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Universal service doesn’t encourage capital for entrepreneurs

Regulating commerce is one thing. Failing to encourage capital formation and distribution of capital to entrepreneurs cannot be acceptable. Section 214 of the Communications Act demonstrates how out of touch current law is with today’s technology and the entities that deliver that technology. The 115th Congress and the next Administration need to revamp universal service such that funding actually encourages new entrants into the broadband market and the innovations that come along with that entry.

Under section 214 of the Act, common carriers designated as eligible telecommunications carriers (ETC) qualify for receiving universal service funds. A common carrier is engaged in providing foreign or interstate communications by wire or radio.  The Federal Communications Commission revamped its 20th century based support program, originally designed to subsidize voice services, to now support deployment of broadband services in high cost areas, areas where broadband providers argue it is cost prohibitive to provide high-speed access services.

Among the criticisms of the program is its inefficiency. Specific concerns have been raised about funds supporting services in areas where competition already exists. On reflection why is this a problem? If a carrier sees the opportunity to take a single-digit percent of market share where garnering such a share covers her fixed and variables costs while generating a profit, so what if other choices already exists? New entrants enter the fray when they believe that they have an innovative way of providing services and eventually taking market share. This is part of the adventure of applying venture capital; digging in for a period of time a generating returns based on new ideas.

The Commission’s concerns about funding services in areas where there is already competition also stems from locking itself into an approach that results in common carriers being funded as opposed to wireless internet access providers. Again, current law paints a box where only common carriers can play. Wireless internet access providers may not want to build infrastructure for the purpose of being common carriers. It is too expensive and unnecessary to duplicate existing networks where instead their focus is rightfully on bringing value to those networks and consumers alike by providing alternative methods of accessing them. The Commission speaks of innovation too frequently to then turn around and pass up an opportunity to put its money where its mouth is.

Until the Commission decides to recognize the value that non-common carrier innovators bring to broadband deployment, the universal service fund as currently constructed will continue to be a pool of capital unavailable for use by certain new entrants.

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Net neutrality will not encourage capital flow to edge providers

Capital flows to an activity that provides the highest returns.  That activity may involve a high level of risk but the premium paid out by entrepreneurs to their investors hopefully compensates for uncertainty.  Policy making by government regulators is a source of uncertainty for entrepreneurs in the Internet space.  Levels of uncertainty increased after the U.S. Court of Appeals-District of Columbia’s ruling in Verizon v. FCC where the court held that the Federal Communications Commission’s authority to regulate access to broadband is based on its duty to promote the deployment of advanced services.

Underlying the philosophy of net neutrality is an argument that the consumer, the end-user, should be responsible for paying all the costs associated with the transmission of data from an edge provider.  This would include costs associated with data traveling down a path that goes from the edge provider through a backbone provider onward to the end-user’s Internet access provider.  For example, Netflix, a company that distributes videos over the Internet, would not be responsible for paying fees to Cisco, a backbone provider, or, should Netflix interconnect directly with it, Comcast, an Internet access provider.

What the net neutrality argument ignores is the multi-sided market that Internet access providers operate in.  The argument also ignores costs generated at interconnection points through the Internet and fails to address the proper costs recovery mechanism at each interconnection point.  The net neutrality argument concludes that cost causation is one-way, from the end-user to and through the Internet and the fees the end-user pays to his Internet access provider should recover this cost.

In actuality, the Internet is what I term, “multi-way.”  The self-healing and permanent virtual circuit characteristics of Internet protocol requires constant communications between nodes, routers, servers, and other devices on the Internet regardless of whether an end-user’s laptop is on or not.  Information requests are constantly being exchanged between backbone providers, edge providers, and Internet access providers.  The end-user is not the only cost causer.  If entrepreneurs cannot explain to investors why costs are not being recovered from all cost causers on the network, capital will flow to the next best generator of returns.

Work by Larry F. Darby and Joseph P. Fuhr appears to bare out this conclusion.  In a 2007 study on the impact of net neutrality on capital flows, Messrs Darby and Fuhr concluded that requiring end-users to pay for next generation networks:

  • Is inconsistent with practice in other multi-sided markets;
  • Will increase investor risk, suppress investment, and slow construction of next generation broadband networks;
  • Will increase rates to consumers; and
  • Will reduce the present value of consumer surplus

Network providers are challenged with coming up with pricing schemes that optimize the scale of their networks while maximizing the networks’ values.  The prospect that investors will recover their investment in networks has a dark cloud hovering over it; a cloud generated by the 2000 dot-com bubble burst.  Wall Street tends to see reductions in short and middle term returns as a result of large infrastructure investment.  Investors are also see growing threats to broadband network deployment from satellite and municipal-provided broadband networks.

According to Messrs Darby and Fuhr, “Specifically, investors have a big stake in the resolution of net neutrality issues and particularly in the outcome of the debate over who can be charged, by what principles and by whom–that is, in resolution of a set of network access pricing issues.”

If the FCC truly wants to promote deployment of advanced services, it should talk more about the importance of not only spectrum as natural capital, but the financial capital necessary for deploying the networks on which advanced services are expected to run.

 

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Will minorities benefit if the FCC lets the market work?

The Minority Media and Telecommunications Council’s Latoya Livingston wrote an insightful blog post on how increasing available spectrum can help entry into the digital economy. Check out her post here.

Ms. Livingston’s article raises two important points. One, why is the FCC afraid of allowing a market strategy such as consolidation do the work that it is not equipped to do? Second, why does the FCC not recognize that growth in the wireless sector does not necessarily mean having a certain number of carriers in the sector?

If you want wireless services produced and distributed at lower costs, you need to allow for scale whenever possible. As wireless services improve with the additional spectrum, entrepreneurs will bring innovative products that enhance the use of wireless networks.

It’s okay to let the market stumble and find itself. We can’t afford to have the FCC trying to hold the industry’s hand every step of the way.