Where It Stands: An Overview of the Ramifications of the FCC Regulation Strategic Interconnection and Competitive Reselling in the Telecommunications Industry James W. Olson Chief, Competition Division Office of General Counsel, Federal Communication Division 25 September 1996 Dallas, Texas Thank you, Mr. Chapman, for that introduction. I also want to thank our hosts for my invitation. I am very pleased to be with you today here in Dallas. What you are about to hear are my views alone, not those of the FCC nor of the General Counsel's Office. As most of you probably know, the FCC will be defending its interconnection order of August 8 against a variety of legal challenges. Given my position as the lawyer heading the Competition Division within the General Counsel's office, I have been advised by my lawyers to limit my comments on any subject reasonably within the scope of litigation. I hope this will not rob my presentation of meaningful content. I would like to begin by asking you to think how you would answer this question: What is your first recollection of consumer choice in telecommunications? My reason for asking is pretty simple. There has been considerable corporate focus, some would say "hype", on what the consumer wants in recent years. So, rather than view you as corporate representatives, I invite you to think of yourselves as consumers of telecommunications. The question again: What is your first recollection of consumer choice in telecommunications? For better or worse, our mental answers invariably date us. But let me share mine with you. My first recollection of consumer choice was the ability of my parents to rent an AT&T Princess Phone in one of several different colors. Those of you a bit older than I may recall that the standard black desktop phone was offered earlier in different colors. But the recollections of those of you considerably younger will be much more varied. Now, let's "fast forward". This time, I would like to ask you to reflect on what telecommunications choices are currently of concern to you. [Pause] Your answers will span a considerable range, but let me suggest that the following themes predominate:  Am I reasonably certain that my long distance plan, if not the best, is not costing me considerably more than an alternative?  Does it make sense for me to substitute (or augment) my cable TV with one of those small dish satellite systems? And if I do that, how do I get local weather and news?  How do I get faster Internet connections? Do I simply replace my 14.4 modem with a 28.8? Or, do I investigate ISDN, or wait until I can get a cable modem? Or what?  What are PCS companies really offering? Will it be cheaper than cellular? And, does their service area go where I go?  My answering phone needs replacing. Should I get a new one, buy some computer hardware, or take service from my local phone company? Now, let's reflect on what underlies the differences between our two sets of responses, recognizing that concerns about long distance plans and cable TV programming are shared pretty much by all Americans, while internet connection concerns are shared by a rapidly increasing number. Here is the point as I see it: Not only has the number of information conduits into our homes increased, the way we think about them, and what we can get through them has changed as well. It is this "access market" -- how we as consumers access telecommunications services and facilities -- that I want to address today. I suspect that very few of you thought of anything to do with television when I asked about your first recollection of consumer choice in telecommunications. But today, a consumer has a choice of television conduits: broadcast (through one portion of the frequency spectrum), cable (through coaxial cable and wireless delivery), and satellite (through several different portions of the frequency spectrum). Moreover, many internet users, let alone industry participants, are aware that someone, somewhere, is planning to offer very fast internet connections over the same cable that provides cable TV. Our concept of the video conduits continues to change, and may change even more with the future introduction of digital television. We are beginning to include internet access, including internet phone functionality, in our mental construct of what cable and satellite TV are all about. "The convergence of television and the computer" some would say. Well, perhaps. But, let me also point out that what is going on is an increasing ability for the consumer to get similar functionality from very different information conduits that have developed in very different traditions and regulatory regimes. We have already identified some of the different conduits for television. Other consumer conduits include: the different frequency spectrum bands that provide cellular telephony and data, personal communications services, satellite mobility and fixed services . But we are here to discuss an older consumer information conduit -- the twisted copper pair. While the Commission's local telephone interconnection rules remake the potential functionality afforded consumers over twisted copper pair, they will also have ripple effects on the services available in the future over other information conduits. This is what competition in the current technological environment is all about. I invite you to view interconnection issues from a consumer perspective -- and not from the normal perspective of more potential choices -- but as the latest step on a continuum of consumer control. In the "princess phone era" we could plug into the wall only one or two phones that AT&T owned. Over the years, with a number of regulatory decisions, consumers could exercise more control over what they could plug into their phone jacks. Moving progressively toward the end office switch, we are all aware that to a considerable degree, most of us are responsible for our in-house wiring to the box that delineates where the local phone company assumes responsibility for the physical facility -- the twisted copper pair. One way to conceptualize the philosophy underlying the interconnection rules is to view the consumer as now being able to exercise control over this information conduit all the way to the end office switch. We, as consumers, now exercise increasing discretion regarding who provides us what over the copper pair physically identified with our residences. This is "unbundling of the local loop" from the perspective of the end user. What is important in this view is who the consumer chooses to give access to his home. I believe that future telecommunications historians are likely to view the Telecommunications Act of 1996, as THE critical turning point in our development as an information society. Even the Modified Final Judgment, as important as it was, did not entirely repudiate the intellectual construct that telecommunications was a natural monopoly -- it only reduced the scope of the natural monopoly to that of the local exchange. In contrast, the Conference Report to the Telecommunications Act describes Congress's intent to establish a "pro-competitive national policy framework" for the telecommunications industry. That is a profound statement, describing profound legislative provisions. Taken collectively, we have a broadly based national policy determination that the consumer choice made possible by competition should replace government regulation as the philosophic basis for electronic information and communication. The FCC staff labored long and hard on the interconnection order released on August 8th. Just how long and hard can be illustrated by the following: within the space of six months, over 17 thousand pages of comments were received and analyzed. This was accompanied by a seemingly helter- skelter cacophony of lobbyist presentations and press comments. The outcome was a good faith effort to implement the provisions of the Telecommunications Act as Congress intended. Merrill Lynch said that by the August order, "the FCC has smoothed the way for ... local market competition." Morgan Stanley called it "evenhanded". CS First Boston said that "the FCC order hits the mark," and that "the FCC is set on the right course." As you are aware, the praise was somewhat less than universal. To date, the National Association of Regulatory Utility Commissions, four states, all the Bell companies, GTE and SNET will be appearing opposite us in the 8th Circuit Court of Appeals. Relying more on my background in antitrust law than in communications, let me make the following observation. The quantity of professional assets that have been expended, are being expended, and will be expended, with regard to the interconnection order will probably run into the millions of hours of attorney time. Ultimately, consumers will bear that expense. The Telecommunications Act contains the implicit assumption that the benefits will justify the costs. After all, the Congress and the FCC are changing the fundamental rules of the game. We are transitioning from a system where would-be competitors fight first with the government over who can offer what to the consumer, and only secondarily in the market place of consumer choice. In that old system, the overhead costs of regulatory delay and legal and lobbying expenses probably were not justified in terms of the benefits they conferred on consumers. These insidious costs flowed from a regime predicated on outcome- oriented regulation. We anticipate they will be considerably reduced in the future. [Now, let me show you my one and only slide.] We are in an anomalous period: The FCC must regulate today in order to deregulate tomorrow. And the form that regulation today takes is one designed to avoid the nasty consequences of the earliest non-regulated era. During the early days of the US. telephone industry -- when the Bell System was only one of 6,000 telephone exchange companies -- the lack of interconnection among rival telephone companies inflicted a considerable burden on consumers. In the extreme, multiple conduits -- two hard wires -- connected to separate instruments -- were necessary so that a consumer could speak to two independent sets of neighbors. What an inconvenience! Not to mention expense! We now have a term to encapsulate this condition and its consequences. What we now call "network effects" is industry shorthand for the proposition that the value of a communications network increases with its size. Simply put, the value of a network to me is very different depending on whether I can contact 250 people or 250 million people. This construct is now applied to the number of nodes on the internet as well as to the interconnection problems of telephone pioneers. Metcalfe's law states that the value of a network increases exponentially with the number of nodes. I have to admit that it is unclear to me whether the non-interconnection problems of the bad old days stemmed from technical limitations, misguided corporate strategies, a failure of the government to intervene, or a combination of all three. However, in the environment of the time, it is not difficult to see the appeal of the natural monopoly model of telecommunications that was, only recently, overthrown by Congress and the American people. While the implementing technologies have changed dramatically, both the Telecom Act and the Commission's implementing Local Competition Order have to deal with the business realities associated with network effects. The operator of a large network simply has little business incentive to interconnect with a smaller network. Inevitably, he will feel himself comparatively disadvantaged because the value of his large network to the new entrant is considerably greater than the value of the small network of the entrant is to him. Consequently, all other things being equal, a dominant facilities provider has considerable incentive to frustrate interconnection offers. The order of 8 August deals with this issue by establishing what might be termed "a Competitive Carrier Bill of Rights" -- a list of default conditions, available countrywide, to new entrants who commence negotiations with the incumbent monopoly facilities provider. This was done to cope with the reality of great disparities in negotiating power. For example, the Telecom Act mandates interconnection between incumbent and rival local carriers at reasonable rates. This prevents the incumbent network from taking exclusive advantage of the current network economies of scale and scope. Thus, calls originating on a rival network -- perhaps a wireless network or a CATV network configured for telephony -- can terminate on the incumbent network at a reasonable cost. Mandatory interconnection, perhaps coupled with unbundling, requires a rival entrant be allowed to share the existent economies inherent in the network that evolved during our "natural monopoly period". On a larger scale, Congress recognized the fact that competitive rivals have little to offer incumbent carriers, and the incumbent carriers -- because of network effects -- have everything to offer competitors. The Act injects a number of incentives and requirements into the bargaining process; and the Commission Order delineates several proxies that may be used by states to speed resolution of disputes between incumbents and entrants. I do not want to summarize the order provisions here. However, keeping in mind our point of view as consumers looking at how our information conduits might be used in the future, consider that under the interconnection order:  Local exchange carriers cannot charge different interconnection rates for wired and wireless providers.  Local exchange carriers can no longer charge providers for the traffic the local exchange carrier originates.  Local exchange carriers must pay mutual compensation for interconnection, and the rates should generally be symmetrical.  New entrants without interconnection agreements can pay default proxy rates while negotiating agreements.  Most favored party clauses are read into all interconnection agreements, ensuring that all interconnecting carriers can be certain that they are always getting the lowest available rates. We have already considered how the unbundling of local loops can be viewed as giving individual customers a measure of control over the twisted pair information conduit into their homes by permitting them to connect those wires to different telecommunications networks. What is dramatic about interconnection is the breadth of the set of possible interconnectors. Interconnection rights are broadly directed at the development of facilities-based competition in all conceivable forms. Among these rights are the right to exchange traffic through transport and termination arrangements (also known as reciprocal compensation), the right to lease unbundled elements of incumbent LEC networks for providing services, and the right to obtain access services at any feasible point in a LEC's network. The information conduit provided by spectrum used by cellular and PCS providers just became more valuable. Viewed from our perspective as consumers we can anticipate that services offered to us over this conduit will be increasingly substitutable for those offered over our twisted pair. Not only does this mean more choice, it means lower priced choices at a given quality of service. In a similar manner, by providing an interconnection baseline, the Telecommunications Act and the interconnection implementing order have modified the risk analysis of Cable TV companies considering whether to offer traditional dial-up telephony over their existing coaxial cable to the home. Now, don't misunderstand, I am not predicting that this service will necessarily come into being. The changes that have been wrought are so fundamental that we should expect to be surprised. I can't predict where all the new entrants will come from, but I would like to take a minute to discuss a new set of potential providers -- public utility holding companies. Section 103 of the Telecom act allows them to diversify into telecommunications industries without prior SEC approval by acquiring or maintaining an interest in "an exempt telecommunications company." Congress clearly believed that these holding companies are well situated to provide rival facilities for the provision of competitive telecommunications and information services. One portion of the Senate Report states: Allowing ... holding companies to become vigorous competitors in the telecommunications industry is in the public interest. Consumers are likely to benefit when more well capitalized and experienced providers of telecommunications services actively compete. Competition to offer the same services may result in lower prices to consumers. Moreover, numerous competitors may offer consumers a wider choice of services and options. More specifically:  Many utilities already have sophisticated communications systems for internal dispatch purposes. This represents a source of wireless expertise and well sited antenna facilities.  Utilities can use their easements to bring newly configured fiber capacity on line and use their neighborhood poles as wireless platforms.  Utilities could use their demand-side management facilities to deliver video programming as an alternative to existing cable service.  Finally, and perhaps most significantly, utilities can make effective partners for new entrants by providing sufficient capital and facilities to compete for local telephony. In short, Public Utility Holding Companies have the potential, alone or with others, not only to provide a new information conduit into our homes, but to provide needed platforms and facilities necessary to augment and expand the existing wireless conduits. Within the last two weeks, the Commission adopted the final rules necessary to implement provisions of the Act relating to holding company entry -- some five months ahead of the statutory requirement. Fifteen out of sixteen applications have already been granted. Although utilities are likely considering, by and large, how best to leverage their existing infrastructure, many other potential new entrants are infrastructure poor. Fortunately for them, Congress enumerated three paths of entry into the local telephone market. In addition to facilities- based entry, and the purchase of unbundled network elements from the incumbent local exchange carrier, the Act and implementing order require resale of the incumbent's retail services. All incumbent LECs are required to offer for resale any telecommunications service that the carrier provides at retail to subscribers who are not telecommunications carriers. We anticipate resale will be an important entry strategy both in the short term for many new entrants as they build out their own facilities and for small businesses that cannot afford to compete in the local exchange market by purchasing unbundled elements or by building their own network. Experience in the long distance service market suggests that performing an arbitrage function can continue to be profitable for resellers. Some 500 long distance companies provide service today over facilities owned by only a handful of facility providers. By buying capacity in bulk, sufficiently close to cost, they can exist profitably by reselling it to consumers. We consumers are benefited by increased choice, and by the fact that the pricing of competitive resellers puts downward pressure on the price the facilities owner charges for comparable retail service. Statutory and regulatory change allow for the possibility that this arbitrage function will appear in the provision of services in the local loop as well. Resale has often been viewed as either a peripheral business, or as a transitional, startup phase where the reseller would eventually "graduate" to owning and operating the underlying facilities. In fact, telecommunications resale may begin to take on characteristics of other markets. For example, automobile manufacturers rely on local dealerships to distribute product. These local resellers provide value both to the manufacturers and to the purchaser of a new car. In an analogous fashion, we can envision a decision by a facilities-based carrier to concentrate on its core business and to rely on resellers to add value to the facility in a way that is meaningful to particular classes of customers. The current move towards "bundling" and "one-stop shopping" may fortify the process. If a provider wants to be many things to many people in many markets, the most cost efficient way to do so may involve the assembly of different "building blocks" of services, some of which may be provided and tailored by resellers. The mixture of resale, facilities-based competition, and use of unbundled network elements is impossible for the Commission to predict. In all probability, new entrants will adopt various combinations as time and circumstances change. This is one of the joys of being a "regulator", and I use the term advisedly, in the new era. We are not wedded to a particular facilities or services outcome. We believe strongly that at this stage of facilities development and at this stage of computer and communications technology, the public interest, represented by summing the varied interests of all consumers, will be enhanced by the fair engineering of competitive markets. This is the message that my organization -- the competition division of the Office of the General Counsel -- brings to the staff of the FCC daily. It is also, quite fortunately for us, the message that Congress has heralded in the Telecommunications Act. One last question for you to ponder: What decisions will be in the forefront of your mind as a telecommunications consumer ten years from today? I confess that I don't have the foggiest idea. But, I am convinced that the services available through existing and new information conduits to the home will be of a nature that will amaze us when we view the present retrospectively. I also suspect we will not be talking about colors of Princess phones. Thank you for your kind attention. I would be happy to take a your questions.