltel — are also spending heavily so that they can offer high-speed Internet connectivity.

Meanwhile, a cable industry consortium last year spent more than $2 billion in a national wireless auction just to acquire the spectrum real estate that would allow it to become the nation’s sixth carrier offering nationwide wireless phone service. Not to be left out, Craig McCaw and Intel are building a national fixed wireless network, and Wild Blue is offering a competitive service from an innovative satellite launched last year.

What is the likely impetus for all of this new investment? In 2004, the federal courts required the FCC to relax its strict regulation of the Bell companies in part because of its depressing effect on the Bells’ investment spending. And, unlike their European counterparts, U.S. wireless operators have been essentially unregulated since 1993. As a result, U.S. telecom capital spending is surging as various competitors are now moving aggressively to provide high-speed Internet services to consumers who want to receive more than email over a variety of different devices.

To some in Washington, the explosion of investment and entry is interpreted with skepticism and hand-wringing. These worrywarts are pressing for a new regulatory regime of “network neutrality.” This would prevent fixed-wire broadband networks from charging content suppliers, such as Google or YouTube, for priority delivery of their services to consumers, much as FedEx routinely does for packages. It would also prevent these operators from building intelligence into their networks, and instead would require them to meet the coming demand for bandwidth-intensive applications solely with fatter, dumber pipes. Such a policy would surely increase the cost of building next-generation, high-speed networks, which in turn would delay investment and increase the price of Internet service.

More recently, the cry for network neutrality has spread to the wireless sector. Proponents of “wireless net neutrality” seek to prevent wireless operators from imposing limitations on certain bandwidth-intensive applications available over their networks. In particular, the Internet telephony (VoIP) companies, such as Skype and Vonage, want regulators to force the wireless companies to allow their subscribers to access these VoIP services through unlimited data plans, thereby allowing subscribers to completely bypass the wireless network owners’ voice services. This proposal has been developed by Columbia law professor Timothy Wu.

Mr. Wu and his confreres ignore the fact that no U.S. wireless carrier has market power. In fact, competition in this sector is so intense that according to FCC data, the price of a wireless call has declined from $0.43 per minute in 1995 to $0.07 in 2005 — roughly 84% in one decade.

This price decline is a function of the number of options facing wireless customers. The lack of market power for any individual carrier makes price reductions irresistible and any anticompetitive practices unsustainable. If consumers were to find that access to VoIP or any other application would increase the value of their wireless experience, surely one or more of the wireless carriers would find it profitable to offer such a service on their own, but not at a loss. If they were forced to allow the VoIP companies such as Skype or Vonage to bid away their own traditional voice revenues, the wireless carriers would simply raise the price of the data services over which Skype or Vonage would be delivered. The obvious losers from such a policy would be the subscribers who rely upon these high-speed data services for other purposes, such as email or Web browsing.

Like wireline operators, wireless operators generally perceive content innovation to be a good thing: The demand for killer applications will drive the demand for faster (and more expensive) broadband connections. Nevertheless, even competitive wireless operators may at first resist offering a service, such as Internet telephony, because it reduces the revenues that they earn from traditional voice services.

But even if all wireless carriers were to decide to block VoIP services on their networks for the foreseeable future, regulators should take a hands-off approach for a number of reasons.

First, the provision of VoIP over other (wireline) platforms provides an outlet for VoIP providers to achieve the requisite economies of scale. Second, the dramatic decline in wireless prices continues with or without VoIP, and the coming entry of the cable companies into wireless services will only accelerate this decline. Third, regulators cannot require wireless networks to allow new Internet voice services to cannibalize the wireless carriers’ principal source of revenues without inducing the wireless companies to recover their network costs from other charges to their subscribers. There is no free lunch here — networks cost money to build and operate.

Thus, even in the single application in which wireless network owners could be said to compete with unaffiliated upstream suppliers, there is no need for regulation. When viewed in this light, network neutrality regulation should be more aptly named: “Life Support for stand-alone VoIP Providers” who are struggling to compete in a world of declining prices and bundled service packages.

With respect to every other conceivable application, regulation would be completely unnecessary, as wireless network owners lack both the incentive and the ability to engage in discriminatory practices because they have no market power.

The lesson for future content providers — particularly those now seeking network neutrality regulation — is that they should develop content that network owners will perceive as being complementary to their offerings and therefore will add value for their broadband customers. Ignoring this advice will work only as long as the regulators are under the content providers’ thumb.

This is the strategy that Apple’s and Microsoft’s rivals are using in Europe, with little apparent success. It is even less likely to work on this side of the Atlantic, where the regulatory winds that blow in and out of Washington are constantly changing. Eventually, either the FCC or the courts will realize that regulating competitive networks for the benefit of select content providers is not in the interest of American consumers.