Telecomm history and regulation

MGT 825

Brief History of Telecommunications

• 1876: Alexander Graham Bell receives patent for the telephone. Bell speaks the first complete sentence transmitted by a “variable resistance transmitter” (“Mr. Watson, come here. I want you!). The first two way conversation takes place between Cambridgeport and Boston.

• 1878: The first telephone exchange is opened in New Haven CT with 28 subscribers.

• 1885 - - The certificate of incorporation for the American Telephone and Telegraph Company is filed in New York City. Its broad claim...to establish telephone communication to cities on the American continent and elsewhere around the world by wire, cable and "other appropriate means".

• Bell system built out over and between major urban areas in the 1880s-1890s.

• 1893/1894 principal Bell system patents expired. 98 independent commercial telephone systems were established, both in cities that American Bell had originally bypassed and in competition with AT&T.

• Build-out of independent systems peaked in 1907, with independent systems accounting for 50% of telephones (about 3mm). In 1907, 50% of US cities had competing telephone services.

How could this happen if network externalities were

important?• Evidence (Mobius 2001) that

competing systems in cities served ethnically and socioeconomically “islands” of customers.

• 75% of calls social according to data from the turn of the century.

• Many businesses subscribed to both phone networks in a city.

How did AT&T regain its Monopoly?

• By the 1920s, AT&T had regained its monopoly over telephone service.– Acquisitions– Demand forces from businesses who did not want to

subscribe to both.– Bell system extensions and improvements to long

distance service made their local services relatively more attractive– consumers switched.

– AT&T long lines initially refused to interconnect with competing local carriers.

– Predation? (Weiman and Levin 1994)

• AT&T CEO motto: “One policy, one system, one Universal Service”

AT&T divisions (pre-1984)

• Regional Bell Operating Companies (RBOCs)– Provided local telephone service.

• AT&T Long Lines– Provided long distance service

• Western Electric– Provided Equipment

• Bell Laboratories– R&D (invented, among other things, the

transistor)

Early Regulatory History

• By 1925, RBOC price regulations in most states.

• Entry sometimes explicitly forbidden.• Federal Communications Commission

created in 1934.• FCC regulated long distance rates.

Any changes to the service required approval.

Universal Service

• Universal service requirements an important component of state and federal regulations.

• “Universal service” arguably necessitated cross-subsidization in telecomm pricing. – Certainly, urban consumers subsidized rural ones.– Arguably, long-distance/business customers

subsidized local residential service.

• Universal service under the 1996 Telecomm Act includes 411 service, 911 service, touch tone, operator access, & access to a long distance carrier.

What precipitated the AT&T antitrust case?

• Competitors like MCI wanted to enter the long distance market, using new microwave technology.

• FCC allowed limited long distance competition.

• Complex regulatory issues because high long distance rates allegedly cross-subsidized universal local service.

AT&T breakup

• 1974 DOJ filed an antitrust case against AT&T.• 1984 AT&T broken up into

– AT&T Long Distance service• Faced serious competition from MCI, Sprint, others.• Average revenues per minute for interstate and international

calls originating in the United States dropped from 62 cents per minute in 1983 to 10 cents per minute in 2001.

– 7 RBOCs • Remained monopolies in local telephone service and

intrastate toll service.– Often intrastate toll calls more expensive than interstate long

distance calls – Not allowed to enter the long distance market, provide certain

other services, or manufacture equipment.Rationale?

Alphabet Soup

• RBOC: Regional Bell Operating Company

• ILEC: Incumbent Local Exchange Carrier

• ILEC = RBOCs + GTE + SNET + Cincinnati Bell + plus a few others.

Purpose of the 1996 Telecom Act

• Attempt to end the monopoly franchise system governing local wireline calling.

• Set the conditions by which carriers would be allowed to provide local and long-distance services.

• Requirement that ILECs provide network access to CLECs at regulated rates. – Include long-distance, cable, wireless firms.

• Once the local market was shown to be functionally open to competition, the ILECs were allowed to enter the long-distance market, offer TV services, and manufacture equipment.

Other provisions in the Act

• Phase out of price controls on cable TV

• Mandated telecommunications subsidies to public schools.

• Relaxed restrictions on cross-ownership of media properties.

Unbundled network elements (UNEs)

• CLECs to petition FCC for access to the ILECs network. The idea was that CLECs would partially (and perhaps temporarily) use part of the ILECs network, while building out their own facilities.

• For example, cell phone users need to receive calls from and send calls to the local loop.

• FCC to “consider, at a minimum, whether…the failure to provide access to such network elements would impair the ability of the telecommunications carrier seeking access to provide the services that it seeks to offer”

UNEs (continued)

• FCC authority to determine which switches, lines, etc. would be shared and how UNE would be priced.

• Later, FCC required all ILECs to provide all elements of the network “platform” (UNE-P) at regulated rates, allowing CLECs to resell ILEC services.

UNEs pricing

• 1996 Act held that prices charged should be based on cost (Section 252d(1))– Left it to the FCC to define “cost”– State regulators to actually implement

the FCC cost formula

• Cost formula FCC established: Total Element Long Run Incremental Cost (TELRIC)

TELRICForward looking, long-run, (minimized) economic cost

of an unbundled element, including the competitive return on capital.

• “Long run” means costs measured with reference to a period long enough such that all costs are avoidable.

• “Forward looking” means replacement cost rather than historic cost.

• Cost calculation assumes the “most efficient telecommunications technology currently available and the lowest cost network configuration, given the existing location of the incumbent LEC’s wire centers.”

• Fixed costs not directly linked to the element, such as executives, billing costs, etc. can’t be included.

Example

• CLEC wants to rent copper loop into a house from a ILEC

• Payment to the ILEC based on what it would cost to build a brand new copper loop with the most efficient and lowest cost equipment available today, without consideration of what the ILEC actually paid historically to construct it.

• Functionally, its an AC measure. AT&T embarks on a CLEC strategy

Arguments for/against UNEs/TELRIC

• For– More competition is better– UNE-P a possible stepping stone to facilities-

based CLEC competition.– Certain parts of the network may have

natural monopoly characteristics, but other parts don’t. Allow entrant to rent the parts that do.

– ILEC investments were made under a regulatory regime with protected rates of return.

Against

• TELRIC prices discourage facilities-based entry.– Why enter if you can get access to ILEC’s network

on the cheap?• TELRIC doesn’t compensate ILECs for their

historical costs.• State PUCs were “random” in implementing

TELRIC, leading to unacceptable cross-state variation in what ILECs can charge for unbundling.

• TELRIC removes ILEC’s incentives to invest in risky new services/technology– If it doesn’t work out, ILEC stuck paying for it.– If it does work out, CLEC can just rent it at “cost”.

Slow death of UNEs

• Bush FCC chairs not fans of UNEs.– Court decisions limiting the scope of UNEs.

• Bush admin didn’t appeal.

– UNEs deemed not appropriate for broadband infrastructure.

– UNE-P effectively eliminated.

France, Korea, Japan going in the other direction

Telecomm meltdown in local-long distance telephone markets

• As of June 2003, 3.4% of end-users were served over CLEC-owned facilities.

• Most CLECs went bankrupt• CLECs disproportionately serve large

businesses, institutions, and government customers.

• RBOCs have been approved to enter the long-distance markets in all states.

UNE-P CLECs

Facility CLECs

Mergers

• 7 RBOCs -> 3 surviving• Vertical re-integration:

– AT&T – SBC – BellSouth– MCI - Verizon

Why was local and long distance broken up in the first place, and why is it okay to put it back together now?

Some conditions put on mergers—

Net neutrality for a time, naked DSL, etc.