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Broadband: Why would an edge provider let FCC see its business model

Technocrat’s Anne L. Kim blogged on comments Consumer Electronics Association CEO and president Gary Shapiro made at a recent Brookings Institution event.  Here is an excerpt from her post:

On net neutrality, Shapiro wants more of a hands-off approach from the government. He wants to see government allow industry and nongovernmental organizations establish principals. “And if the principals are violated, then act,” he said.

“I personally am fearful of all of a sudden sending those companies into a new area of regulation like utilities,” referring to the FCC considering using Title II of the 1996 Communications Act to rewrite net neutrality rules.

He said he likes things the “way they are” and that he’s rather not see them changed, adding that “good intentions scare me.”

Take a look at Title II, something more edge providers need to do, and you can appreciate some of Mr. Shapiro’s fear.  For example, section 211 of the Communications Act requires that common carriers (a classification that net neutrality advocates want applied to broadband providers) file copies of all contracts that they have with other common carriers.  So, if Google, a broadband wannabe, has peering or transit contracts with Comcast, Google will have to file its contracts with the Federal Communications Commission, and probably with state public utility commissions as well.  If these contracts contain information regarding traffic from certain edge providers a la Netflix, Netflix wouldn’t be happy that some aspect of its business model may be on public display with the FCC.

This type of transparency may bring joy to net neutrality proponents but not to the edge providers they purportedly are so concerned about.  In my opinion, letting the government have a copy of a contract entered into autonomously is the same as the government regulating your free speech.  Unless there is a dispute to be resolved between two parties to a contract, I see no reason to let the government have access to its contents.  If edge providers want to see a slippery slope created that takes regulation right to their doorsteps, Title II will lay the bricks for that driveway.

My walk down the Yellow Brick Road of regulation gets scarier when I take a look at section 215.  Section 215 allows the FCC to examine transactions involving the furnishing of services, supplies, equipment, personnel, etc., to a carrier.  Also, the FCC, pursuant to this section, may examine transactions that impact charges a common carrier assesses for provision of wire or wireless services.  Section 215 also allows the FCC to determine how reasonable these charges are.  Also, the FCC may report its recommendations to Congress as to whether charges are invalid and should be modified and prohibited.

Now, not to knock on Google, but since they are the Internet flavor of the week given the disclosure of their perceived wretched diversity in hiring practices, disclosing matters regarding personnel much less on their services should make the company and its investors think twice about supporting net neutrality brought to you via Title II classification.

All of Title II should be scary to venture capitalists, private equity, and their investor clients, but section 218 should bring great pause. This section allows the FCC to inquire into the management of all common carriers.  The FCC may obtain management information not just from the carriers, but from entities that directly or indirectly control them.  That, in my mind, includes private equity firms or venture capitalists that may have a controlling interest in some little regional or rural broadband provider.  With the SEC stepping up its scrutiny of private equity via the Dodd Frank Act, does private equity want another alphabet soup agency knocking on its door?

Here is one more, especially for the app developers.  Section 231 speaks to app developers, or more definitively access software providers.  This section prohibits the use of the World Wide Web to transmit material harmful to minors.  I wonder how many apps fall under this category.

When you look behind the curtain of good open network intentions, you can find some scary stuff.

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A number of rural carriers say no to FCC’s rate of return analysis

A number of rural telecommunications carrier associations yesterday filed joint reply comments in a Federal Communications Commission proceeding where the FCC is considering reducing authorized rate of return on a rural carrier’s assets from the current 11.25% to a rates of return range of 7.39% to 8.79%.

Needless to say the rural carriers are a bit miffed. The rate of return is used to determine how much revenue a carrier can generate on assets put into use to provide telecommunications services. When the revenue is determined, the FCC determines the appropriate rates for interstate special access services and common carrier line rates, as well as the appropriate amount of universal service contribution a rural carrier may receive. The higher the rates of return, the greater the rates a carrier may charge to recover these revenues.

The carriers argue that lowering the ROR means there will be less funds available for reinvesting in the deployment of broadband facilities. The FCC argues that since 1990, the last year the ROR was determined, changes in technology warrant a change in these rates and initially found that the appropriate rate should be around 9%.

But could that be the FCC’s approach from the beginning? Regulators reason that the higher the rate of return, the less the incentive to invest in innovation. I don’t think that is necessarily true. For example, if a carrier has aging assets in its rate base, they will remove them, either on their own or as a result of a rate review. As technologies change and carriers find themselves facing competitive pressures brought on by cord cutting and cable companies able to bundle in on-demand services, these carriers will want to keep up, but they will need the revenues necessary for purchasing and deploying the facilities necessary for deploying new facilities and services. It’s during this period that ROR should be remain at the same level or even increased.

The FCC’s logic seems to be centered on keeping rural carriers captive to the updated, new and improved universal service fund. We’ll keep your interstate rates low and force you to come to the trough and drink even if you feel your customers are better served if you fund broadband deployment on your own dime. The FCC believes that there is market failure sufficient enough to keep rural providers from meeting voice and broadband needs of consumers. If that is the case, then the FCC is ensuring that market failure by decreasing the ROR rural carriers should earn.

It’s truly ironic given the FCC’s policy goal of basing inter-carrier compensation received by rural carriers on a free market framework, but I see nothing free market about forcing rural carriers to stay on a universal service funding scheme premised on fake innovation.

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Using broadband to create? Then you need to live in an urban or suburban area

The U.S. Department of Commerce yesterday put out a report documenting gaps in access to broadband between rural and urban communities as well as the variation in access to broadband within these two communities. The major conclusions of the report was that urban areas had greater access to both wireline and wireless broadband versus their neighbors in rural areas. Also, while population density played a role in which areas have higher access to broadband, locating closer to central cities may be of more significance in broadband adoption.

For example, according to the report, residents living in the exurbs, where population density is around 37 residents per square mile, have greater access to higher-speed wireline services than their counterparts in small towns, where population density is approximately 1,447 residents per square mile. Keep in mind that exurbs are considered as part of the rural community while small towns are urban areas. Exurbs, however, are part of metropolitan statistical areas (MSA) where central cities are the core of their populations. The study concludes that this proximity of exurbs to central cities may play a role in why a smaller density jurisdictions like an exurb may have greater access to higher speed services versus a small town which is not located in an MSA.

As I do here as well as on my other blog at Alton Drew, I place a lot of emphasis on accumulating and using capital, whether financial, or natural as in spectrum. Broadband is capital in the hands of creatives. Whether writers, designers, or app developers, access to broadband is key and if location to central cities increases the chances of quality broadband availability, people like me will be staying in Atlanta and other MSAs.

But what should this say about public policy? Should the Federal Communications Commission create more interventionist policies in order to bring some balance to the variations between and within the urban and rural communities? You can’t order carriers to provide the same speeds to rural and urban areas and universal service funding is far from guaranteeing a provider will enter rural markets to provide higher speed services. Evidence shows, especially where municipals provide broadband services, that new entrants are entering markets where incumbent services already exist.

The best policy would be to allow consumers to signal to market players that they are willing to pay the premium for services that are more costly to provide because of the low population densities. This is the best incentive for attracting broadband providers.

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There is infrastructure. Then there is broadband infrastructure

Highways, airports, roads, bridges, harbors. All are part of the conduit that moves American commerce, getting goods and services from consumer to producer. They are part of the commonwealth, owned by municipalities, states, and the federal government. When commenters talk about building or renovating America’s infrastructure, these are typically the components they are referring to.

The financing of these components is usually done with tax revenue or revenue or bond issues paid back with tax revenues. Accounting wise, a municipality may have a specific fund established which accounts for the revenues dedicated to and expenditures resulting from an infrastructure project.

Broadband facilities tend to be mentioned in the same breath as the infrastructure components mentioned above. Broadband facilities, the “information superhighway”, carry digitized voice and data between our cell phones, lap tops, and tablets. Broadband facilities are described as the on ramp to electronic commerce, much like the on ramp to Interstate 20 at Joseph E. Lowery and Oak Street in the West End of Atlanta.

That’s about where the similarities end.

Unlike airports, highways, bridges and toll roads, the vast majority of broadband facilities are owned by private entities; Comcast, Verizon, Time Warner, and AT&T, to name a few. The vast majority of the capital used to build and deploy central offices, nodes, other packet switches, and cable is provided either from equity shareholders or creditors. Broadband providers go into the markets to buy the capital needed to meet the demand for facilities. The private versus public ownership of these facilities creates a dependence on the private sector for the financing. Price paid for capital, not government mandate, determines whether capital will be available to meet the consumer demand for broadband facilities.

Sometimes the consumer demand comes from geographical areas that make a business model very expensive to finance; specifically rural and insular areas. Terrain and climate raise challenges to broadband providers because in addition to the physical deployment of facilities, a business case must be made about the probability that consumers in rural and insular areas will be able to pay the higher than average cost of receiving broadband services. The price mechanism may preclude broadband providers from buying the investment capital needed to make the investment. The rational investor or underwriter may not buy into a rural or insular broadband business model.

Enter the irrational. Enter the Federal Communications Commission.

Driven by its interpretation of universal service as provided in the Communications Act, the FCC has over the past few decades implemented a universal service and inter-carrier compensation scheme designed to subsidize delivery of telecommunications services to the poor, underserved rural markets, and health care providers in underserved areas. Business customers were basically overcharged in order to subsidize residential customers. Interexchange companies paid originating and terminating fees to local exchange companies with these funds placed into a pot where LECs would receive a cut after certifying the expenses claimed were for providing telecommunications services.

The FCC, threw its Connect America Fund, has essentially modified the model so that funds go to broadband services versus the legacy plain old telephone service network prior universal service finds financed. To date, the FCC is still trying to get broadband companies to bite on the remaining $180 million in subsidies available during the first phase of CAF. Broadband providers leaving money on the table should be a red flag that something is wrong with this model.

What’s wrong with this model is that it does not take into account that the infrastructure belongs to private entities, entities that could borrow at near zero rates, but who do not finance infrastructure projects in unserved, rural, or insular areas because a strong business case cannot be made for it. The FCC and the Congress throw money at them anyway, hoping that the initiative will get broadband to the homes. In a free market, capitalist society where the method of production and delivery is held in private hands, this 1930s view of stimulation cannot work. What is needed is something more direct especially if government is to participate in stimulating broadband demand.

While it is good to see Mr. Genachowski and his Gang of Four act like supply-siders, what is needed for broadband deployment is a combination of demand stimulation and a “private equity” mindset on the part of government, in this case, the FCC.

First, Congress should get rid of language describing the methods of implementing universal service. Rather than extorting money from IXCs to fund universal service, Congress, via the FCC, should issue poor consumers vouchers to be used with the broadband provider of their choice. This voucher could reflect the difference between the average monthly amount paid for broadband in the consumer’s market area and what they pay for telephone service.

Second, Congress should establish a broadband infrastructure bank to be administered by the U.S. Department of Commerce. The infrastructure bank would be funded from general tax revenues and would lend funds to broadband providers who present innovative business plans for providing service in insular, rural, and urban unserved and under-served areas. Funds would be paid back to the infrastructure bank at some rate below prime. The infrastructure bank could also issue debt giving investors another avenue for hedging other investments. Profits would either be returned to the Treasury, reinvested in the voucher program, or go on to support broadband in schools and libraries.

The current universal service program is open to abuse, such as skewing most funding toward carriers that do not need the funds. It introduces additional government regulation for the purpose of financing broadband deployment by private actors when those actors could go into the markets and get financing themselves; financing based on the showing of a good business model. By requiring the showing of a good business model, broadband providers would be required to develop innovative technologies to provide service. Innovation will beget financing which begets the value added to a service, value that consumers will identify and demand.

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Court of appeals says no to USF refunds

Posted October 31st, 2012 in FCC, Government Regulation, rural, universal service fund and tagged , , by Alton Drew

The United States Court of Appeals for the 11th Circuit held yesterday that a federal district court had no jurisdiction to review an action of the Federal Communications Commission. Only the court of appeals has exclusive jurisdiction to enjoin, set aside, suspend, or determine the validity of all final orders of the FCC. District courts cannot determine the validity of FCC orders.

The ruling came on appeal of a federal district court decision that the court had no jurisdiction to rule on a decision by the FCC to apply, on a prospective basis, an order that required universal service funds be calculated based on a carrier’s interstate and international revenues. Prior to the FCC’s order on recalculating universal service contributions, the FCC had calculated universal service support for rural healthcare providers, and schools and libraries based partially on a carrier’s intrastate revenues.

A 1998 ruling from the United States Court of Appeals-Fifth Circuit had determined that federal universal service support could not be based on intrastate rates. To implement the court’s holding, the FCC issued an order that starting November 1, 1999, universal service support would not be based on intrastate revenues.

Citing the ruling in the Fifth Circuit, an individual plaintiff brought an action in federal district court seeking refunds retroactively of pass through charges she had been assessed for universal service support. The district court found that pursuant to the Communications Act it had no jurisdiction to rule on the validity of the FCC’s prospective order on universal service support. The court of appeals concurred with the district court’s ruling.

Investors should be mindful that neither the 5th or 11th circuits addressed the issue of refunds of universal service contributions made between January 1, 1998 and October 31, 1999. The total amount of contributions made during this period was $1.6 billion. An action could still be brought to recover this amount in refunds. I do not believe that the FCC or the industry would endorse initiatives to identify who these refunds would go to because of the administrative burden that would be imposed. The cost to the FCC and the industry to identify potential recipients and distribute these funds may well exceed $1.6 billion.

Martha Self v. BellSouth Mobility, No. 11-13998, United States Court of Appeals, 11th Circuit