TCS Daily

The Inflection Point

By John W. Mayo - April 30, 2003 12:00 AM

As the FCC draws up the order implementing its February 20 decision on phone network access, competition in the telecommunications industry is at an inflection point. The vast majority of the Bell operating companies' lines are now allowed to carry both long distance and local telephone traffic, a re-integration that is effectively ending the era of "local" and "long distance" markets. We are moving instead toward an "all-distance" market, and FCC rulemaking will determine whether or not that market is characterized by competition.

Meaningful all-distance competition that gives consumers real choices requires the presence of a number of active competitors who can provide the entire bundle of services. Importantly, before you can be in all-distance, you must first be in both long distance and local. Thus, to maximize consumer options, the FCC must foster an environment in which competitors can enter and thrive in the local portion of the bundled offering.

Establishing viable local competition, though, is no easy task. As we all learned in Econ 101, monopolists do not willingly cede their monopoly power. Since passage of the Telecom Act of 1996, the incumbent local exchange companies have used every means at their disposal to retain control of the monopoly components of the local exchange network. Their tactics have included: attempts to charge new local exchange entrants interconnection rates that reflect historical (rather than economically efficient, forward- looking) costs for network access, attempts to establish differentially lower wholesale rates to their own retail local exchange operations, and discriminatorily providing lower quality provisioning of lines to non-affiliated new entrants relative to their own local exchange operations.

These tactics are understandable (and predictable) as one can hardly expect the incumbents to lead the charge to open the local exchange network, a change that can only reduce the incumbents' profit.

That is why regulators at both the federal and state level must actively and unwaveringly adopt policies designed to enable local exchange competition. And, fortunately, that is what the FCC majority agreed in its February 20 vote to enable competitive carriers to continue to access the UNE-P platform. The Commission must uphold that instinct in crafting its order.

The 1996 Act conceived three potential ways in which new local exchange companies might enter the market. First, the Act permits new entrants to build their own parallel networks. Second, the Act permits new entrants to simply buy the retail services of the incumbent monopolies and resell the unaltered services at retail. Finally, and most creatively, the Act conceives that new entrants may enter by purchasing various elements of the local exchange network while self-provisioning others. The Act requires that incumbents unbundle these elements, creating "unbundled network elements," or UNEs, that new entrants can purchase at economically efficient rates. To the extent that some new entrants have not been in a position to self-provision any of the local exchange network elements, to date they have been permitted to purchase the entire array of elements as a "platform," or what has become know as a UNE-P.

Because local exchange telephony consists of an assortment of urban and rural markets, residential and business users, and small and large customers, the optimal entry path will generally evolve as a combination of total service resale, UNE-P and facilities-based investment. Policy measures that intentionally, or even unintentionally, inhibit or retard any of these entry pathways will doom the Act's goal of promoting the emergence of local exchange telephone competition. That is why the FCC's vote to maintain UNE-P was so critical.

The Bells had sought to block this path, arguing that by making UNE-Ps unavailable, new entrants will choose to enter the local exchange industry by greater initial investments in their own facilities.

But this argument is completely contrary to sound business practices. Rational firms seek to enter markets without investing huge amounts of capital in the event that the market foray is unsuccessful. In this instance, the availability of UNE-Ps allows new entrants to avoid the huge sunk costs that accompany facilities-based provision of local telecommunications services. Over time, as new entrants are able to develop stable and loyal customer bases, these new entrants increasingly are able to - and will - efficiently invest in their own facilities and free themselves from reliance on the incumbents' facilities.

Importantly, this pathway to a more robust, facilities-based competition is not a theoretical concept but a proven proposition. The successful development of competition in the long-distance marketplace followed exactly this path, when in the 1980s the Federal Communications Commission facilitated the ability of new entrants to resell the facilities-based offerings of the then-incumbent AT&T. The result was a flood of new entry and the subsequent investment in facilities by MCI and Sprint.

Today, this approach is beginning to produce benefits in those local marketplaces where state regulators have unequivocally opened all entry paths. For example, SBC Ameritech has responded to competition in Illinois with price cuts that will save consumers $24 million per year. It has similarly cut prices by up to 33 percent in Michigan and the Competitive Telecommunications Association, CompTel, has recently performed an analysis indicating that the emergence of vigorous local exchange telephone competition could save consumers up to $9.24 billion in local telephone bills.

Thus, if policymakers seek to enable competition, it is critical that they develop and maintain policies that facilitate low sunk cost entry methods. This standard business principle has important implications for policymaking. In particular, should the FCC's upcoming order in any way make the rates, terms or availability of UNE-Ps less attractive, the end result will be a reduction in local exchange competition - and ultimately in all-distance as well. Attempts to create additional investment in the local exchange arena by making the low-sunk cost UNE-P option less available or less attractive will simply end the entry process. Eliminating UNE-Ps would be tantamount to strapping on leg weights to prospective swimmers and saying "jump in, if you survive you will be a strong swimmer." The rational choice by the prospective swimmers (new entrants) will simply be to not "jump in."

Competition in the telecommunications industry is at a critical juncture. Some amount of competition, particularly for high-end business companies has arisen, but roughly 90 percent of all households remain under the thumb of incumbent local exchange companies without meaningful alternatives for local telephone service. Any wavering by regulators in the commitment to competition-enabling policies and open, economic access to UNE-Ps in particular will mean fewer choices for consumers - not just at the local level, but in all-distance as well. What's at stake is nothing less than the competitiveness of every segment of the evolving telephony marketplace.

John W. Mayo is Dean and Professor of Economics, Business and Public Policy, McDonough School of Business, Georgetown University. This column is based on his recent paper "Is it the Long Run Yet?"

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