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telephone companies
Page 156
18
Funding the National Information Infrastructure: Advertising,
Subscription, and Usage Charges
Robert W. Crandall
Brookings Institution
The stunning changes in information and communications
technologies are focusing attention on the gap between the
potential services available from new telecommunications networks
and the much more limited services now available from our existing
communications infrastructure. While this focus is useful in
galvanizing political support for action, it may divert attention
from the magnitude of the economic task involved in building the
new information superhighway. Investors will be committing enormous
resources to risky new technologies with uncertain information on
future service revenues, the cost of these services, and the
prospect of further technical breakthroughs that could render new
facilities obsolete in a short time.
In this environment, policymakers must be careful not to
foreclose the opportunity to develop new facilities, new services,
and new sources of economic support for both. The federal and state
governments should be encouraged to allow new services to develop
over a variety of distribution systems and to permit vendors of
these services to select the funding mechanisms for such systems or
services. Indeed, it is precisely because we have already begun to
open our telecommunications markets to competition and to reduce
government regulation of them that we are now likely to develop the
new national information infrastructure more rapidly than most
countries and that other countries are moving to emulate us.1
In this paper, I review the recent historical data on the
evolution of U.S. communications and media industries with a
particular focus on the sources of revenue that have propelled this
growth and the effects of restrictive government regulation. In
addition, I provide a brief review of the potential costs of the
new technologies and the uncertainties involved in implementing
them. My conclusions are as follows:
•
Advertiser-supported media have shown the most
rapid growth since 1980. Even subscriber-supported media, such as
cable television or the print media, have relied heavily on
advertising for their growth.
•
Most of the competing technologies for the
national information infrastructure will require large capital
expenditures, perhaps as much as $125 billion, in a risky
environment.
•
Regulatory restraints on new media, designed to
protect incumbents, have inevitably suppressed the growth of the
communications sector and have often proved unnecessary or even
counterproductive.
•
In the current risky environment, it would be
imprudent to exclude any new services or sources of funds that
could be used to defray the costs of building the national
information infrastructure (NII).
NOTE: Robert Crandall is a senior fellow at the
Brookings Institution. The views expressed herein are the author's
and not necessarily those of the Brookings Institution, its
trustees, or other staff members.
The Coalition for Advertising-Supported
Information and Entertainment, which sponsored this paper, is a
joint effort of the Association of National Advertisers, the
American Association of Advertising Agencies, and numerous leading
advertisers and advertising agencies across the nation.
Page 157
The Growth of Communications
Media
I define ''communications media" as all of those delivery
systems through which information and entertainment are transmitted
to and among businesses and consumers. These include traditional
print media (newspapers, magazines, journals, etc.), broadcasting,
cable television, satellites, and traditional and newer wireless
forms of telephone service. Historically, these various media
occupied somewhat independent markets in the United States. The
print media provided information and advertising aimed at
specialized national markets or at decidedly local markets. Radio
broadcasting provided entertainment services for which it had
little direct competition other than records, but it competed with
print media in disseminating local and national news. When
television broadcasting emerged, it began to offer entertainment
that competed with motion picture theaters, but it too became an
important distribution medium for national and local news. Cable
television developed as a simple form of television-broadcasting
retransmission, but—when allowed to develop without regulatory
controls—rapidly became a medium for distributing a wide range
of entertainment and information services. More recently, direct
satellite transmissions have begun to compete with cable television
and broadcasting in the distribution of national entertainment and
information services.
Virtually all of the above media have developed with at least
some form of advertiser support. In the case of cable television,
it was the FCC's decision to allow cable operators to import
distant advertiser-supported signals that provided the impetus for
cable systems to expand into large urban markets and to increase
their channel capacity. These expansion decisions, in turn,
facilitated the development of new basic cable networks that were
also supported by advertising.
The telephone industry, on the other hand, has traditionally
been supported by direct customer access and usage payments. The
only source of advertiser support for traditional telephone
carriers has been from the publication of Yellow Pages directories.
This reliance upon direct customer support was dictated by the
nature of the service: two-way switched voice communications. It
would have been difficult and disruptive to have advertisements
interspersed with these conversations. However, with the
development of computer connections through modems or local-area
networks, the delivery of information and entertainment services
over telephone circuits became possible. As with other
communications services (other than voice telephony), customers may
now be offered a choice: pay for these services directly, accept
advertisements in them, or accept some combination of the two. For
example, electronic Yellow Pages may be advertiser supported,
require a subscriber usage charge, or both. Similar options may be
available for electronic want ads, home-shopping services, or even
electronically delivered financial services.
The role of advertising revenues in the growth of the various
media is evident in Table 1. Since 1970, there has been substantial
growth in all media that offer advertiser-supported content. Video
markets, in particular, have grown substantially, but even the
print media have enjoyed an expansion of total revenues from
advertising and direct circulation fees. In recent years,
multichannel video media, such as cable television and direct
broadcast satellite (DBS), have grown more rapidly than traditional
radio-television broadcasting. In the next few years, as additional
DBS services and even terrestrial multichannel wireless systems are
built, video service revenues are likely to continue to grow,
supported by both advertising and direct consumer outlays.
For more than a decade, regulation restricted the growth of pay
or subscription television services in order to protect off-the-air
broadcasters. This, in turn, limited cable television to the
retransmission of advertiser-supported off-the-air television
broadcasting. This repressive regulation was slowly eliminated by
the courts, the FCC, and the Congress in the period from 1977 to
1984, spurring cable to grow very rapidly and to expand its channel
capacity.
Even though cable subscription revenues grew very rapidly,
however, broadcasting revenues continued to expand, in part because
cable retransmissions made marginal UHF stations more viable, a
result predicted by academic studies of the medium.2 Thus, cable subscription growth
induced further growth of advertiser-supported broadcasting. But
even though cable operators would be able to survive and even
expand by relying solely on direct subscriber revenues, they also
found that they could now tap advertising markets to grow even more
rapidly. Direct cable television advertising expenditures began to
grow very rapidly in the 1980s, increasing from virtually nothing
in 1980 to nearly 20 percent of total cable revenues in 1993.
TABLE 1 The Growth of Communications Media
Revenues Since 1970
Year
TV Homes (million)
TV Advertising Revenue (billion $)
Cable TV Homes (million)
Cable TV Subscriber Revenues (billion $)
Cable TV Advertising Revenues (billion $)
TV/Cable Revenues per TV Household ($)
Newspaper & Periodical Circulation Revenues
(billion $)
Newspaper & Periodicals Advertising Revenues
(billion $)
Telephone Industry Total Revenues (billion $)
Telephone Industry Directory Advertising (billion
$)
1970
58.5
3.6
5.1
0.3
—
62
3.0a
7.0
19.4
0.7
1975
68.5
5.3
9.8
0.8
—
77
5.3a
9.7
33.4
1.1
1980
76.3
11.4
17.5
2.4
—
149
9.2a
18.1
59.8
2.3
1985
84.9
20.3
36.7
8.8
0.8
249
13.2
30.9
92.3
2.3
1990
90.8
26.8
51.7
17.2
2.5
323
17.9
40.1
114.6
2.6
1993
93.9
28.7
57.2
22.2
4.0
348
20.3
41.2
128.7
2.9
(a) Estimated by the author from Census
data.
SOURCES: Paul Kagan Associates; Statistical Abstract of the United
States; FCC, Statistics of Communications Common
Carriers.
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Page 159
TABLE 2 Real (Inflation-Adjusted) Growth in
Revenues for Video, Print, and Telephone Sectors, 1970–93
(1982–84 Dollars)
Year
Television Broadcasting and Cable Television
Newspapers and Periodicals
Telephone Companies
1970
10.0
25.8
50.0
1980
16.7
33.1
72.6
1993
38.0
42.6
89.1
Average Annual Growth, 1970–80
5.1%
2.5%
3.7%
Average Annual Growth, 1980–93
6.3%
1.9%
1.6%
NOTE: All data deflated by the Bureau of Labor
Statistics Consumer Price Index.
The telephone industry, supported almost exclusively by
subscriber payments for conveying voice and data messages, has
grown much more slowly. Telephone companies have not moved
aggressively into the provision of content, in part because of
regulatory policies that have excluded them from some of the most
important of these markets. As a result, their growth has been much
slower than that of the print and video media. Indeed, in real
(inflation-adjusted) terms, telephone revenues increased at a rate
of only 1.6 percent per year from 1980 through 1993. (See Table 2.)
During the same period, broadcasting and cable revenues rose at an
annual real rate of 6.3 percent per year, and newspaper and
magazine revenues rose at a real rate of 1.9 percent per year.
Obviously, telephone companies recognize that their growth has
slowed dramatically and have therefore moved aggressively to seek
relief from regulation that has kept them from offering new
services. In this pursuit, the regional Bell operating companies
(RBOCs) have won court reversals of the restriction on their
provision of information services that was part of the decree
breaking up AT&T.3 In addition,
invoking the First Amendment, several RBOCs have recently mounted
successful First Amendment challenges to the legislative ban on
telephone company provision of cable television service in its own
region.4
New Communications Technologies
In the next few years, cable television operators, telephone
companies, and satellite operators will be facing off in the
competition to build new broadband distribution networks. These new
networks, utilizing a mixture of wireless and fiber technologies,
may offer a variety of switched and distributive broadband
services. At this juncture no one knows which technologies will
ultimately succeed, no which services will propel these new
technologies.5 This is a risky
environment for private investors and policymakers alike given the
magnitude of the necessary investments.
Cable television operators now have one-way "tree-and-branch"
broadband networks composed of fiber optics and coaxial cables.
These networks are typically unable to offer switched services to
most subscribers, although such services are possible with major
investments in switching equipment and changes in network
architecture. To upgrade cable networks simply to provide switched
voice (telephone) services would probably cost $300 to $500 per
subscriber.6 To provide full
interactive switched video might cost as much as $800 per
subscriber depending upon the amount of fiber optics already in the
cable system's feeder plant.
Telephone companies are now exploring technologies for expanding
the bandwidth of their networks so that they can offer video
dial-tone or full switched video service. Many companies are
pursuing a fiber/coaxial cable architecture that is likely to cost
$800 to $1,000 per home passed.7 A
full fiber-to-the-curb architecture might be more expensive but
provide greater flexibility in terms of bandwidth available for
one-way and interactive switched video applications. Simply
upgrading the existing copper wire distribution plant with
asynchronous digital subscriber loop (ADSL) technology8 is much more expensive per
subscriber, but allows the telephone company to target its
investment at only those households that wish to subscribe to its
video services.
A recent entrant into the video distribution market is
high-powered satellite delivery to the home. This direct broadcast
satellite (DBS) service has been launched by Hughes Aircraft and
Hubbard Broadcasting and
Page 160
will soon be emulated by two other consortia, including one that
now operates with a lower-powered C-band service. Each of these
enterprises requires about $750 million to $1 billion in initial
investment plus possible start-up losses.9
Other wireless services are attempting to compete with cable
systems for one-way, distributive video services, but none has yet
been shown to be a viable launching pad for the interactive
broadband network of the NII variety. It is possible, however, that
terrestrial wireless services can be adapted for this purpose,
particularly if the FCC shifts to using market mechanisms for all
spectrum allocations. Multichannel multipoint distribution services
(MMDS) or cellular cable systems could have sufficient channel
capacity, particularly with digital signal compression, to offer
competition to wired systems. Finally, it is possible that a system
of orbiting satellites, such as that being developed by Motorola
for narrowband communications, could also provide switched
broadband services.
This brief review of the technical possibilities for building
the NII is not intended to be comprehensive. Rather, it is included
to show that the number of competing technologies is growing and
that the ultimate winner or winners is (are) not known or even
likely knowable at this time. Some telephone companies are
reexamining their earlier commitments to a fiber/coaxial cable
technology.10 At least one large
cable television/telephone company merger has failed, and other
consortia may be foundering. DBS systems may have arrested some of
the momentum for building interactive terrestrial broadband
networks because the latter would probably have to rely heavily on
traditional one-way video programming at first. However one
interprets the recent technological and economic developments in
this sector, it is quite clear that building versions of the NII is
not becoming less risky.
Even at costs as low as $800 per home, the cost of extending the
NII to all residential households is at least $80 billion. To
extend it to all business and residential customers would require
at least $120 billion.11 This latter
estimate is almost exactly equal to the book value of the entire
net plant of all regional Bell operating companies and about 80
percent of the book value of the net plant for all telephone
companies in the United States.12
Thus, if the NII is to be built by established telephone companies
with technology now under development, it would probably require a
near doubling of these companies' assets. Since no one is seriously
advocating government support that would cover even a small
fraction of this added investment, private firms must have the
ability to obtain large cash flows from a variety of sources to
fund such a massive expansion of our communications
infrastructure.
The sobering fact about any such large investment in the NII is
that it will likely be overcome by different or improved technology
soon after it is built. Perhaps such networks can be continuously
adapted to these technical improvements, but it is also possible
that a completely different technology—perhaps based on
orbiting satellites, for example—could render an $80 billion
to $120 billion terrestrial investment obsolete within a decade.
Under these circumstances, investors should be permitted to explore
all possible sources of revenues from the marketplace if we expect
them to commit such large amounts of capital to so risky an
enterprise.
Recent Trends in Communications-Sector
Capital Formation
The explosion in new technology might be expected to generate a
boom in investment in the various communications sectors. The
advances in fiber optics, electronic switching, asynchronous
switching, digital compression, and consumer electronics are
providing all market participants with the opportunity to deliver a
multitude of new services if they invest in new equipment.
The evidence on capital formation in the communications sector
only partially reflects this rosy assessment. Telephone companies
responded to the new opportunities by investing in new switching
systems and fiber-optics distribution systems through the early
1980s. Much of this investment was spurred by competitive entry
into long-distance markets and even some urban local-exchange
markets and by the necessity for local carriers to provide equal
access to these new competitive carriers in their switching
systems. Thereafter, however, telephone company investment slowed
markedly. (See Figure 1.) In the past 5 years, investment in this
sector of the economy has been insufficient to maintain the net
value of its capital stock.13
By contrast, the radio-television sector continued to expand its
net capital stock through 1993. Fueled by cable deregulation in
1977–79, the net capital stock in this sector nearly doubled
between 1979 and 1989—a
Page 161
period in which telephone plant increased by less than 20
percent. (See Figure 2.) This growth reflects the substantial
expansion in the number of homes wired by cable in the 1980s as
well as the investments in increasing channel capacity during these
years.
Figure 1
Real net capital stock—U.S. telephone industry, 1970 to
1993.
Figure 2
Real net capital stock—television and radio industry, 1970 to
1993.
A lesson to be learned from these divergent trends in capital
formation is that regulatory constraints that restrain competition
and new entry, whether in the name of promoting "universal service"
or "fairness," create a substantial risk of slowing investment and
the spread of new technology. Cable television investment
accelerated after the severe regulatory restrictions on cable
service, motivated by the desire to protect off-the-air
broadcasting, were lifted in the late 1970s. The removal of these
restrictions caused cable revenues to rise rapidly, fed by both
advertising and subscriber fees, while traditional broadcast
advertising revenues continued to rise. Telephone investment rose
rapidly in the 1970s after entry restrictions on long-distance
competitors were lifted. Once restrictions were placed on telephone
company offerings of information and cable television services,
however, investment in traditional telephony slowed dramatically.
Were new investments in the NII to be constrained by the desire to
cross-subsidize new universal-service offerings or by a concern
that advertiser-supported services
Page 162
might supplant other services, the prospects for rapid
deployment of risky new technology could be severely impaired.
Advertising Versus Subscriber
Fees—The Implications for Economic Welfare
Economists have studied the economic welfare implications of
using advertising or direct subscriber payments to support radio
and television programming. The results of this research suggest
that a mix of the two support mechanisms is likely to be the
optimal source of revenues.14 The
reasoning is fairly straightforward.
Advertisers are likely to be motivated by the desire to maximize
their reach among a target population at the lowest possible cost
consistent with persuading consumers of the attractiveness of their
products. For this reason, they are likely to eschew the support of
programming (or other software) that appeals to a narrow set of
potential consumers. Thus, advertiser-supported services are likely
to be less finely differentiated than are subscriber-supported
services under most circumstances. If some consumers are not
willing to pay much for highly differentiated services, their
economic welfare will be greater with advertiser-supported
services. It is for this reason, presumably, that more than
one-third of all households now passed by cable television do not
currently subscribe despite the fact that cable offers much more
choice than the available array of broadcast stations in even the
largest markets.
On the other hand, some consumers may desire more choices than
those that can or would be supported totally by advertising.
Subscriber-supported services can reflect the intensity of consumer
preferences, not simply their willingness to use a service—the
criterion that is important to advertisers. It is for this reason
that pay-cable and pay-per-view services have proliferated in the
current multichannel video environment. Only a few hundred thousand
subscribers, each paying a substantial one-time user fee, may be
required to support two or three hours of a nationally distributed
service or event. Foreign soccer games, obscure older feature
films, or live concerts may be offered for a one-time charge, while
more popular events may be advertiser supported.
A third possibility for supporting services on the current or
future information infrastructure is a mixture of user charges and
advertiser support for the same service. Pay-per-view services
could still carry advertising billboards or even interspersed
advertising messages. For example, videocassettes and motion
picture theaters are now supported by both subscriber charges and
advertising. In addition, the sam programming could be offered
simultaneously without advertising but with a subscriber fee and
with advertising and no subscriber fee. This combination of support
mechanisms could lead to greater diversity and a larger array of
available services.
It is important, therefore, that policies for developing the NII
should not directly or inadvertently exclude new service options
that might contribute importantly to the cash flows necessary to
amortize the large investments required to build the
infrastructure. As long as there are no prohibitions on advertiser
support or direct subscriber payments in a competitive marketplace,
there is little reason for policymakers to attempt to prejudge the
choice of support mechanisms for the current information
infrastructure or for the NII. It can always be argued that
virtually any information or entertainment service has attributes
of a public good. One consumer's use of such a service may not
reduce the amount of it that is available for other consumers;
therefore, no consumer should be excluded from consuming it through
a price that is above zero. Advertising could help provide a
solution to this problem since it can be employed to generate free
broadcasting or print services with low subscriber fees, for
example. However, without a combination of advertising and direct
subscriber fees, there is no mechanism for consumers to indicate
the intensity (or lack of intensity) of their preferences.15
Regulating the NII
It is impossible for anyone to understand fully the potential of
the changes that are now occurring in telecommunications
technology. Even if the technical choices for network design could
be forecast for the next 10 or 20 years, no one could possibly
predict how these technologies would be used. The potential changes
in the delivery of financial, shopping, entertainment, medical, and
government services—to name a few—that are likely
Page 163
to occur are so vast that they cannot possibly be forecast with
any precision. But the ideal design of new networks will be highly
influenced by both technology and the evolution of and demand for
these new services. Therefore, investments in new networks will
necessarily take place on a trial-and-error basis.
In this environment, it would be counterproductive for
government policymakers to attempt to guide investments or to
require carriers to offer services to segments of the population at
nonremunerative rates in the name of "universal service." Such
demands can only be made on carriers that are protected from
competition in other markets because intra-firm subsidies require
that the firm earn supra-competitive returns somewhere. If certain
(early) NII services are selected as the domain for
universal-service requirements, the protection afforded the
carrier(s) in other markets may inhibit entry and the introduction
of new technology elsewhere. This was precisely the outcome of the
FCC's protection of television broadcasters from the development of
cable in the 1960s and 1970s and of the federal/state protection of
telephone companies from competition in customer-premises
equipment, long-distance services, and wireless services.
The calls for preferential access to the NII from a variety of
worthy public institutions are understandable, but they should be
resisted if they require carriers or other service providers to
cross-subsidize them from other service revenues. If there is a
legitimate case for subsidizing some of these institutions' access
to the NII, it would be far better to provide these subsidies
directly from public tax revenues. Otherwise, the built-in
cross-subsidies will serve as the rationale for barring new
entrants with even newer services in the years to come. If there is
one lesson to be learned from past exercises in regulatory
protection in this sector, it is that such protection delays new
services, such as cable television, cellular telephony, personal
communication service, video-on-demand, or direct broadcast
satellite services. Free entry to new facilities, new services, and
all sources of revenues will provide the fastest route to the
NII.
Notes
1. For example, Japan is now urgently
considering new approaches for allowing competitive entry into its
telecommunications markets, including the possible emulation of our
approach to breaking up AT&T. The European Community, which
featured entrenched Postal, Telegraph, and Telephone authority
(PTT) control of its national telephone monopolies, is now moving
to liberalize its telecommunications sector by January 1998.
Australia has already admitted a second telephone carrier, Optus,
and New Zealand has not only privatized its national carrier and
opened its market to competition but has also completely
deregulated telecommunications. Finally, Canada has recently
admitted entry into its long-distance sector and is considering the
liberalization of local telephone service and video delivery
services.
2. R.E. Park was the first to show that
cable television would increase the viability of UHF broadcast
stations. See R.E. Park, "Cable Television, UHF Broadcasting, and
FCC Regulatory Policy," Journal of Law and Economics,
(1972), Vol. 15, pp. 207–31.
3. This restriction was one of the
line-of-business restraints on the RBOCs that were built into the
antitrust decree that was entered in 1982 to break up AT&T. The
information-services restriction was removed in 1991. (See Michael
K. Kellogg, John Thorne, and Peter W. Huber, Federal
Telecommunications Law. Boston: Little, Brown and Company,
1992, Section 6.4, for a detailed history of this restriction.)
4. The successful challengers have been U
S West, Bell Atlantic, Southwestern Bell (now SBC), NYNEX, Southern
New England Telephone, GTE, BellSouth, and Ameritech. These cases
have been brought in various U.S. District Courts and, in two
cases, U.S. Courts of Appeals. The Supreme Court has yet to rule on
the issue.
5. An excellent example of this
uncertainty was provided by Bell Atlantic in the past month. It has
withdrawn its Section 214 applications for the hybrid fiber/coaxial
cable and ADSL technologies, announcing that it now wishes to
pursue the fiber-to-the-curb technology and various wireless
technologies, such as MMDS.
6. See David P. Reed, Putting It All
Together: The Cost Structure of Personal Communications
Services. FCC, OPP Working Paper #28, November 1992, p. 35, and
"Will the Broadband Network Ring Your Phone," Telephony,
December 6, 1993, p. 34.
7. This estimate is based on recent
filings by Pacific Bell before the Federal Communications
Commission (see, for example, Robert G. Harris, "Testimony in
Support of Pacific Bell's 214 Application to the Federal
Communications Commission," December 14, 1994). Slightly higher
estimates are to be found in David P. Reed, Residential Fiber
Optic Networks: An Engineering and Economic Analysis. Boston:
Artech House, 1992.
Page 164
8. This technology allows telephone
companies to deliver video services over the paired copper wires
that are now used to connect subscribers to the companies'
plant.
9. See "Digital TV: Advantage, Hughes,"
Business Week, March 13, 1995, pp. 67–68. Similar
estimates may be found in Leland L. Johnson and Deborah R.
Castleman, Direct Broadcast Satellites: A Competitive
Alternative to Cable Television? RAND, 1991.
10. Bell Atlantic has recently withdrawn
its Section 214 applications for hybrid fiber/coaxial cable
technology but remains committed to building a broadband network
using other technologies, such as fiber to the curb.
11. This estimate is based on a national
total of about 150 million access lines. (United States Telephone
Association, Statistics of the Local Exchange Carriers,
1993.)
12. FCC, Statistics of Communications
Common Carriers, 1993/94 edition, p. 38.
13. It should be noted that part of this
slowdown is attributable to the liberalization of customer premises
equipment. Since the late 1970s, customers have been able to
purchase their own telephone handsets, key telephone systems,
PABXs, modems, answering machines, and fax machines. As a result,
perhaps 20 to 25 percent of all telephone-related capital equipment
is owned by telephone customers. See R.W. Crandall, After the
Breakup: U.S. Telecommunications in a More Competitive Era.
Washington, D.C.: The Brookings Institution, 1991.
14. For an excellent review of this
literature, see B.M. Owen and S.S. Wildman, Video Economics.
Cambridge, Mass.: Harvard University Press, 1992, ch. 4.
15. For an excellent compendium of studies
of the public-goods problem, see T. Cowen (ed.), The Theory of
Market Failure. Fairfax, Va.: George Mason University Press,
1988.
