Slicing Telecom the Right Way: Making a Real Market is the Best Cure for Monopoly

Mergers involving SBC and Verizon and a recent Supreme Court decision exempting cable-modem companies from open-access regulation have reignited fears of market domination in the communications industry. Even though technology is transforming the industry, some consumer and regulatory groups think that we're still not far removed from the monopoly days of AT&T.<?xml:namespace prefix = o ns = “urn:schemas-microsoft-com:office:office” />


Indeed, we are too close to those bad old days, but this is why we should want larger and more integrated networks, and not more regulation.


First, let's dispel the old illusion that telephone service ever was a “natural monopoly” needing political regulation. In the early 1900s, rival companies were stringing lines to as many households as they could sign up. But Ma Bell, through a well-funded public-relations campaign, successfully persuaded the public that telephone technology was “different” – a “natural monopoly” that wouldn't be viable in an open competitive market. In an antitrust settlement with the Department of Justice in 1913, AT&T brokered a sweet deal: In exchange for exclusive territories and “reasonable” profits, it would provide the nation with efficient, reliable and uniform telephone service.


For many years, <?xml:namespace prefix = st1 ns = “urn:schemas-microsoft-com:office:smarttags” />America's telephone network was the envy of the rest of the world. Even that salutary experience with regulation, however, also demonstrated that regulated monopolies increased prices and stifled innovation. By the mid-1970s, even AT&T's legions of lobbyists could not hide the fact that new technologies—the development of computers and new transmission technologies using microwaves, satellite, and optic fiber—had radically undermined whatever logic might ever have existed for monopolized phone service.


After another antitrust investigation, AT&T agreed to break up its vast, vertically integrated telephone, research and equipment-manufacturing units.


While encouraging competition in long-distance services, the Bell breakup left in place the geographic phone monopolies at the local level. Instead of solving the problems of one national monopoly, the breakup perpetuated monopolies at the local level.


Chef's Choice


Stratifying the AT&T monopoly into local and long-distance service segments- like a chef snaps green beans into separate horizontal sections—ignored the efficiencies of vertically integrated networks. The reformers would have been wise to have considered a julienne style of breaking up AT&T. By splitting the industry vertically, they would have allowed full-service end-to-end operations while dividing the business between two or more competitors.


End-to-end networks are valuable because they provide operational control for their owners and a seamless experience for the user. With the telephone network, there was never a good reason to force local telephone customers to pick their long distance carrier. The new Baby Bells would have competed nationally for all services.


AT&T's divestiture, like its original monopolization, did not encourage competition. There was still one network, although its operations were run locally by regional Bell companies connected to each other through AT&T's long-distance service.


Yet networks, by their very nature, transcend geographical boundaries. Government regulations prevented companies on either side from taking advantage of the great efficiencies associated with operating an end-to-end network. The “last mile” connection between homes and businesses and the rest of the telephone network became the logjam that the alternative competing-network reform concept would have avoided.


Jamming Networks


Confusion about how best to reform over-regulated network sectors is not unique to telecommunications. Many reform efforts in networked industries have left critical components frozen. Electric utilities and airlines, for example, are now encountering problems similar to those that bedevil telecom. Electricity blackouts, airport congestion, and the seeming inability of telephone companies to provide broadband service over that last mile to American homes all reflect the same problem. Freeing up part of an integrated network encourages greater efficiencies, selective price cuts and thus expands demand. But then that expanded demand requires new investments in grid capacity. Without freeing the grid they use, the service providers have little incentive to design and invest in capacity expansion.


Federal law long restricted AT&T from leveraging its monopoly into other networks, which slowed the adoption of new technology. Bell Labs would come out with amazing new discoveries, but unless they had a direct application to the telephone system, AT&T could not utilize them. AT&T was frozen into wireline services, even though AT&T's own scientists were creating communications satellites, cellular telephones, laser-light transmission over glass-fiber cables, digital transmission of voice and data and other technologies that could have been used much earlier if AT&T had been allowed to use them.


At the time of divestiture, AT&T had a promising advanced-communication service called Net-1000 that eventually faltered without a completely connected end-to-end network. If this or other data services on the telephone network could have been developed more quickly, the old telecommunications infrastructure might not be so far behind in the Internet economy.


Free to Compete


Despite regulatory miscues, new technology is carrying the day anyway. Competitive cable and wireless networks have emerged outside the regulated landline sector. These competitors are largely free to manage themselves as fully integrated networks. The cable industry is leading the way toward a julienne-style product with a vertically integrated network and is offering voice, video and data in one service bundle.


Phone companies should have the same right. Regulators should allow the traditional wireline companies to merge with long-distance companies and create vertically integrated networks.


Regulators and consumers alike should support the right of local and long-distance phone companies, cable companies, computer companies to merge or make any other business combinations that seem promising to them. They also should cheer the Supreme Court's recent ruling exempting cable broadband companies from the requirement that they allow competitors access to their network infrastructure because it might provide a precedent for phone companies to win the same freedom.


Cable companies are aggressively entering the Internet phone (known as VoIP) market, leveraging their networks and 108 million homes in ways that would have been impossible were they regulated like the AT&T monopoly. The government should extend this competitive freedom to the Bell companies also.


New technology has created an environment allowing cable, telephone and wireless companies to compete with each other. Government regulators should stop treating them as if they are different.


It's time for state and federal-telecom regulators to take a cooking lesson: If they had sliced the industry vertically, julienne-style, consumers would already be enjoying the benefits of fierce competition and greater investment in the telecom infrastructure.