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

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Every once in a while a proposal comes along that is sopreposterous you don't know whether to laugh or scream. Structuralseparation of the Regional Bell Operating Companies is a goodexample. In a previous newsletter, the notion of breaking up theBaby Bells was briefly discussed (see TechKnowledge #9), but now the concept hastaken on new importance with the introduction of S. 1364, The Telecommunications Fair Competition EnforcementAct of 2001 by Sen. Ernest Hollings (D-S.C.).

Sen. Hollings, a long-time critic of the Bells, didn't wait longto take advantage of his re-ascendance to the throne of the SenateCommerce Committee to declare war on the RBOCs. His bill wouldforce 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 theearly 1980s-the famous breakup of AT&T that created the BabyBells-were not enough. The Hollings bill would set backtelecommunications policy 20 years and constitute possibly the mostradical, pro-regulatory measure to come along for any Americanindustry in decades.

Hollings and other structural separation proponents describedivestiture as simple regulatory surgery, as if the Bells justneeded to have a stubborn ingrown toenail removed to makeeverything better. In reality, however, structural separation ismore akin to amputation, and in this case the proposed radicalsurgery is for a patient who doesn't need any appendages removed inthe first place.

"But it's about competition!" proponents will exclaim. Well,theoretically, splitting the Bells in two might make it a biteasier for regulators to encourage more of the same sort offreeloading by rivals that the Telecom Act's open access provisionshave fostered. But sharing is not competing, and policymakers needto stop pretending it is. The FCC's below-cost pricing structuresfor access to local telecom systems have produced a temporary risein the number of resellers in that market, providing the illusionof increased competition for the Bells. But competition in networkcreation itself is more important than illusory competitiontraversing already existing networks.

The problem is not that the Bells own the majority of theimportant old "last mile" copper lines that connect our homes andbusinesses to the larger communications grid. The real problem isthat other firms have not built competing facilities to challengethe Bells' hegemony. So how would structural separation remedy thissituation? Answer: It wouldn't. The only thing structuralseparation would do is entrench the crummy old copper wires thatwere strung through the air and under the ground years ago-and insome cases decades ago-as permanent natural monopolies.

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

Structural separation supporters conveniently ignore anothertroubling issue associated with splitting the Bell networks intowholesale and retail components: Who will maintain and upgrade thelast mile to our homes and businesses after divestiture? Turningthe local loop into the equivalent of just another lacklusterpublic utility service not only stamps out investment incentivesbut leaves troubling questions about future network managementunanswered. Why optimize a system if competitors benefit?

To the extent that further structural separation had been worthconsidering given residual government-granted monopoly power, thedeadline for taking such action was five years ago when theTelecommunications Act of 1996 was passed. While a few companiesand consumer advocates did broach the idea in filings or speeches,Congress never picked up the idea. Instead, anopen-access/interconnection regime was implemented, such that theBells would open their networks to competitors in exchange forpermission to enter the long-distance marketplace. Especially sincethe wisdom of imposing a forced access regime was faulty in thefirst place, turning back the clock at this point in the game wouldderail any possibility of phasing out the volumes of telecom rulesalready on the books. In fact, another Bell divestiture would justbeget years of additional litigation and paper-intensiverulemakings.

Finally, such a move would have profound ramifications for theeconomy as a whole. The harm that would come to the Bells and theirmillions of employees and shareholders is obvious. But consider theimpact on communications equipment providers, computer companies,broadband application and content providers, and the many othersectors and businesses that depend upon a stable communicationsindustry.

Legislators should not buy into the notion that structuralseparation is a neat and simple division of a preexisting pie. Thecommunications industry should not be treated like a regulatoryplaything, like a collection of Legos and Lincoln Logs that can betorn down and then neatly put back together again. The localexchange is vastly more complicated than many policymakersappreciate, and, besides that, there are great benefits in thevertically integrated, end-to-end type service that the Bellsprovide.

If legislators really want to encourage increased competition inlocal telephone markets they must first eliminate the highlyillogical rate subsidies that continue to artificially depress theprice of local telephone service well below actual costs. GartnerDataquest has estimated that the average cost of providing basicresidential phone service in America to be roughly $20 per month.Yet, many states freeze rates at or below $15 per month. As Gartneranalysts Ron Cowles and Alex Winogradoff point out: "It's notdifficult to see that competitors will not be attracted to marketswhere they take a loss on each unit sold, regardless of theservices they bundled together. . . . Even with [resale] discounts,the potential margins are minimal. It's also not hard to understandthat it is the regulators themselves . . . that have created thisregulatory barrier to competitive entry." Facilities-basedcompetition will not develop as long as the local exchange marketis riddled with such inefficient subsidies. If local regulatorstold McDonalds to offer Big Macs for half their actual cost andoffered them subsidies to do so, do you think Burger King orWendy's would ever come to town?

But talk of ending price supports for cheap telephone service istaboo in Congress and the regulatory community. Americans haveseemingly gained an inalienable right to have their gabbingsubsidized. But what makes for good politics rarely makes for goodeconomics, and if policymakers refuse to allow companies to chargethe market price for existing or new service offerings, genuinecompetition will never come to the local loop. Instead we're stuckwith half-baked ideas like another big breakup of the Baby Bells.Deregulation's chances appear dimmer than ever.