TechKnowledge No. 58

Was the UNE Triennial Review Worth the Wait? Part II: The Substance

By Adam D. Thierer
September 15, 2003

Part I of this memo discussed the troubling procedural issues surrounding the Federal Communications Commission’s August 21 release of the its long-awaited final ruling in its massive Unbundled Network Element (UNE) Triennial Review. Although the process behind the UNE Triennial Review Order (TRO) was distressing, the substance of the edict is cause for even more concern.

At its most basic level, the 576-page, 2,447-footnote ruling represents an attempt to rationalize and extend the FCC’s infrastructure-sharing rules for older networks and technologies, while firewalling off new services (fiber in particular) from those same rules. Thus, the inherent contradiction of the TRO becomes immediately clear: FCC officials are smart enough to realize that the agency’s current infrastructure-sharing regime has wrought havoc within financial markets, discouraged investment, and threatened innovation, so they have begun quarantining new services and technologies from those destructive regulations. Yet they are either too embarrassed or stubborn to admit that fact and begin dismantling all of the infrastructure socialism that has plagued the sector since the passage of the Telecommunications Act of 1996. So a veritable Berlin Wall for telecom is being erected with unrestrained services and technologies on one side and micromanaged services and technologies on the other.

Containing the Old Industrial Policy. Of course, a regulatory firewall can have benefits for those industry segments or technologies lucky enough to be on the free side of the wall. This is why many industry analysts have long favored the firewalling approach; it’s the easiest way to limit the damage associated with the old rules and encourage firms to deploy advanced networks and technologies.

The old industrial policy leans heavily on UNEs and the UNE wholesale platform (UNE-P) scheme the FCC concocted, which required incumbent local exchange carriers to unbundle and share virtually every element of their networks at regulated rates and then reassemble those elements so that rivals could resell the entire package of services. The FCC and state public utility commissions (PUCs) have spent the last seven years aggressively subsidizing CLECs via UNE-P. Not surprisingly, that industrial policy worked marvelously since, if you subsidize something you typically get more of it, sometimes far more than you really need. Dozens of new “competitors” entered the market and began reselling telecom access over the lines owned by incumbent firms. Some CLECs built their own switches or other systems, but the vast majority opted for infrastructure sharing via UNE-P over facilities-based investment. Why build when you can borrow, and borrow at rates far below the cost of the good in question?

This game worked for a few years, but the regulatory house of cards came crashing down a few years ago as telecom stocks tanked and even the most generous infrastructure-sharing rules couldn’t save companies that hadn’t invested a penny in their own facilities. The reverberations were widespread and devastating: a massive market meltdown spilled over into adjacent markets and resulted in bankruptcies, heavy job losses, and a slowdown in industry investment. That explains why the FCC has proposed a Berlin Wall for broadband in the TRO.

Cash Flow and New Investments. But there’s always been one nagging flaw in the idea of broadband firewalling. Freeing up broadband from regulation is a sensible decision that may lead to some new investment by carriers. But will the continuation of infrastructure-sharing rules on older systems cut into the cash flow necessary to make significant investment in new networks and technologies?

Investment analysts at the Precursor Group rightly label the UNE-P regime “a profit killer” that eats into the operating margins incumbent carriers need to invest in expensive and risky new high-speed systems. And other investment analysts have noted that broadband demand remains somewhat uncertain, making high-speed deployment an even riskier proposition. Incumbents are also losing access lines for the first time in decades due primarily to intense cellular competition as consumers increasingly substitute buckets of wireless minutes for traditional wireline calls. And Internet telephony is finally becoming a credible threat, with dozens of firms (including less-regulated cable firms) deploying packet-switched voice services over the Internet. The combination of UNE-P regulation, wireless substitution, and real access line loss means incumbent operators may find it difficult to significantly ramp up capital expenditures in new high-speed networks in the short term.

The Hyper-Balkanization of Telecommunications. And the cash flow picture won’t get better any time soon thanks to the most unfortunate element of the TRO: the FCC’s generous delegation of UNE authority to state regulators. The word of the day at the FCC is “granular.” The term is sprinkled throughout the new order and reflects the FCC’s new infatuation with “states’ rights” within telecom markets. Apparently by allowing state public utility commissions (PUCs) to engage in more granular regulatory analysis on a market-by-market basis, 51 PUCs will be able to more scientifically micro-manage telecom competition into existence.

The perils of this approach cannot be understated. Suffice it to say, there are plenty of other public policy issues for which devolution makes a great deal of sense, but telecom and broadband regulatory policy is not one of them. If, however, the FCC’s intention is to create even more synthetic competition and save the resellers, who depend on a steady flow of low-priced UNEs, then the devolution plan laid out in the TRO may work. In fact, increased sharing is a virtual certainty under the language of the TRO since the order contains a number of self-fulfilling tests and triggers that state PUCs can use to retain or expand the use of UNE-P. For example, switching will only be removed from the list of shared UNE items if a state finds that there are three or more unaffiliated carriers serving customers in a given market using their own switches. (The TRO also lets the states define “markets” as broadly or narrowly as they want for purposes of enforcing this rule). But, again, why build a switch when you can borrow someone else’s at low UNE rates? In other words, these rules result in business decisions that cause the very problem the rules are supposed to remedy. Worse yet, the self-perpetuating nature of the new TRO state-driven framework means that “UNE-P may never go away,” as a recent Credit Suisse / First Boston investment report argues.

Bottom line: The TRO is one small step forward (the broadband firewall), but two or three giant steps back (the retention and devolution of UNE-P authority in particular). Little in the TRO will likely incentivize the true facilities-based competition so desperately needed in telecom markets. Instead, the TRO is just more of the FCC’s old infrastructure sharing but this time doled out on a more parochial basis. As Precursor Group analysts conclude, “This order effectively completes the FCC’s de facto socialization of the Bells’ infrastructure to artificially drive prices down…. [R]esale competition has ceased to be a transition to facilities competition and become an end in itself.” Regrettably, it now appears this managed competition-infrastructure socialism game will continue ad nauseam, potentially for many years longer than anyone initially envisioned when the Telecom Act was passed back in 1996.

Adam Thierer (athierer [at] cato [dot] org) is the Director of Telecommunications Studies at the Cato Institute in Washington, D.C. ) and co-author with Clyde Wayne Crews Jr. of What’s Yours is Mine: Open Access and the Rise of Infrastructure Socialism (Cato Institute, 2003). To subscribe, or see a list of all previous TechKnowledge articles, visit www.cato.org/tech/tk-index.html.