TechKnowledge No. 17

Structural Separation of the Bells - An Idea Whose Time Has Passed

By Adam D. Thierer and Clyde Wayne Crews Jr.
August 20, 2001

Every once in a while a proposal comes along that is so preposterous you don’t know whether to laugh or scream. Structural separation of the Regional Bell Operating Companies is a good example. In a previous newsletter, the notion of breaking up the Baby Bells was briefly discussed (see TechKnowledge #9), but now the concept has taken on new importance with the introduction of S. 1364, The Telecommunications Fair Competition Enforcement Act of 2001 by Sen. Ernest Hollings (D-S.C.).

Sen. Hollings, a long-time critic of the Bells, didn’t wait long to take advantage of his re-ascendance to the throne of the Senate Commerce Committee to declare war on the RBOCs. His bill would force the Bells to separate their wholesale (wires and switches) and retail (business services) functions into distinct companies, as if the gut-wrenching divestiture the industry underwent in the early 1980s-the famous breakup of AT&T that created the Baby Bells-were not enough. The Hollings bill would set back telecommunications policy 20 years and constitute possibly the most radical, pro-regulatory measure to come along for any American industry in decades.

Hollings and other structural separation proponents describe divestiture as simple regulatory surgery, as if the Bells just needed to have a stubborn ingrown toenail removed to make everything better. In reality, however, structural separation is more akin to amputation, and in this case the proposed radical surgery is for a patient who doesn’t need any appendages removed in the first place.

“But it’s about competition!” proponents will exclaim. Well, theoretically, splitting the Bells in two might make it a bit easier for regulators to encourage more of the same sort of freeloading by rivals that the Telecom Act’s open access provisions have fostered. But sharing is not competing, and policymakers need to stop pretending it is. The FCC’s below-cost pricing structures for access to local telecom systems have produced a temporary rise in the number of resellers in that market, providing the illusion of increased competition for the Bells. But competition in network creation itself is more important than illusory competition traversing already existing networks.

The problem is not that the Bells own the majority of the important old “last mile” copper lines that connect our homes and businesses to the larger communications grid. The real problem is that other firms have not built competing facilities to challenge the Bells’ hegemony. So how would structural separation remedy this situation? Answer: It wouldn’t. The only thing structural separation would do is entrench the crummy old copper wires that were strung through the air and under the ground years ago-and in some cases decades ago-as permanent natural monopolies.

Proponents of the split are basically saying that the current telephone network is the only one we can expect to see in our lifetimes and so we’d best find a way to divvy up and optimize its use. Isn’t this selling companies and consumers a little short? Are the current local wireline telephone exchange facilities that most Americans use today the only systems they will ever know? It requires real technological pessimism to believe that, especially with millions of Americans increasingly opting for cellular and satellite systems for their communications and entertainment needs.

Structural separation supporters conveniently ignore another troubling issue associated with splitting the Bell networks into wholesale and retail components: Who will maintain and upgrade the last mile to our homes and businesses after divestiture? Turning the local loop into the equivalent of just another lackluster public utility service not only stamps out investment incentives but leaves troubling questions about future network management unanswered. Why optimize a system if competitors benefit?

To the extent that further structural separation had been worth considering given residual government-granted monopoly power, the deadline for taking such action was five years ago when the Telecommunications Act of 1996 was passed. While a few companies and consumer advocates did broach the idea in filings or speeches, Congress never picked up the idea. Instead, an open-access/interconnection regime was implemented, such that the Bells would open their networks to competitors in exchange for permission to enter the long-distance marketplace. Especially since the wisdom of imposing a forced access regime was faulty in the first place, turning back the clock at this point in the game would derail any possibility of phasing out the volumes of telecom rules already on the books. In fact, another Bell divestiture would just beget years of additional litigation and paper-intensive rulemakings.

Finally, such a move would have profound ramifications for the economy as a whole. The harm that would come to the Bells and their millions of employees and shareholders is obvious. But consider the impact on communications equipment providers, computer companies, broadband application and content providers, and the many other sectors and businesses that depend upon a stable communications industry.

Legislators should not buy into the notion that structural separation is a neat and simple division of a preexisting pie. The communications industry should not be treated like a regulatory plaything, like a collection of Legos and Lincoln Logs that can be torn down and then neatly put back together again. The local exchange is vastly more complicated than many policymakers appreciate, and, besides that, there are great benefits in the vertically integrated, end-to-end type service that the Bells provide.

If legislators really want to encourage increased competition in local telephone markets they must first eliminate the highly illogical rate subsidies that continue to artificially depress the price of local telephone service well below actual costs. Gartner Dataquest has estimated that the average cost of providing basic residential phone service in America to be roughly $20 per month. Yet, many states freeze rates at or below $15 per month. As Gartner analysts Ron Cowles and Alex Winogradoff point out: “It’s not difficult to see that competitors will not be attracted to markets where they take a loss on each unit sold, regardless of the services they bundled together… . Even with [resale] discounts, the potential margins are minimal. It’s also not hard to understand that it is the regulators themselves … that have created this regulatory barrier to competitive entry.” Facilities-based competition will not develop as long as the local exchange market is riddled with such inefficient subsidies. If local regulators told McDonalds to offer Big Macs for half their actual cost and offered them subsidies to do so, do you think Burger King or Wendy’s would ever come to town?

But talk of ending price supports for cheap telephone service is taboo in Congress and the regulatory community. Americans have seemingly gained an inalienable right to have their gabbing subsidized. But what makes for good politics rarely makes for good economics, and if policymakers refuse to allow companies to charge the market price for existing or new service offerings, genuine competition will never come to the local loop. Instead we’re stuck with half-baked ideas like another big breakup of the Baby Bells. Deregulation’s chances appear dimmer than ever.

Adam Thierer (athierer [at] cato [dot] org) is the Director of Telecommunications Studies and Clyde Wayne Crews Jr. (wcrews [at] cato [dot] org) the Director of Technology Studies at the Cato Institute in Washington, D.C. To subscribe, or see a list of all previous TechKnowledge articles, visit www.cato.org/tech/tk-index.html