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60
Prospects and Prerequisites for Local Telecommunications
Competition: Public Policy Issues for the NII
Gail Garfield Schwartz and Paul E.
Cain
Teleport Communications Group
The national information infrastructure (NII) vision embraces
three communications components (exclusive of information libraries
and other content repositories): internodal networks, access nodes,
and end-user access to the nodes. Internodal networks and access
nodes are currently subject to competitive supply. End-user access
is the only NII component that remains monopolized virtually
everywhere in the United States. Such access is costly to provide.
Costs of new or improved end-user access facilities must be
justified by usage in a two-way mode, in an environment that will
probably evidence substantial price elasticity. Nevertheless, many
risk-taking access providers are preparing the technologies with
which to offer economic, reliable end-user access, confident that a
strong market will develop. Still, the in-place, monopoly-provided,
end-user access seems to be useful for a great many consumers.
Increased consumer demand for the greater capacity and speed of
digital technologies within the NII will be conditioned largely by
the behavior of public policy makers vis-à-vis the
entrenched monopolies. In this paper we discuss the opportunities
for and obstacles to replacement of the monopoly for end-user
access.
Competition in the Last Segment of the
Telecommunications Industry
It has long been recognized by economists that a monopoly has
less incentive to innovate than does a firm in a competitive
market. Firms in a competitive market will seek to gain a
competitive advantage over their rivals through innovation and
differentiation, thus enhancing consumer surplus as well as
producer surplus. Events in the long-distance and equipment
segments of the telecommunications industry seem to have confirmed
the result predicted by economic theory. In the inter-LATA long
distance market, AT&T's market share has dropped from over 80
percent to less than 60 percent since 1984, and the number of
carriers has risen to over 4001. The
facilities-based long distance carriers increased their deployment
of fiber-optic transmission facilities fivefold between 1985 and
19932. Long-distance rates have
fallen more than 60 percent3.
Similar gains have been realized in the demonopolized market for
telecommunications equipment. Now handsets can be purchased for
less than the price of a pair of movie tickets, and businesses and
consumers are linking ever more sophisticated equipment (computer
modems, PBXs, cellular phones, and handsets that have computer
memory) to the public switched-telephone network.
Theoretically, the same benefits would accrue to consumers from
competition in the remaining monopolized local exchange market as
have been realized in the equipment and long-distance market
segments (efficiency, diversity, innovation, and price reductions).
But the grip of government-sanctioned monopoly remains powerful.
Only slowly has it been understood that local exchange monopolies
may temporarily drive down costs but never as far as would
competition: They may innovate, but not as swiftly as competitors
would; they may improve service quality, but not as readily or
effectively as they would under competition. The full benefits of
the NII require efficient exploitation of all telecommunications
technologies, including photonics, coaxial cable, fiber optics,
wireless, and even the existing twisted pair technologies, linking
subscribers to one another via a ''network
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Representative terms from entire chapter:
local telecommunications
Page 539
of networks." A competitive market for local exchange services
is essential to such efficient exploitation of all
technologies.
Moving from theoretical concepts to the practical reality of
creating local exchange competition requires certainty and
flexibility: certainty to inspire investor confidence, and
flexibility to respond to constantly changing—and largely
unknown—market realities. Achieving balance between certainty
and flexibility means opening up existing monopolized market
segments as much as possible without threatening the long-term
stability of competition itself. Both industry and public
policymakers must take this challenge seriously if the NII promise
is to be realized by 2000—or ever.
The Current Status of Competition in
Local Telecommunications Services
Revenue for the local telecommunications market in 1993 exceeded
$88 billion4. Of that total, 99
percent was captured by mature, traditional local
telecommunications carriers. The 1 percent of the market liberated
by new entrants was composed almost entirely of private line and
special access services; they have not yet begun to reach a mass
market5.
Still, competitive access providers are optimistic about the
future of competition, building or operating networks in some 50 or
60 metropolitan statistical areas. A recent report by the Federal
Communications Commission indicates that over 10,070,308 miles of
fiber has been deployed in the United States by local,
long-distance, and urban telecommunications providers, and shows
that the rate of deployment by competitive access providers far
exceeds that of the incumbent local exchange carriers6. The largest competitive access
provider, Teleport Communications Group (TCG), has installed
SONET-based, self-healing, two-way ring networks capable of
transmitting information at a rate of 2.4 gigabits per second. ISDN
is provided over these networks, and TCG offers frame relay at up
to 1.5 megabits per second and ATM (switched data) service at up to
155 megabits per second. With more than 167,314 miles of fiber
throughout 22 networks and a strong switch deployment program, TCG
is technically positioned to serve larger markets7.
Cable television operators, whose networks now pass 97 percent
of the nation's households and provide television service to more
than 65 percent, are the obvious "other" end-user access provider8. Cable companies are upgrading their
distribution plant and must provide for switching to offer local
exchange services. Experiments, such as the Motorola-TCI-TCG trial
of residential service using radio frequencies over
fiber-optic-coaxial cable, will identify technological
requirements. The promise of wireless subscriber loops has also
drawn considerable interest from a wide range of industry
participants. Bidders in the FCC's recently concluded Personal
Communications Service (PCS) spectrum auctions committed more than
$7 billion for licenses to build and operate local
telecommunications networks9. A
recent Merrill Lynch report predicts that one of the successful PCS
bidders would have a 5 to 8 percent penetration of the local
exchange market by 200410. There is
no shortage of potential entrants seeking to provide local exchange
services. Meeting consumer demand will mean the employment of a
variety of distribution systems, both broadband and narrowband,
wireline and wireless.
However, it is not yet certain what customers want and when they
want it. Though studies such as a recent Delphi study of industry
executives and academics have projected 2010 as the outside year in
which a mass consumer market will exist for network-based
interactive multimedia products and services provided over switched
broadband, market research is notably thin on the subject of what
people will pay for "infotainment" or household management
services11. As with the case of
previous telephone, television, computer, and audio products, much
investment rides on the premise that supply will create demand.
Despite the limited deployment of broadband networks, consumers
have not been especially hindered in their attempts to establish
themselves as providers, as well as users, of information. Internet
platforms and a plethora of electronic bulletin boards allow
consumers to "publish" information available on demand by other
consumers. Aside from providing the conduit over which the
information travels, the network operator has no role in the
content of the traffic speeding over its lines. The development of
local network competition will only hasten the development of more
information services and more gateways through which consumers can
share information.
Page 540
The prospects for local competition, therefore, depend in part
on the perfection of new technologies, but more importantly on
reduction of their cost. However, factors other than technology
itself pose greater obstacles to deployment of competitive choices
and must be dealt with expeditiously if investment is to
accelerate. Before the various broadband and other end-user access
technologies can be widely deployed, legal, technical, and economic
hurdles must be overcome in every state. Furthermore, even though
technical interconnection and interoperability of networks have
been shown to be feasible without serious difficulties, many
aspects of the seamless interoperability of competitive networks
remain to be resolved. Among them are a number of portability and
central office interconnection arrangements. Finally, economic
interconnection of competing local networks has to be achieved so
that new entrants can develop their own services and prices that
maximize the revenues from their own networks.
Legality of Competition
Regulatory barriers remain the threshold barrier to entry into
local telecommunications services. Only seven states have
authorized or permit competitive local exchange carriers to provide
service: New York, Illinois, Maryland, Massachusetts, Washington,
Michigan, and Connecticut. Making competition legal means removing
a series of entry barriers imposed by different government agencies
whose interests are not necessarily congruent. The primary issues
that must be resolved include exclusive franchises, qualifications
for entry, franchise fees, and access to rights-of-way and to
buildings. Market entry that is conditioned upon demonstrating that
the incumbent carrier is providing inadequate service is an
unreasonable burden, as are franchise fees or other payments to
local government as a condition of operating, if the incumbent does
not pay equivalent fees. But the most difficult ongoing issues will
be the access issues, because that is the area where the incumbent
monopoly has the ability and the incentive to encourage unequal
access. Incumbent LECs enjoy generally unlimited access to public
right-of-way and often control the rights-of-way needed by
entrants. They also have established access to building entrance
facilities, at no cost. New entrants must have access to those
rights-of-way at the same rates and on the same terms and
conditions as the incumbent.
In 1995, 13 states enacted legislation removing barriers to
entry and endorsing local exchange competition. Federal legislation
preempting state entry barriers and setting guidelines for local
competition is again under consideration. The technical and
economic aspects of network interoperability are rising to the
forefront of public policy issues that will condition NII
development.
Technical Feasibility
At the end of the nineteenth century and continuing into the
early years of this century, local exchange "competition" did
thrive. But rather than a "network of networks," consumers faced a
tangle of discrete networks, all of them talking at once but none
of them talking to each other. To be certain that they could reach
everyone with a phone, customers had to subscribe to the local
exchange service of every provider.
As that experience—which gave way to government-sanctioned
monopoly—demonstrated, the key to an efficient and effective
"network of networks" is interconnection. Adjacent (i.e.,
"noncompeting") carriers interconnect seamlessly with each other
today and have done so for more than 80 years. Now competing local
exchange networks must be able to interconnect with the incumbent
local exchange network on the same terms and conditions as the
incumbent interconnects with adjacent carriers and with itself. At
a minimum, the technical interconnection arrangements should
include the following.
Central Office Interconnection
Arrangements
Central office (CO) interconnection arrangements are the
physical facilities that connect a competitor's network to the
local exchange carriers' (LEC) network. An efficient cost-based CO
interconnection arrangement consists of three elements:
Page 541
•
Interconnection electronics. Optical and
electronic equipment physically located in the LEC CO, but remotely
operated and controlled by the local competitor, used to multiplex,
demultiplex, monitor, test, and control transmission
facilities;
•
Interconnection cable. Fiber optic cables,
dedicated to the local competitor's use, interconnecting the local
competitor's location and the interconnection electronics located
in the LEC CO(s); and
•
Interconnected services. LEC-provided
services and facilities interconnected to the interconnection cable
and electronics at the CO at cost-based rates.
Connections to Unbundled Network
Elements
Although the long-term NII vision presumes that existing copper
pair will be replaced (or upgraded) by broadband or at least
enhanced narrowband access, a transition period during which local
exchange competitors are maximizing their return on other network
investment (in internodal transport and access nodes) will occur.
These competitors will be able to offer service to a mass market
during the interim period only by reselling existing subscriber
loops under monopoly control. Currently, whether providing
single-line basic local exchange service or multiline local
services such as Centrex, LECs usually bundle together the "links"
and the "ports" components of the loop. LECs must unbundle the
local loop elements into links and ports, individually pricing each
element at cost-based rates.
Seamless Integration into LEC
Interoffice Networks and Seamless Integration into LEC Signaling
Networks
A LEC's tandem switching offices and end offices are
interconnected via the LEC's interoffice transmission network.
Adjacent LEC switching offices are also interconnected via the same
network for the distribution of intra-LATA traffic. Routing through
the interoffice network is governed by a local exchange routing
guide (LERG) unique to each LATA. The LERG prescribes routing of
all traffic between and among all LEC and interexchange carrier
(IXC) switching offices. Cost-based interconnection arrangements at
tandem offices as well as end offices are necessary, and the Class
4 and 5 switches of local competitors must be incorporated into the
LERG on the same basis as (and with the same status as) the LEC's
end and tandem offices. This will enable a competing local exchange
carrier to efficiently and effectively route calls originated by
customers on its network to the LEC for final termination at the
premises of a LEC customer, and vice versa. This includes access to
Signaling System 7 (SS7) with a line information database (LIDB).
In an SS7/LIDB environment, routing, translation, service, and
account information is stored in centralized databases that LEC and
IXC switches can access through service control points (SCPs).
Local competitors must be able to interconnect and query the LEC
SS7 databases at the SCPs in a nondiscriminatory manner and under
equitable terms and conditions.
Equal Status in and Control over
Network Databases
Competitive local service providers must be allowed to have
their customers' telephone numbers included in telephone
directories, directory assistance, LIDB, advanced intelligent
network (AIN), 800-number, and other databases. Their access to
such resources must be equal in price, functionality, and quality
to those of incumbent local telephone providers.
Page 542
Equal Rights to and Control over
Number Resources
Numbering policy must be broadly developed and administered in a
competitively neutral manner. The administration of area codes
provides an excellent example of the problems that can arise under
LEC-administered code assignments. In recent years, as competition
has developed, the incumbent LECs have proposed a deviation from
their historic practice of assigning customers to a new area code
according to geography when the existing area code numbers were
approaching depletion. That is, customers in one part of the
existing area code territory would retain their area code, while
customers in an adjacent area would be assigned a new area code.
The new approach favored by some local exchange carriers is to
assign a different area code to customers of the new providers
(wireless and competitive access providers), allowing only the
LEC's customers to remain undisturbed by the new area code
assignments. The anticompetitive effects of such a plan are not
hard to imagine: customers of the new carriers are difficult to
locate, and only customers of the new entrants must incur the
expense of changing their numbers (e.g., letterhead, business
cards, advertising). Such expenses could be a significant deterrent
to a customer who might have found it otherwise economical to
switch to a new entrant provider.
Local Telephone Number
Portability
The ability of customers to change service providers and to
retain the same local telephone number at the same location
(service provider number portability), without having to dial extra
digits and without being burdened by "special" actions, is a
critical component of the economic viability of local exchange
competition. Interim number portability mechanisms (such as remote
call forwarding) are an inferior form of number portability that
impairs a new market entrant's service, and such impairment should
be reflected in interconnection charges.
Cooperative Practices and
Procedures
Local exchange telephone companies maintain a detailed set of
administrative, engineering, and operational practices and
procedures. These coordination practices must extend to new local
competitors if competition is to emerge. In addition, the
traditional local telephone companies maintain a detailed set of
practices governing revenue pooling, intercompany settlements, and
other financial interactions between and among established local
carriers. These also must be extended to local competitors.
Finally, any other intercompany notification procedures,
standards-setting procedures, and the like, through which LECs may
now or in the future interact with one another, must be extended to
include local competitors. These requirements may appear
reasonable, but the task of integrating such behaviors into huge
corporations with many employees and a monopoly mentality will be
daunting.
Economic Viability
The ultimate determinants of the amount and extent of local
exchange competition will be neither legal nor technical, but
economic. The ability of competitors to meet consumer demand
depends ultimately on economic interconnection arrangements for
competing local networks. The new entrant must install capacity to
accommodate peak-hour traffic, even though initially it has little
inbound traffic. Arrangements for reciprocal compensation for the
mutual exchange of local traffic should allow both carriers to
recover the incremental cost of capacity. This cost is low: about
0.2 cents per minute, on an average basis12. Given the trivial cost of supplying
incremental capacity, it makes practical sense to implement a
"sender-keep-all" arrangement, like that now used by Internet
providers, rather than to impose explicit charges on terminating
carriers. Sender-keep-all is also administratively simple.
Page 543
Such arrangements should minimally be in place until data-based
number portability is established. The lack of number portability
and the substitution for it of measures such as remote call
forwarding impair the new entrant's ability to use its network to
its full capabilities and to sign up customers. Remote call
forwarding and other so-called interim number portability measures
entrench the incumbent's position and give it an economic advantage
because all calls are routed through the existing LEC's network.
Under current regulation, this means that the LEC as intermediary
could collect terminating access charges from interexchange
carriers for calls destined to a customer on a competing local
exchange carrier's network. Although arrangements to overcome this
economic inequity might be made, they would be complex and costly.
It is far more efficient to plan for and expeditiously implement a
long-term solution to the number portability problem. This must be
a data-based solution that does not put any telecommunications
service provider at a disadvantage and allows all providers to
maximize the utility of their networks.
Universal Service
The long-held policy objective of universal service must be
addressed before competitors can compete effectively throughout
mass markets for local telecommunications services. This will make
it possible for efficient competition to eliminate uneconomic or
noncompetitive subsidies embedded in telecommunications pricing
structures over a reasonable transition period. This is an expected
result of competition. Incumbent LECs argue that retail rates
(especially for residential consumers) may be priced substantially
below costs and will be subject to upward price pressure. But
again, as distribution networks achieve economies of scale,
incremental costs are expected to fall, mitigating such price
pressures.
Nevertheless, social policy pressures to maintain average prices
for similar offerings across the country and between urban and
rural subscribers will constrain providers' pricing practices for a
transition period of at least 10 years—until competitive
facilities-based distribution networks reach a substantial portion
(say 30 to 40 percent) of rural subscribers. During this period
(and for certain communities, perhaps permanently) universal
service must be assured. The ability to obtain access to the public
switched network voice-grade service with tone dialing on a
single-party line, at affordable rates, together with operator
assistance, directory listings, and emergency service, is the
minimal level of residential service and may require subsidies for
some customers. If public policymakers seek to mandate a higher
level of service, such as broadband access, the costs will soar;
currently there seems to be a political consensus that market
forces should define what "basic" service requires subsidy.
Subsidies to preserve universal service must be explicitly
identified and administered through a provider-neutral fund so as
to minimize their cost and maximize their efficiency. All
telecommunications service providers should contribute to the
subsidy fund based on their share of the market. Subsidies should
be portable among carriers; that is, all local exchange carriers
must have the opportunity to receive a subsidy when selected as a
service provider by a subsidized customer.
Prospects for Local Telecommunications
Competition
The prospects for local competition are improving. In 1995, 13
states enacted legislation making local exchange competition
possible, and most of these laws directed state regulators to
provide for the requisite technical and financial interoperability
and equal access. In nine other states, the critical issue of
reciprocal compensation for the mutual exchange of local traffic is
being addressed and interim agreements have been concluded between
new entrants and LECs. Up to 15 additional states will soon develop
rules for local exchange competition. Federal legislation setting
the standard for local exchange competition and giving all major
industry groups something of what they want in a competitive
environment has passed the Senate; many observers give it at least
a 50 percent chance of becoming law in 1995. Three trials designed
to assess the technical requirements for telecommunications number
portability are under way. And activity in the courts has sharply
accelerated as parties seek to end existing legislative or judicial
curbs on their ability to address each other's markets.
Page 544
Among the restraints under attack are the line-of-business
restrictions on the Bell operating companies (BOCs) entering the
interexchange market or manufacturing, included in the consent
decree that divested the BOCs from AT&T. These restrictions
were intended to endure so long as the divested regional BOCs
(RBOCs) retain control of the local exchange bottleneck, which
gives them the ability and incentive to impede competition in
adjacent markets. The "VIIIc" test applied by the court overseeing
the decree requires the U.S. Department of Justice to report that
there is "no substantial possibility" that a BOC seeking relief
from the decree would be able to impede competition in the
adjacent, restricted market. Some members of Congress seek through
legislation to abrogate the decree entirely, eliminating the role
of the DOJ, without evidence that the local exchange bottleneck has
actually been broken. Others would substitute a more liberal
test—the "public interest" test—for VIIIc and make the
FCC rather than the DOJ and the court responsible for its
application. Still others would have the DOJ involved in an
advisory capacity. And some, like the Clinton Administration,
prefer to retain the Justice Department's role 13.
Several BOCs are seeking relief from the decree directly from
the court. On April 3, 1995, the DOJ filed a motion to permit a
trial supervised by the DOJ and the court in which Ameritech could
provide interexchange service after the development of actual
competition, including facilities-based competition, and
substantial opportunities for additional competition in local
exchange service 14.
The questions of how much and what type of competition warrants
relief will be the key to whether or not durable and robust local
exchange competition is possible. Even if all the "paper"
requirements for local exchange competition are met, the incumbents
can and do manipulate each and every aspect of access to their
essential facilities. As BOCs have demonstrated frequently, they
can frustrate and thwart competitors in numerous ways: by imposing
different and unnecessary physical interconnection requirements for
competitors; by engaging in pricing discrimination, tying
arrangements, and selective cost de-averaging; by imposing
excessive liabilities on customers who wish to change to a
competitive carrier; by engaging in sales agency agreements that
effectively foreclose markets to new entrants; and more. As a
result, a public policy that seeks the full benefits of competition
for the greatest number of telecommunications customers must
include safeguards that constrain anticompetitive behavior and
sanction the parties having market power that engage in it. A
rigorous effective competition test prior to BOC relief is such a
safeguard.
The other required safeguard is continued regulatory oversight
of the firms having market power, with lessening intervention as
that market power diminishes. During the development of
interexchange market competition, AT&T, the dominant
interexchange carrier, endured economic regulation while its
competitors were free to price their services to the market. A
similar approach is necessary in the local exchange market.
Incumbents may be granted pricing flexibility, so long as they do
not reduce prices of competitive services below their incremental
cost; but cross subsidies from captive customers must be prevented.
New entrants must face minimal regulatory burdens because, lacking
market power, they cannot harm the public interest. However, new
entrants must contribute to the maintenance of universal
service.
Conclusion
By any measure, local competition does not exist today, but a
more competitive environment is being created. Full-scale
competition will require huge investments, which in turn calls for
relative certainty as to the pace and outcomes of regulatory and
legislative actions. If new entrants have technological innovations
to exploit, their ability to complete cost-effective deployment
depends on their relative financial strength vis-à-vis the
incumbent monopolies. The latter often can manipulate financial
faucets by means of their negotiated agreements with state
regulators, whereas competitors depend entirely on risk markets for
their capital.
Competitors are engaged in a historic process on the
legislative, regulatory, and judicial fronts. There is no doubt
that the barriers to entry will fall. The safeguards to control
residual market power as local telecommunications competition
emerges will be lodged in different government agencies, as they
currently are, but the guidelines will become clearer as the
benefits of competition become more obvious and more
widespread.
The final determinant of the pace at which these policy
adjustments occur is consumer demand. Demand will surge when
"infotainment" is varied and priced to mass market pocketbooks.
Page 545
Notes
1. Industry Analysis Division, Common
Carrier Bureau, Federal Communications Commission. 1995. "Long
Distance Market Shares: Fourth Quarter 1994," Federal
Communications Commission, April 7.
2. Industry Analysis Division, Common
Carrier Bureau, Federal Communications Commission. 1994. "Fiber
Deployment Update: End of Year 1993," Federal Communications
Commission, May.
3. "FCC Monitoring Report, Table 5.5." CC
Docket No. 87-339, June 1995.
4. Federal Communications Commission.
1994. Statistics of Communications Common Carriers.
5. Connecticut Research. 1993. "1993 Local
Telecommunications Competition … the 'ALT Report.'"
Connecticut Research, Glastonbury, Conn.
6. Industry Analysis Division, Common
Carrier Bureau, Federal Communications Commission. 1994. "Fiber
Deployment Update: End of Year 1993," Federal Communications
Commission, May.
7. It has been announced that TCG will be
contributing to a new venture of Sprint, Tele-Communications, Inc.,
Comcast Corporation, and Cox Cable that will package local
telephone, long-distance, and personal communications with cable
services into a single offering for residential and business
consumers.
8. National Cable Television Association.
1993. "Building a Competitive Local Telecommunications
Marketplace," National Cable Television Association Position Paper,
October.
9. Federal Communications Commission
Bulletin Board, March 13, 1995. Wireless Co., a consortium formed
by cable television operators TCI, Cox, and Comcast, and long
distance carrier Sprint, successfully bid over $2 billion for
licenses in 29 markets.
10. Merrill Lynch & Co. 1995. "The
Economics of the Sprint/Cable Alliance," Merrill Lynch & Co.,
February 10.
11. Kraemer, Joseph S., and Dwight Allen.
n.d. "Perspectives on the Convergence of Communications,
Information, Retailing, and Entertainment: Speeding Toward the
Interactive Multimedia Age," Deloitte Touche Tohmatsu
International, p. 13.
12. Brock, Gerald. 1995. "Incremental Cost
of Local Usage," prepared for Cox Enterprises, March, p. 2.
13. See S. 652, "Telecommunications
Competition Act of 1995"; H.R. 1555 Discussion Draft, May 2, 1995,
"Communications Act of 1995"; and H.R. 1528, "Antitrust Consent
Decree Reform Act of 1995."
14. United States of America v. Western
Electric Company, Inc. et al., and American Telephone &
Telegraph Company, Civil Action No. 82-0192.
