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MCI’s Layered Approach: A Horizontal Leap Nowhere

Issue Analysis

Title

MCI’s Layered Approach: A Horizontal Leap Nowhere

Cox Chapter in Free Ride: Deficiencies of the MCI ‘Layers’ Policy Model and the Need For Principles that Encourage Competition in the New IP World

A new policy framework by MCI recommends a paradigm shift in telecommunications toward regulation based on how the Internet operates.1 MCI has even gone as far as drafting proposed legislation to codify its approach.2 Dubbed the “Network Layers Model,” MCI’s proposal builds upon an academic movement that has been gaining increasing visibility due to the obvious need for telecommunication regulatory reform. Rather than regulate by service categories, the network layers approach utilizes the structure of the Internet as the model for deciding what and how to regulate.

On its face, the layers model is a seductive analytical tool that improves upon the current lack of cohesiveness in telecom regulation. It breaks down policy goals by network layers – physical, logical, application, and content – and advocates for regulation that is specific to each, regardless of the technology used or service provided. However, what is a superior analytical tool for network engineers is not necessarily good for network regulators. The layers model does not translate to effective public policy because it is burdened with the same regulatory traps of current law – it retains too much faith in the capability of government regulators to beneficently intervene in the market. In particular, it places an inordinate amount of emphasis in antitrust law to improve consumer welfare and it ignores the reality of how markets respond to consumer demand and preferences. Under MCI’s proposal, the physical network is at the same time overburdened and underappreciated by regulation.

The Network Layer as FCC, DOJ, and FTC Playground

The layers model assumes that the physical network is a natural monopoly that requires extensive regulation. In this way, the layers model is, as MCI’s policy paper asserts, “not a radical departure from the basic regulatory structure and precedent of the last four decades.” 3 Indeed, this is a problem, though the paper presents this as a positive. The difficulty is one of defining “market power” and how to test for its existence .4 Antitrust law has not been very good at solving this problem, as much as its proponents would like to proclaim that it has. Defining the “relevant market” for antitrust purposes is as much of an arbitrary process as the current silo service definitions are for telecom law.

The fundamental goal of the layering principle is to “focus on where the concern lies ... and then determine how best to achieve the goal without disrupting other layer-affecting objectives.”5 The overriding concern of MCI, as expressed in both its policy paper and draft legislation, is in the network layer. Indeed, the bulk of the MCI’s draft text consists of a section on broadband access platforms competition, which is none other than the broadband equivalent of the Unbundled Network Element (UNE) system currently in place for “traditional” telecom. And it seems to guarantee that changes in technology will affect changes in law without the concomitant assurance that government regulations will change quickly, if at all.6 

Layer Regulation Will Not Necessarily Increase Consumer Welfare

The layers model cannot translate to effective public policy because it mandates a business model. Cable or telephone companies may in the future wish to establish “closed” networks, and doing so may indeed be within the interests of consumers. Peter Huber presciently asserted in 1987 that “as networks expand horizontally the companies that manage them grow vertically” in response to consumer demand for a single provider of integrated service packages.7 A portion of this vertical development may be in response to the needs of a provider to effectively price differentiate in an industry affected by declining marginal costs.8

The layers model invites overly ambitious regulatory scrutiny when a technology provider attempts to operate within more than one layer. Often, tying applications to network infrastructure may be the only way to pay for the network. A critical question is whether the network is financially viable based on connectivity revenues alone. Price discrimination is often an effective (albeit misunderstood) way to increase consumer welfare. It may be necessary to meter consumer usage by measuring intensity of use at one layer through controlling another layer. Market segmentation may require multiple layer control, depending on what consumers value and are willing to pay.

Advances in technology often result in the increasing commoditization of products, resulting in increased consumer welfare. Regulators should focus on ways that will allow providers of commoditized products to thrive, instead of saddling them with “open access” and “common carrier” burdens. A new telecom act must protect the ability of telecom providers to quickly respond to and operate within a dynamic environment. However, the layers model may be just as rigid as current law in allowing the market flexibility in pricing and service, especially at the network level. The MCI paper quotes Lawrence Lessig and Timothy Wu at an FCC hearing:

If this ‘Darwinian evolution’ is the best path of innovation, it follows that the most promising path of development will be difficult to predict in advance. Hence, despite the ‘waste’ generated by a competitive process, the results will be superior to planned innovation directed by a single prospect holder, however well-intentioned.9

The largest “prospect holder” under the layers approach is the FCC. This is not a horizontal leap forward for the telecommunications market or consumer welfare.10

The MCI Draft Legislation – A Regulatory Wolf in Layered Sheep’s Clothing

MCI has outlined its version of what a reformed Communications Act should look like. MCI calls it “The Internet Innovation and Broadband Competition Act of 2004” yet it is very similar to the 1996 Telecommunications Act. The Basic/Enhanced distinction is now Layer 1 (Physical) versus Layer 3 and 4 (Application/Content). The proposed legislation is semantic re-regulation. For instance, is Active X control content or code? It doesn’t make much of a difference under MCI’s current construct, but one can envision the technical definitional matters that a court of law might have to decide and the problems that this would create. Engineers would replace economists in the battle of expert witnesses.

An analysis of MCI’s draft legislation reveals that (italicized emphasis added):

Broadband networks will be subject to continuous and pervasive FCC regulation according to ambiguous standards such as:

“the FCC shal adopt rules and regulations necessary to further foster the development of intramodal and intermodal competition, to the benefit of al Americans.

Waiver of open access requirements upon “no further evidence of market power or other relevant standard and/or at least three other commercialy-viable competing broadband access platforms serve a substantial majority” or if the platform provider can demonstrate that end users are able to fuly exercise their Internet access rights;

Antitrust principles are given prophetic status: antitrust law will play an unprecedented role in telecommunications, using the imprecise Herfindal-Hirschman Index (HHI) and other forms of “anticompetitive practices demonstrating the existence of market power”;

Property rights get no respect: unbundling and price regulation remain by way of extensive wholesale carriage requirements for ISP access, CLEC unbundled access to broadband local loops at TELRIC prices; and

A new subsidy program for broadband and wiretapping access of all Internet communications will invade consumers’ wallets and privacy.

Conclusion

Layered model advocates believe that regulators should reformulate communications policy with the Internet at the center. Instead, what we should be discussing is how to change communications policy so that market forces, instead of government regulators, affect consumer welfare. The free market should be at the center. Ultimately, we want to reduce the role of the FCC in micromanaging the market for communications products and services. The layered model will not lead us toward this deregulatory path. Simply put, layering is an object-to-think-with but not a model-to-regulate-with. The layers principle may excel at respecting the integrity of TCP/IP, but it fails at respecting the integrity of market forces.