Friday, April 22, 2005

Reading :: After the Breakup

Originally posted: Fri, 22 Apr 2005 09:46:04

After the Breakup : U.S. Telecommunications in a More Competitive Era

by Robert W. Crandall

It's difficult to emphasize exactly how important the breakup of AT&T was for the US telecommunications industry. The US had something that turns out to be quite rare -- a private telecommunications infrastructure -- and AT&T held a virtual monopoly on it until the Department of Justice brought an antitrust suit and AT&T was forced to settle it with a consent decree in 1982. This book, written in 1991, asks: how has the telecommunications system fared in the intervening years?

Robert Crandall, to his credit, doesn't try to give us a simple answer. The telephone equipment and services sector has turned into a set of increasingly competitive markets (p.1); phone bills are more detailed and complex (p.1); regulators have overlapping jurisdictions (p.2). And the peculiar economy of telecommunications, in which every subscriber represents a separate service, means that the economy is not intuitive: "the cost of connecting any subscriber to a switch increases with distance to the switch," so economies of density do not translate into economies of scale (p.3). The latter point contributes to the fact that it's tremendously expensive to service rural customers. If you're running a virtual monopoly (80% of the local exchange market going into the 1960s - p.8), you can subsidize the rural customers from profits drawn from urban areas (p.13) -- as well as from long distance profits, which subsidized all local service anyway. But once the market is vertically fragmented (p.41), this arrangement becomes harder to sustain.

According to Crandall, the telecommunications market's rates were distorted in five ways between 1934-1960:

1) Long distance rates were kept artificially high to subsidize local service.

2) Long distance rates were based on distance -- but distance was not a good measure of actual cost; call density was.

3) Local service had a higher operating cost in rural areas than in urban ones, but the rates were the opposite: Rural customers paid less for their expensive service.

4) Business customers were charged more, although the real cost of the service was the same as for residential customers.

5) Local service was offered as a flat rate, meaning that heavy users paid as much as light users. (p.23)

This uneasy settlement, which had much to do with keeping politicians and their constituents happy, became more difficult to sustain once new technologies were brought into play. Microwave transmission, for instance, has a relatively low economy of scale; satellite and fiber-optic transmissions also allow low economies of scale (p.4). But it was microwave transmission that really changed things. Imagine being AT&T: you've spent an enormous amount of money on your "long lines," your miles and miles of copper wire strung along wooden poles, connecting different parts of the country. If anyone wants to compete, they have to be willing to duplicate your network, an extremely expensive proposition not just to set up but to maintain. Then suddenly MCI comes along with two microwave towers, placed in two different cities on one of your most profitable routes, and sets up an instant long distance connection -- no poles, no lines, no maintenance of miles of copper, no tree pruning or line splicing!

In any case, various changes led the FCC to reprice long-distance and local service in the 1970s: it proposed phasing out "non-traffic-sensitive cost recovery from access charges on long-distance carriers by instituting fixed monthly subscriber-line charges (SLCs) on business and residential customers" (p.31). The full plan was frustrated politically, but the SLCs are right there on your phone bill today.

Another really intriguing development is that private networks are being set up with increasing frequency. Private branch exchanges (PBXes), private microwave transmissions, and local fiber-optic networks are proliferating, as well as cellular telephone networks (p.52, 75). And all have to deal with what I've called the first articulation of universal service, in which different networks must be linked to form a single subscriber universe.

And then there's regulation:

The liberalization of telephone services and equipment markets and the AT&T divestiture have placed enormous pressures on regulators, telephone companies, and labor. The entire telephone rate structure, a reflection of generations of political decisionmaking, is being radically revamped by regulators who are now much more attuned to market forces. Carriers must respond to the changes in regulation and to the rapid growth in competition. These responses, in turn, affect the efficiency of the entire telephone network. (p.106)

Liberalization doesn't mean deregulation, except for terminal equipment (phones, faxes). Currently, the telecommunications industry is regulated by three regulatory bodies with overlapping jurisdictions: the FCC, state public utility commissions, and the US district court for the District of Columbia (a result of a foolish decision Justice Greene made while dealing with the 1982 Modification of Final Judgment) (pp. 12-13). The problem, Crandall worries, is that when you combine heavy regulation and liberalization of entry (competition), you often get cartels: "Regulators are likely to be forced into the role of cartel managers, particularly if one or one carriers find themselves unable to compete. New entrants or even incumbents may use the regulatory process to prevent their rivals from cutting rates, claiming that such rate reductions are 'predatory'" (p.155).

All in all, Crandall's 1991 book pointed out several pressures and disjunctures originating before the breakup and building afterwards. It's instructive to read this book in conjunction with one of the many post-1996 books discussing how the Telecommunications Act of 1996 handled these issues. >

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