CHAIRMAN REED HUNDT Federal Communications Commission Alex. Brown & Co. "Media & Communications '96 Conference" Waldorf-Astoria Hotel, New York September 17, 1996 Competition: Walking the Walk and Talking the Talk One of the great missions of the United States government is to pursue the goal of open and competitive communications markets in all countries, especially, of course, our own. To this end, we at the FCC are doing all we can to assist the United States Trade Representative Charlene Barshefsky to negotiate a successful multilateral agreement in the World Trade Organization. I recently returned from London where we were comparing notes and strategies on this goal with our counterparts in the United Kingdom. Thanks to the United States Congress and the Administration, I was able to say that here in the U.S. we are not only talking the talk; we are walking the walk. Indeed our policies now have a great deal in common with the procompetition policies of the United Kingdom and leading States like Illinois, Wisconsin, Ohio, and others. The rest of the world, I might add, for the most part has a long way to go in order to catch up to the U.K. and the U.S. The goal in all States in our country, in the United Kingdom, and in the WTO negotiations, is simple: as to the pro-monopoly policy in telecom, to paraphrase a Rolling Stones song from my distant youth, we used to love you, but that's all over now. For industries such as shoes or soap or software or salsa, government should not champion monopolies, restrict investment or set retail prices. The same can be true for communication services, if we reject the old monopoly regime and embrace competition. In short our ultimate goal for communications should be: no rules. The only exception should be, ironically, the rules that get us to this goal. All countries should agree on this goal. Certainly all states of the United States must agree on it, because Congress has made this the law of the land. But today 94% of all world communications revenue is earned by monopolies. And every state plus DC still relies principally on a local service monopoly. Telecommunications policy historically embraced monopolies because economists taught that telephone networks are natural monopolies. Innovation and insight has revealed that networks do have vast economies of scale and scope, but the only thing natural about communications monopolies is that naturally the companies with market power will try to keep that power unless governments, through rules, constrain their potential anticompetitive impulses. That's why, in the great new telecom law passed in February of this year, Congress asked the FCC to write new rules of competition to check such "natural" impulses. But our ultimate goal is to reach the sunny uplands of deregulated markets in which the prices and output of telecom services, like software and soap, are set by markets and not governments. Already the FCC has almost completely deregulated the long distance business: 500 long distance companies make for enough competition that we don't any longer regard AT&T as the dominant carrier. In mobile communications we have preempted state regulation of retail prices and used auctions to distribute quickly and fairly hundreds of new licenses to firms that will provide at least a handful of choices for mobile carriers in all markets. And we haven't restricted the use of these licenses. Whether you want to use the airwaves for fixed wireless or mobile services, for voice or data, we are committed to keeping the government out of the business of telling you how to run your business. Our competition policy will accelerate the wireless conversion to digital, break the back of duopoly pricing in cellular, and stimulate innovation as new entrants seek product differentiation and first mover advantage in niche markets. Ultimately wireless will not just complement wire phone service -- it will substitute for it. This is a reason why at least one Bell company is withdrawing from a wireless trade association. The way to the sunny green fields of vigorous deregulated competition in local telephony is to focus on facilitating entry by new firms and in liberating existing firms from unnecessary restraints. Congress made brilliantly clear in the new law that new entrants need to be able to lease portions of the telephone company networks. And they need the right to buy the telco services at wholesale in order to resell at retail in competition with the incumbent. And they need to connect their own new networks and new customers to the existing telephone networks. The job of the FCC and its state counterparts is to write fair rules that make these rights real and practically exercisable. Our interconnection order of August 8 is one part of a three part trilogy that will set forth the code of procompetition rules. This code, when put in place in every state, will lead eventually to the elimination of thousands of pages of state and federal rules that are designed to control monopolies instead of promote competition. Anyone familiar with contests like investing or football, sales or baseball, will recognize that basic rules of competition make the games fairer, faster and even more fun. And you will be gratified also to know that our interconnection rules, 48 pages in length, are in word count only 61% as long as the rules of Little League Baseball. Whether they are as important is a value judgment each person must make on his or her own. I will acknowledge that more money is riding on the interconnection order and that the Eighth Circuit is not sitting in judgment on the Little League. At least not yet, as far as I know. Our four dozen pages of interconnection rules could be followed in all countries as the right way to get from monopoly to competition. After all, economics is like physics: its laws don't vary from state to state or country to country. It is also true that you prove the truth of the laws of physics and economics by experiment, but all experiments in competition in communications indicate that the monopoly policies of the past hamper growth, harm productivity, and hamstring all sectors of the economy -- because all depend on efficient communications in our Information Age. If we saw competition in all communications markets, we would see also a vast increase in worldwide revenues for telecommunications: right now it's about $550 billion worldwide; it could quickly be a trillion. And the $50 billion market for international communications alone could double in only a few years if competition policy were put in place worldwide. Most important, the growth of these markets would greatly stimulate all other aspects of world economic growth. Of course we will never persuade the rest of the world to accept our competition policy if we don't implement it right here at home. As I mentioned, our code of competition will have three parts -- interconnection, universal service and access reform. Only the first part is written so far -- our interconnection order published on August 8. Merrill Lynch said that by this 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." The stock market has reacted with equanimity. And I bet that those of you with investment hopes overseas would love to have these rules in, say France or Germany or Japan. Notwithstanding the widespread acceptance of our order by the Street, 23 states and all the Bell companies have taken us to the 8th Circuit Court of Appeals in protest. So we live in a country of lawyers. What else is new? What is most important about these legal challenges is that they have no merit and they must not be permitted to delay our country's progress towards deregulation and competition. In any event, I do expect that by the time we finish the trilogy almost every communications company will have sued us about something, and we will have won all cases. Meanwhile, I am counting on all 50 states this fall to write every aspect of the interconnection order into the specific terms and conditions of the interconnection arrangements between each would-be new entrant and the incumbent telephone company. These contracts between new entrants and incumbent are the documents that will give the new entrants the rights to lease parts of the existing networks, buy services at wholesale, and connect the new entrants' customers to the telco's customers. Under the new law the states arbitrate these contracts where the parties cannot negotiate an agreement. And in those arbitrations the states must adhere to the terms of our order, even if they disagree with the congressionally ordered competition policy. Barring the disruption of the whole congressional plan by a court (something that would be an economic tragedy for our country and a serious blow to our trade policy), by the new year these arbitrations will enable the long distance companies and any other new entrant to compete fairly in local exchange markets. There are two things our interconnection order does not do. First, it does not take away incentives to maintain and invest in modern networks. Our order should, must and certainly can be read to state that anyone who wants to operate a network will be able to obtain a fair return on their investment, whether by selling services to retail customers or having their networks leased by new entrants. As a result, we very well may see companies splitting into wholesale and retail providers. For example, in the wireless world Nextwave plans to be primarily a wholesaler. Some or all of the Bell companies may very well adopt this same approach, and split into separate wholesale and retail affiliates. We should also see telcos moving even more quickly into delivering big bandwidth -- by ISDN or ADSL or wireless solutions. Indeed, any State that firmly follows our interconnection order should also consider deregulating enhanced telecom services. Is it necessary for Maryland to fix the price of ISDN so that Bell Atlantic cannot raise or even lower its prices without a lengthy approval process? Under our interconnection order, isn't there enough potential for entry to trust that the market will keep ISDN at a reasonable price? After all, you can hardly argue either that regulation has effectively promoted this long-overdue service or that ISDN is a basic commodity that should be priced by rule at affordable levels. Why not give deregulation of ISDN a chance? The second thing our interconnection order does not do is set any specific prices new entrants will pay for leasing elements of the existing network, like unbundled loops and switching capacity. These will be set in state arbitrations or through negotiations between the parties. We did tell States that they must determine the prices on a forward looking basis, instead of historic cost. But no business in a competitive marketplace is guaranteed a recovery on past investment and Congress did not include such a guarantee in the telecom reform law. Only forward-looking cost concepts are consistent with a competitive market, because any other approach either makes the new entrant pay a tribute to the incumbent for the privilege of entry, or creates disincentives for the incumbent to invest in the network. The second and third volumes of our deregulatory, procompetitive trilogy are called access reform and universal service. We will issue a Notice of Proposed Rulemaking on access reform in the fourth quarter of 1996. We will bring home a completed Order in the first quarter of 1997. A joint board of state representatives and FCC Commissioners will make recommendations on universal service in November. The FCC will issue an Order in the first quarter of 1997. These orders might take our new paradigm of competitive rules to about the length of the Little League Rules, but they will usher in a Major League explosion in billions of dollars of investment, millions of new jobs, and a reduction by thousands of the pages in state rules managing the local phone companies. At the very minimum, this will be for equipment suppliers a benign version of what war is for arms dealers: a good time to be in the business. And competition will deliver increased bandwidth to many more Americans than monopoly regulation could ever do. Starbucks is successful because coffee is a lawful, socially acceptable, but addictive, product. Thanks to the Internet, bandwidth is the same sort of product: you can never get enough of it. Our trilogy will let hundreds of firms enter the business of specialty bandwidth provision -- and if state regulators relax their grip, the telcos will also gain substantial revenues from such value-added services. Meanwhile, basic dialtone will get cheaper and cheaper to provide because costs will continue to decline. For now, government policy must keep the telco's delivery of basic phone service at today's low, eminently affordable rates. How do we know basic phone service is affordable? because 95% of homes subscribe. Congress and the FCC and the states want to keep subscription rates at least as high as they are today. Indeed they should be much higher for demographic groups that are far below that average, such as Hispanics, African Americans and kids and teachers in classrooms. (The last group has a penetration rate of about 10%, for example). Already today, a subsidy in the range of billions of dollars is necessary to sustain affordable basic phone service. But today a large part of that subsidy comes from access charges. Access is the charge paid by long distance companies to connect to the local exchanges. The FCC has set access charges for interstate traffic; the states for traffic within state lines. Everyone agrees that these charges are far higher than forward-looking cost would dictate. The difference between actual charges and forward looking cost based prices is measured in the billions of dollars. How should the access subsidy be raised if access is priced competitively? Similarly, states set the price of what are called vertical services, like call waiting, far above their actual cost. Again the purpose is to generate revenue to subsidize other services. Call waiting and caller id and call forwarding will sell like hotcakes when the prices go down about 90% -- and that's what competition will cause. But then another source of subsidy for basic phone service will disappear. New revenue sources will be rapidly exploited by telcos, but it won't be wise to create a discontinuity in the revenue streams of our leading telephone companies as we transition from the old monopoly regime to the new competitive paradigm. Fortunately, under Section 254 of the communications law, Congress gave the FCC the authority to create a durable, effective universal service system that will meet the three goals (everything comes in three) of keeping basic phone service low priced, compensating fairly any company for providing basic phone service, and making sure that new entrants and existing telcos each carry a fair share of the financial burden of keeping basic phone service affordable. Here are some of the key principles of what ought be our new universal service plan, in my view. The goal should be to pay for a modern communications network built out to every American. Every American should be able to be connected and to get some basic usage at an affordable price -- and those Americans who need extra assistance to subscribe should get it. We must break down the barriers that keep everyone from being connected. We should make subsidy funds available to anyone who will further this goal, but of course the initial takers of these funds overwhelmingly will be the existing telcos. The funds ought to come from all telecommunications providers, probably by means of a contribution of a portion of all retail revenues. And we should give up on the historic, outmoded, and (for the consumer) meaningless distinction between interstate and intrastate revenues as a source of universal service funds. As of now hundreds of people are employed by telephone companies and regulators to sort out what revenues of communications companies come from interstate traffic and what come from interstate traffic. This system is the triumph of an idea over reality. The idea increasingly will have little or no meaning in communications markets. Already you couldn't find a customer in the country who cares about the interstate versus intrastate distinction; indeed most customers think it sounds more like a tongue twister than a sensible public policy. The basic goals of access reform follow from our goals for universal service. In access reform, we need to make the incumbent's system of charging for the costs of serving you more economically rational and competitively survivable, and we need to disentangle the cost recovery system from the costs of serving someone else. That is, we should separate out universal service or other subsidies from the charges for the network elements used to originate and terminate calls. For example, the current carrier common line charge makes no sense. This is a per-minute charge that long-distance companies must pay to recover a portion of the interstate allocated costs of local loops. McDonalds doesn't charge you more for a hamburger if you chew it slower than the average time for eating. Borders doesn't charge you more for a book if you read it twice over. That's because books and burgers do not have usage sensitive costs. The cost to make these products does not go up if the products are consumed more leisurely or more often. Similarly, the cost to build a line to your house does not go up if you use the phone to make more long distance calls than your neighbor does. So that's why it is illogical to charge the heavy long distance caller more in order to pay for the local network. But that's what the current crazy system does. We have to change this, for two reasons. First, the current system is not fair to heavy users, who pay in effect not just for their own phone line but for their neighbors' as well. Second, under the current system the heavy user has an incentive to bypass the public network. This is of course what the well financed businesses are already doing, for the their own advantage but to the detriment of the maintenance of a modern public network. And we probably should make a distinction between originating and terminating access. The former is much more likely to be contestable in a competitive market, and not to need price regulation, sooner than the latter. As long as the customer has choice of who provides service, than the market will put at least some pressure on the price of originating access. But terminating access is about who you call, and since you can't choose the carrier that controls the path to terminating a call, there is not so much likelihood that the market will keep the termination charges at reasonable, competitive levels. Competition will also lead to new pricing structures and product innovation. Most telecom services will eventually be priced on a value added basis instead of on a rate of return basis. We don't care how much margin, if any, Microsoft is getting from its new browser. The reason is because we are counting on Netscape and others to compete against that browser. In the fullness of time we will be similarly indifferent to the profit margin on caller ID, videoconferencing, multimedia, and even the yet-to-be-invented call anywhere product that I imagine competition will generate. I read in a recent article in the Dallas Morning News that Southwestern Bell is thinking about offering a service in which a customer would pay a flat fee to call anywhere in the SWB region, and possibly even Mexico. After the Bell companies work with the States and the Department of Justice to satisfy the competitive checklist for offering in-region long-distance, they will seek permission to go into the long distance market from the FCC. Eventually, and I don't know when, Bells will be able to package and sell innovative new services like the one in that newspaper article. This kind of product makes state lines and even national boundaries disappear. And furthermore, this call anywhere product may be priced 1% or a 1000% above historic costs or forward looking costs, but because we will have competition, government can rely on the marketplace for price discipline. In the fullness of time, governments should applaud the existence of such products and otherwise not regulate them. To get to this sunny day after the end of the era of big communications government, our 251 interconnection order will have to be in full force and effect in every State. And we will have to use our authority under 253 of the Act to preempt state rules and laws that inhibit competition. Our first draft order along these lines will be discussed among my colleagues later this week. And we will have to invent a new universal service and access charge plan. In our deregulatory, pro-competitive efforts at the FCC, and in the World Trade Organization negotiations, we are convinced that we are following the will of Congress and the right economic policies. I don't doubt that we will make some mistake here or there, but if so, plenty of lawyers and economists will tell us about it, and we will correct. The general direction and the specific steps we should take in fact are consistent with overwhelming academic commentary and practical experience is deregulated markets. This isn't rocket science, which is a good thing because I am only a lawyer. All serious students of these issues agree on the fundamental principles. Our job is just to out them into practice. -FCC-