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

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In papers published by Cato before the 1996 TelecommunicationsAct became law, I predicted that the act's attempts to regulateaway the supposedly unfair advantages of the Bell companies wouldundercut its objective of improving telecommunications quality inthe United States. However unfair the historical circumstances mayhave been under which the Bell companies originally acquired theirnetworking expertise and resources, barriers to their offeringservices would, I claimed, only hurt the customer.

A recent report from colleagues at Communications Industry Researcherson dense wave division multiplexing (DWDM) vindicates those fears.(DWDM technology enables multiple channels of information to besent on a single optical fiber.) In "BellSouth and Qwest:Distinctive Metro Business Models Face Similar Regulatory Hurdlesin Providing Wholesale DWDM Services," researchers Mark Lutkowitz,Sam Greenholtz, and David Gross show how burdens placed on Bellofferings of so-called "wavelength services" led to fewer choicesand higher costs for larger customers that demand them. Wavelengthservices provide large telecommunications users with their owndedicated channel on the telephone company's network over whichthey can rapidly send almost unlimited amounts of information. Manyconsumers do not need wavelength services because they offercapacity significantly above typical needs, but those users who doneed them face higher operational costs than might otherwise havebeen the case. Those costs get passed on to their business orindividual customers.

Wavelength services are the latest version of the privatenetworks that most large financial and manufacturing firms, as wellas government agencies, have long operated to support theircommunications needs. Those networks are not actually private inthe usual sense. Instead, they run over parts of the telephonecompany network specifically dedicated to that purpose. Privatenetworks are often based on leased "dark fiber"-that is, strands offiber not being used for other purposes. Any such fiber can carrydozens of communications channels, each of a different wavelength.But few users make use of all this capacity, effectively wastingmuch of the space they are paying for. It makes economic sense forcustomers to lease not entire dark fibers but individual channels.That is what the new wavelength services offer. The cost of thefiber is shared by multiple wavelength users, and, in the manyareas where dark fiber is scarce, wavelength services may be theonly way of serving current needs without laying more expensivefiber.

Telecom policy should allow such services to flourish. The 1996Act specifically promises to remove regulatory burdens on thedeployment of advanced communications services. Unfortunately, inthe case of wavelength services, that is not what happened. Thelogical providers of such services would, of course, be the localincumbent telephone companies, which already have lots of fiber inthe ground that are capable of providing wavelength services. Butit is a regulatory nightmare for a Bell company to providewavelength services. Immediately after the 1996 Act was signed intolaw, some state public utility commissions ruled that if a Bellinstalled any wave division multiplexing (WDM) equipment-the gearthat enables multiple channels to be sent on a single fiber-theywould be forced to sell some of the channels to their competitors.The result was predictable. In 1997, U.S. West stopped deploymentof WDM systems, even though WDM was much less expensive than layingadditional fiber. Here, the 1996 Act, which was supposed to freethe telcos to improve the communications infrastructure, had theexact opposite effect.

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

Even if one discounts the disincentives to improving thecommunications infrastructure caused by forced sales, there is alsothe matter of forced pricing. Wavelength services can carryinformation at any speed, so can reasonably be considered a premiumoffering and priced higher than fixed data rate services. However,that free-market scenario is entirely different from the presentone, in which regulators decide how wavelength services will bepriced. The FCC has forced the Bells to price wavelength servicesequal to or higher than their fastest conventional private networkservice. That gives the Bells very little marketing flexibility.For example, a Bell may want to price low in order to migratecustomers to wavelength services as a way of justifying the cost ofsuch services through a larger customer base, or to compete withits rivals.

Although the 1996 Act was supposed to promote the deployment ofadvanced communications infrastructure and services, the wavelengthservices example illustrates that the FCC has failed to interpretthe act in line with that objective. The state utility commissionsalso continue to present the Bell companies with a regulatorymorass that can make the approval process very costly and timeconsuming. 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 puttogether a tariff, or pricing schedule, for high data rateservices. That is because such tariffs get challenged by consumerprotection agencies, which believe that such services give specialbreaks to businesses at the expense of "consumers." (They arguethat consumers are paying for building an optical infrastructurethat is used primarily to support business services, but evidencefor this is lacking.)

Some would argue the ends justify the means and that regulatoryburdens placed on the Bells help create more competition by givingcompetitive carriers a better chance of success. However, thosecompetitive local exchange carriers (CLECs) are failing in droves.Does that mean that we haven't placed enough regulatory burdens onthe Bell companies? Hardly. There are many reasons for the CLECslack of success, but one is that they have failed to build networksthat are anywhere near as sophisticated as those of the Bells. Theinherent advantages of the Bells-survivability and stability-oftenresult in business customers, including other carriers, realizingthat going after the cheapest local service is not always the beststrategy. Customers go back to the incumbent after discovering howmuch business they lose if CLEC services fail. During the horrorsof September 11, for example, Verizon's redundant network savedmost of its competitors in Manhattan by providing emergencycircuits.

This is not to say that competition with the Bells should beentirely discounted. Public policy should do everything to promotethe creation of multiple networks that compete for local customersand have a robust and redundant infrastructure like the Bells. Itis only through the creation of such networks that CLECs will beable to retain customers and provide long-term competition to theBells. Multiple redundant networks may also help address needs intime of national emergencies, when individual networks may bedisrupted or destroyed. This objective will never be promoted byforcing the Bells to hand over part of their network to theircompetitors as is the case today with wavelength services.

Lawrence Gasman

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).