Thursday, April 19, 2007

Government Rent Seeking Versus Commercial Profit Seeking

Managers of commercial ventures invariably have to decide the proper balance of profit seeking investments and efforts versus seeking benefits (rents) from various government programs. For example, a professional sports team might leverage the possibility of leaving a city if the local or state taxpayers do not underwrite construction of a new stadium.

In telecommunications incumbent carriers have engaged in similar leverage: limiting investment in next generation networks unless and until government creates financial incentives or other inducements, e.g., removing “regulatory uncertainty” which might just mean unfavorable and costly regulatory obligations. For example, a telephone company might not build a fiber optic network capable of providing video competition with incumbent cable television ventures in a particular state or region unless and until the newcomer can avoid having to secure operating authority (a franchise) from each and every municipality within which the newcomer wants to operate. I understand that CEO of one major telephone company opted to “punish” the state of Illinois by targeting other states for new technology trials.

The tension between rent seeking and profit seeking has adversely affected the pace of next generation network deployment. Too many actual or prospective investors recognize the benefits in seeking government-generated incentives to invest. It becomes difficult to determine when competitive necessity would have forced an investment without government assistance and when incentive creation was necessary.

The recent substantial infusion of capital investment by incumbent carriers into next generation networks may evidence a healthy response to the elimination of unbundling and below market access pricing regulations. But it just as readily may evidence the fact that incumbent ventures, cable television and telephone companies alike, could not longer rely on core and previously captive revenues streams.

How much longer could the incumbent local exchange telephone companies see declining local voice service revenues, before they had to find and serve new profit centers? When stakeholders demand government incentives, it probably makes sense to ask whether the stakeholders would make the investment and take the risk without special accommodations.

Wednesday, April 18, 2007

Bandwidth and Throughput Math

Part of my current research agenda involves a comparative assessment of U.S. broadband market penetration and next generation network deployment. I am glad to note that the incumbent wireline carriers, such as Verizon, belatedly have invested billions of dollars. But on the other hand, because I live in the hinterlands I can get broadband at staggeringly high rates compared to what other consumers play in U.S. cities and in other nations. So I see a mixed bag corroborated by the relatively poor comparative performance of the U.S. in unbiased measurements of market penetration, digital opportunity and network readiness conducted by the International Telecommunication Union, see,category,Broadband.aspx; the Organization for Economic Cooperation and Development, see,2340,en_2649_34223_37529673_1_1_1_1,00.html#Data2005; and; and the World Economic Forum, discussed in a previous blog entry.

Part of the challenge in this research lies in normalizing the data, i.e., comparing apples to apples, and deciding what constitutes success. The data compilations consider most helpful identify the number of subscribers per 100 residents, a broadband measure of “teledensity,” and the cost per 100 kilobits per month. See the ITU’s Digital Life Internet Report,

But even before one looks at the data, it makes sense to achieve consensus on the definition of terms such as bandwidth and throughput. Ironically the much maligned Senator Stevens from Alaska got it right: the Internet is a bunch of tubes or pipes. For the Digital Literacy course I teach at Penn State I analogize bandwidth as the size of the pipe, e.g., half-inch bathroom pipe versus 12 inch water main pipes. For throughput the pipe analogy considers the number of gallons that flow through the pipes per minute.

I am trying to consider the value proposition of broadband access in terms of available bandwidth (dedicated or shared), the likely throughput and aggregate usage per month. This is where the math and the value proposition get curious. You might not know that cable systems typically allocate only 6 MegaHertz of bandwidth for shared Ethernet-type access to the Internet. So if I am sharing 6MHz or less with hundreds of other subscribers, my virtual bandwidth allocation is quite small, even though I get multi-Megabit per second throughput and “All You Can Eat” uncapped access. Bear in mind that dial-up Internet access derives about 50,000 bits per second (50kbps) from an allocated bandwidth of 3-4 kiloHertz. For DSL, the dedicated copper local loop bandwidth expands by about 1.25 MHz. See

Internet access subscribers actually care little about bandwidth except for its impact on about throughput, the number of downloadable and uploadable bits per second. But getting back to the value proposition, the ITU (in the Digital Life publication) ranked the U.S. 10th globally in terms of prices per 100 kilobits per second for 2006 using a $20.00 monthly subscription. Because I pay double the imputed rate, my value proposition would rank about 18th globally. Of course if you can get multi-megabit per second service for less than $20 a month, your value proposition is better than the national average

So the U.S. has some ways to go before government and carrier officials can self-congratulate. Still no one in the U.S. can come close to the global best practices of $0.07 per 100 kbits/s in Japan. Put another way the average U.S. broadband price is 700% higher than the Japanese average.

Tuesday, April 17, 2007

The Dark Side of Intelsat's Privatization

Once upon a time Intelsat operated as the International Telecommunications Satellite Organization, a global cooperative, with small debt and the ability to borrow more at near governmental rates. Intelsat dominated the global marketplace primarily because its government "signatories" agreed not to cause the gooperative "significant economic harm" by authorizing competing systems.

The U.S. government properly determined that satellite competition could occur without harming Intelsat's mission as the carrier of last resort. PanAmSat and other ventures thrived and Intelsat adapted to change, ultimately becoming a private venture. Ironically the privatized Intelsat subsequently acquired it former nemesis PanAmSat.

Intelsat never got around to an Initial Public Offering of stock as it became an easy mark for private equity investors who now seek to cash out their $515 million investment with an expected 6 billion dollar sale. Along the way Intelsat lost its blue chip debt risk, because the private equity players saddled the venture with $11 billion in debt.

The dark side of Intelsat's privatization is the extraordinary leverage risk undertaken by Intelsat's private, unregulated investors. In the satellite marketplace few players can come up with the equity and debt necessary to construct, insure, launch and track a constellation of satellites. A back of the envelope cost is about $300 million per satellite. The undertaking has significant risks, exacerbated by the statistic that on average one of three satellites fail to reach orbit or otherwise become operational.

While I generally endorse privatization, in Intelsat's case, the private equity gambit has left the venture at greater risk than prudent in light of the extraordinary role performed by the very few global satellite players that remain. For many nations off the major telecommunications grid, with little or no access to fiber optic cable trunks, Intelsat serves as the only carrier capable of providing global connectivity.

How ironic that the United States government worries about the prospect of a competing non-American global positioning satellite navigation system, but has no concerns about the extraordinary leverage risk Intelsat has incurred.

Monday, April 16, 2007

Review of Latest Sidak Piece on Network Neutrality

Even as the piece probably will induce significant mashing of teeth among network neutrality advocates, I strongly recommend a recent article by Greg Sidak entitled A Consumer-Welfare Approach to Network Neutrality Regulation of the Internet; available at: It’s a comprehensive document with many compelling and legitimate points.

I am not completely opposed to “access tiering” if an ISP can offer complete end-to-end enhanced routing without violating Service Level Agreements and without deliberately dropping packets and degrading service to “regular” peering and transit users. Greg makes some fair points about the right of a network operator to discriminate on price and QOS both downstream to end users and upstream to other ISPs and content providers. I’m not sure how this can be done in light of existing peering and transit agreements, which are largely best efforts, but the potential for a complete end-to-end, “better than best efforts” exists.

He and I part company on a number of issues including his conclusion that the broadband access marketplace is robustly competitive and therefore there is no risk of price squeezes, anticompetitive pricing of access tiering, collusion, etc. Greg sees a competitive marketplace, based on the inclusion of dial up Internet access and based on the FCC’s broadband penetration statistics. I don’t agree that VoIP easily routes via POTS Internet access, particularly because Vonage and others state their service requires broadband access. The FCC’s use of zip codes is a very flawed measure for determining whether consumers have competitive options. The zip code measure attributes access in terms of numbers of ISPs if even one potential subscriber exists, regardless of price. So just about every zip code area has satellite access despite the lack of significant cross-elasticities between a $100 a month service and a $50 service. BTW Greg reports an average price of $25 for broadband access! I’m paying $60, but then again I’m one of the extraordinarily rare U.S. consumers in one of those rare rural zip codes that has one and only one option, cable modem service, unless you include DBS.

Greg reiterates much of the private property common law taking arguments to justify the premise that network operators should have total control over their networks including the right to deny interconnection, refuse to carry specific content or applications, including unaffiliated ventures’ VoIP traffic, and the option of vertically integrating and favoring corporate affiliate’s traffic. He does not give much credence to the rights of DSL/cable modem subscribers to expect an unfettered bitstream pathway to the Internet cloud.

I was confused by Greg’s extensive examination of the Madison River case and his apparent endorsement of the lawfulness in a network operator’s option of blocking downstream carriage of specific bitstreams. He does not acknowledge that the FCC could engage in an enforcement action only because Madison River falls under Title II of the Communications Act, as a telecommunications service provider and not an ISP. Madison River refused to terminate telephony traffic. I don’t think Title I would have the same force as Title II if an ISP refused to terminate traffic, particularly if the traffic is deemed part of an information service.

Lastly I did not see much discussion of whether a network service provider has the ability and inclination to drop packets and create congestion. Absent robust inter-modal competition an ISP could accrue monetary benefits by punishing ventures that do not agree to take more expensive routing options and who trigger robust demand for their services by end user DSL and cable modem customers.


William B. Petersen, President of Verizon Pennsylvania visited the College of Communications at Penn State where I teach. Mr. Petersen's presentation was entitled "Broadband Services Convergence: The Benefits of a 'High Fiber' Diet." No dispute there.

Mr. Petersen, an affable fellow, blamed "regulatory uncertainty" for the relative poor progress in broadband market penetration that occurred in the decade following enactment of the Telecommunications Act of 1996. While I could have noted that Verizon and other incumbents surely contributed to the uncertainty through endless litigation, I chose to question Mr. Petersen's allegation that the courts always supported the Bell point of view in such litigation.

That's not how I read the case law. Yes the courts on three occasions reversed the FCC on the scope and level of unbundling obligations. But the Supreme Court on two occasions endorsed the FCC's implementation of a Congressional mandate to promote competition. In AT&T Corp. v. Iowa Utilities Board, 525 U.S. 366, 119 S.Ct. 721, 142 L.Ed.2d 835, 67 USLW 4104 (1999) the Supreme Court largely upheld the Commission's implementation of the Congressional mandate contained in Section 251 of the Telecommunications Act of 1996 as a reasonable exercise of its rulemaking authority, including its requirement that ILECs unbundle network elements and offer CLECs the opportunity to pick and choose from an ala carte menu or platform of elements. The Court also ruled that in identifying which network elements ILECs should unbundle, the Commission did not limit the set of network elements to those necessary to promote competition whose absence from the list might impair ILECs' ability to compete.

In other words the Court did not deem unconstitutional the Congressional mandate of unbundling. The Court also largely deferred to the FCC's dtermination how to price these unbundled elements. In Verizon Communications, Inc. v. FCC, 121 S.Ct. 877 (2001)
the Court rejected incumbent local exchange carrier arguments that using a theoretical, most efficient cost model, instead of actual historical costs, constituted a taking that violated the Fifth Amendment. The court noted that no party had disputed any specific rate established by the TELRIC pricing model and concluded that “[r]egulatory bodies required to set [just and reasonable] rates . . . have ample discretion to choose methodology.” Additionally the Court stated that the ’96 Act did not specifically require historical costs, particular in light of its explicit prohibition on the use of conventional “‘rate-of-return or other rate-based proceeding’ . . . which has been identified with historical cost ever since Hope Natural Gas was decided.”

Mr. Petersen appeared to dismiss these cases as nothing more than Chevron-type deferral to agency expertise, something he surely must have welcomed in the Brand-X case. These cases do more than indicate the Court's unwillingness to second guess the FCC. Federal courts have made a sport of second guessing the FCC, particularly its implementation of the '96 Act.

I read the two Supreme Court cases as a fundamental endorsement of the lawfulness of the '96 Act's model for promoting competition. The law failed in part, because the ILECs simply would not go along with the transition, instead prattling on about "confiscation" and "taking of property." Indeed Mr. Petersen hailed Korea as an example of where competition flourished, ignoring that the incumbent cooperated thanks to the heavy hand of government stewardship in that country.

The point here is that hindsight in telecom policy does not offer 20-20 vision. The laws that Verizon and other incumbents help draft did not offer the expected payoff. The litigation that Verizon and other incumbent initiated did not absolve these carriers of having to interconnect and price access elements at below market rates.

We can dispute the wisdom of a Congressional mandate for cooperation among competitors--a fundamental concept in common carrier-- and the terms for such access. But it surely comes across as revisionism of history and case precedent to claim the courts invalidated the Congressionally created scheme.

Sunday, April 15, 2007

World Economic Forum Network Readiness Index--U.S. Drops From 1st to 7th

For the better part of a decade local exchange carrier management claimed that regulatory uncertainty and unbundling obligations removed incentives to build next generation networks. Since 2006 the FCC has created an information services "safe harbor" that insulates carriers from having to unbundle, share or interconnect. There is absolutely no common carrier obligation for broadband fiber and greenfield installations.

So it comes as a surprise to me that despite plenty of incentives to invest, including lost market share and revenues for local voice services, the WEF Network Readiness Index shows U.S. carriers as comparatively losing ground:

I appreciate that the WEF offers but one measure, but I would place more creditability to this index than say U.S. New and World's Reports' college rankings. Do Verizon and AT&T need more incentives, does the universal service fund need to expand coverage of broadband, is the U.S. suffering from a broadband duopoly regardless of what the FCC says in its zip code based measure of 200 kbps or higher "broadband" competition?

What accounts for a 7th place ranking in network readiness? Hmmm, good question.

I believe our leading telecommunications service providers no longer operate with global best practices. They haven't had to for so long. Even before enactment of the Telecommunications Act of 1996, and certainly since then, the major U.S. carriers have found it easier and more lucrative to compete in the court room instead of the marketplace. It's been too easy to demand and receive incentives to invest in next generation facilities and services.

Carriers such as Verizon and SBC had seats at the tables where the '96 Act was crafted and these carriers agreed to a simple quid pro quo: agree to lose local exchange service market share by cooperating in the introduction of competition and in turn the market access prohibitions contained in the 1956/1982 divestiture of AT&T (know as the Modification of Final Judgment) would evaporate. In other words the Bell Companies had to unbundle their local exchange network and interconnect with the competition at below market rates in exchange for access to long distance markets. As it turned out the long distance market did not prove lucrative enough to satisfy the Bell Companies, so they immediately refused to comply with the deal they cut. Putting it in its best light the Bell Companies tirelessly litigated the meaning of what they had agreed to.

So in a sense the Bell Companies willingly help create the regulatory uncertainty they claimed as foreclosing investment in next gen networks.

There's little regulatory uncertainty now, so I'd appreciate hearing from you the reasons for the decline.