TechKnowledge No. 27

Why “Fair” Competition Fails in the Telephone Industry: The Case of Wavelength Services

In papers published by Cato before the 1996 Telecommunications Act became law, I predicted that the act’s attempts to regulate away the supposedly unfair advantages of the Bell companies would undercut its objective of improving telecommunications quality in the United States. However unfair the historical circumstances may have been under which the Bell companies originally acquired their networking expertise and resources, barriers to their offering services would, I claimed, only hurt the customer.

A recent report from colleagues at Communications Industry Researchers on dense wave division multiplexing (DWDM) vindicates those fears. (DWDM technology enables multiple channels of information to be sent on a single optical fiber.) In “BellSouth and Qwest: Distinctive Metro Business Models Face Similar Regulatory Hurdles in Providing Wholesale DWDM Services,” researchers Mark Lutkowitz, Sam Greenholtz, and David Gross show how burdens placed on Bell offerings of so-called “wavelength services” led to fewer choices and higher costs for larger customers that demand them. Wavelength services provide large telecommunications users with their own dedicated channel on the telephone company’s network over which they can rapidly send almost unlimited amounts of information. Many consumers do not need wavelength services because they offer capacity significantly above typical needs, but those users who do need them face higher operational costs than might otherwise have been the case. Those costs get passed on to their business or individual customers.

Wavelength services are the latest version of the private networks that most large financial and manufacturing firms, as well as government agencies, have long operated to support their communications needs. Those networks are not actually private in the usual sense. Instead, they run over parts of the telephone company network specifically dedicated to that purpose. Private networks are often based on leased “dark fiber”-that is, strands of fiber not being used for other purposes. Any such fiber can carry dozens of communications channels, each of a different wavelength. But few users make use of all this capacity, effectively wasting much of the space they are paying for. It makes economic sense for customers to lease not entire dark fibers but individual channels. That is what the new wavelength services offer. The cost of the fiber is shared by multiple wavelength users, and, in the many areas where dark fiber is scarce, wavelength services may be the only way of serving current needs without laying more expensive fiber.

Telecom policy should allow such services to flourish. The 1996 Act specifically promises to remove regulatory burdens on the deployment of advanced communications services. Unfortunately, in the case of wavelength services, that is not what happened. The logical providers of such services would, of course, be the local incumbent telephone companies, which already have lots of fiber in the ground that are capable of providing wavelength services. But it is a regulatory nightmare for a Bell company to provide wavelength services. Immediately after the 1996 Act was signed into law, some state public utility commissions ruled that if a Bell installed any wave division multiplexing (WDM) equipment-the gear that enables multiple channels to be sent on a single fiber-they would be forced to sell some of the channels to their competitors. The result was predictable. In 1997, U.S. West stopped deployment of WDM systems, even though WDM was much less expensive than laying additional fiber. Here, the 1996 Act, which was supposed to free the telcos to improve the communications infrastructure, had the exact opposite effect.

Eventually, the FCC overruled those decisions. Currently, as long as a Bell can prove that it is deploying WDM channels merely for its own commercial use, it will not be forced to give its competitors access to them. But this is only a modest improvement, because if a Bell company sells just one channel to a competitor for good commercial reasons, it opens itself up to the charge that it has installed WDM for reasons other than its own use, and it is likely to be forced to make all of its wavelengths available to its competitors. That is one reason the Bells have been slow to deploy WDM in their networks.

Even if one discounts the disincentives to improving the communications infrastructure caused by forced sales, there is also the matter of forced pricing. Wavelength services can carry information at any speed, so can reasonably be considered a premium offering and priced higher than fixed data rate services. However, that free-market scenario is entirely different from the present one, in which regulators decide how wavelength services will be priced. The FCC has forced the Bells to price wavelength services equal to or higher than their fastest conventional private network service. That gives the Bells very little marketing flexibility. For example, a Bell may want to price low in order to migrate customers to wavelength services as a way of justifying the cost of such services through a larger customer base, or to compete with its rivals.

Although the 1996 Act was supposed to promote the deployment of advanced communications infrastructure and services, the wavelength services example illustrates that the FCC has failed to interpret the act in line with that objective. The state utility commissions also continue to present the Bell companies with a regulatory morass that can make the approval process very costly and time consuming. Major filings in just one or two states can cost $5 to $10 million and it can easily take a year for a Bell company to put together a tariff, or pricing schedule, for high data rate services. That is because such tariffs get challenged by consumer protection agencies, which believe that such services give special breaks to businesses at the expense of “consumers.” (They argue that consumers are paying for building an optical infrastructure that is used primarily to support business services, but evidence for this is lacking.)

Some would argue the ends justify the means and that regulatory burdens placed on the Bells help create more competition by giving competitive carriers a better chance of success. However, those competitive local exchange carriers (CLECs) are failing in droves. Does that mean that we haven’t placed enough regulatory burdens on the Bell companies? Hardly. There are many reasons for the CLECs lack of success, but one is that they have failed to build networks that are anywhere near as sophisticated as those of the Bells. The inherent advantages of the Bells-survivability and stability-often result in business customers, including other carriers, realizing that going after the cheapest local service is not always the best strategy. Customers go back to the incumbent after discovering how much business they lose if CLEC services fail. During the horrors of September 11, for example, Verizon’s redundant network saved most of its competitors in Manhattan by providing emergency circuits.

This is not to say that competition with the Bells should be entirely discounted. Public policy should do everything to promote the creation of multiple networks that compete for local customers and have a robust and redundant infrastructure like the Bells. It is only through the creation of such networks that CLECs will be able to retain customers and provide long-term competition to the Bells. Multiple redundant networks may also help address needs in time of national emergencies, when individual networks may be disrupted or destroyed. This objective will never be promoted by forcing the Bells to hand over part of their network to their competitors as is the case today with wavelength services.

Lawrence Gasman is President of Communications Industry Researchers and a Senior Fellow at the Cato Institute. He is the author of Telecompetition: The Free Market Road to the Information Highway (Washington: Cato Institute, 1994).