Fixing the FCC

With four new members on board, including a new chairman, there's a chance the Federal Communications Commission can turn things around and make sure the next two years aren't like the last two. To pull it off, the commission has to recognize why it has failed to foster the kind of competition envisioned by the framers of the Telecommunications Act of 1996 and, with help from Congress in some areas, take corrective measures.

For starters, the interconnection rules governing how competing carriers link their networks need to be rewritten with the right players in mind - the entrepreneurs and technology leaders who are creating next-generation equip-ment and services. The rules need to be simple and transitory, with as much left up to negotiation as possible and with deregulation as the ultimate goal.

The rules also have to be backed with swift, sure enforcement that includes sufficiently severe penalties for noncompliance. And the legal proceedings that are paralyzing reform should be streamlined and consolidatedthe lines suggested in a bill that has already been presented to Congress.

Above all, there must be a clearly laid out endgame with sunset provisions for the rules and various functions of the FCC itself.

Data, not voice

Until now, policymakers have focused on nudging the dominant incumbent local exchange carriers (ILECs) and interexchange carriers (IXCs) into each other's markets so there will be more than one source of local voice service.

But basic phone service isn't the problem. The U.S. already has the best and cheapest residential voice service in the world, and regulatory policies have made it a largely subsidized and unprofitable business. Competitive local exchange carriers (CLEC) would just as soon leave it to the incumbent monopolies.

"What we really want is ubiquitous IP dial tone," says Thomas Nolle, president of CIMI Corp., a consultancy in Voorhees, N.J. The demand is for advanced digital services, with voice just one of the applications that run on top of them.

The FCC must review its telecom act rules in 1998 to determine their effectiveness in fostering competitive markets and promoting the deployment of advanced services. The massive interconnection order should be revisited with different players, technologies and approaches in mind.

For example, interconnection and colocation rights should be extended to enhanced service providers and Internet service providers. This would off-load data traffic from the ILEC voice switches and provide a better Internet infrastructure. Similarly, extending local-loop unbundling provisions to the subloop level would enable CLECs to provide 3M bit/sec high-bit-rate digital subscriber line service at a small fraction of the cost of 1.44M bit/sec T-1 lines.

Mission-driven, not rules-driven

In order to develop this kind of responsiveness to market needs, the FCC has to transform itself from an organization driven by rules to one driven by a mission: competitive entry. Heavily regulated markets aren't going to be opened by applying even more elaborate regulation.

"The rules that are supposed to prevent bad things from happening also prevent good things from happening," says Ted Gaebler, president of the Gaebler Group in San Raphael, Calif., and coauthor of Reinventing Government. "They make it impossible to respond to rapidly changing environments."

The new commission needs to step back and consider whether all the FCC's detailed involvement has been effective. "There are risks in allowing entry too early, but the bigger danger is that it will happen too late," says Ken Gordon, a former state regulator and now senior vice president of National Economic Research Associates, Inc. of Cambridge, Mass.

Interconnection agreements between new entrants and ILECs should be left to negotiations as much as possible. "Overall, there are way too many rules and way too many hoops for people to jump through," says Alfred Sikes, president of Hearst New Media & Technology in New York and FCC chairman from 1989 to 1993. "It's a mess both legally and practically."

The focus on rules creates a rigid, coercive environment that is not likely to spawn the networks of the future. "It produces a lot of ill will," says Solveig Singleton, director of information studies at the Cato Institute, a Washington, D.C. think tank. "Relationships between buyers and sellers are supposed to be mutually beneficial, not adversarial."

Instead, regulators should concentrate on results, enforcing agreements that the two parties work out and booting into fast-track arbitration any party that falls short of contractual obligations.

Regulators also need to adjust the model they are using for measuring competition. Counting the number of companies providing traditional voice service is not the way to calculate whether a particular market is open.

"Competition is when I'm in business and there are no barriers to entry by others, so the threat of entry alone keeps my prices down," says Lawrence Gasman, president of Communica-tions Industry Researchers, Inc., of Char-lottesville, Va. This threat is always looming in a dynamic industry such as telecommunications, in which new technologies are always lurking in the wings.

Metaphorical mice

The Internet revolution is making deployment of new technologies imperative. The volume of Internet data traffic on public switched networks is doubling every quarter, and rapid network build-out is indicated.

However, a monopoly environment lacks the competitive threats that stimulate capital investment and spending on research and development. Consequently, the behavior of the ILECs today is in striking contrast to the norm among information technology enterprises.

"Both R&D spending and capital investment per telephone line have actually been flat or declining in the United States over the past five years, despite growing LEC profits and the emergence of the Internet industry," says Charles Ferguson, cofounder of Vermeer Technologies, Inc., an Internet software company acquired by Microsoft Corp. last year (see graphic).

The price/performance of network technologies in general has been improving at a rate of 30% to 50% each year. However, the cost of digital services such as T-1 and ISDN have held fairly steady for the past decade because of monopoly pricing. Worse, Ferguson says technology executives in New York and California have told him that the metropolitan-area bandwidth they need from the ILECs is sometimes not available at any price.

As a visiting scholar at the Massachusetts Institute of Technology, Ferguson recently published an extensive study, "The Internet, Economic Growth, and Telecommunications Policy." He concludes that the state ILEC infrastructure constitutes a major threat to the U.S. economy.

Competitors that are trying to lease unbundled network elements also report that ILECs' facilities are less than impressive.

"One of the reasons the ILECs have been trying so hard to keep people out of their operations support systems is that they don't want anyone to see the condition that things are in," says an official of one aspiring CLEC start-up. "Meta-phorically speaking, there are mice running around and the floorboards are loose. You don't really want to rent this place, but there aren't any other options."

One is left wondering why the IXCs are so afraid of such dinosaurs.

"These monopolies are very tired and very slow, so it's kind of a fair fight," says Mark Fowler, chairman of UniSite, Inc. and FCC chairman from 1981 to 1987. "If we let the marketplace work, competitors would figure out a way to go around or over or under the ILECs. It would take a lot of capital and patience, though, and people don't want the red ink, so they run to Washington for regulation."

Getting unbundling right Washington has responded in part by mandating access to unbundled network elements. This mandate enables new entrants to put together networks that consist partly of elements in the ILEC infrastructure and partly of new value-added components.

Under the right conditions, unbundling will foster facilities-based competition as CLECs incrementally add advanced components and force ILECs to respond with their own enhancements. Under the wrong conditions, facilities-based competition will be stifled.

Current FCC unbundling rules have no expiration dates and include any advanced facilities the ILECs develop in the future.

These conditions can combine to make CLECs permanently dependent on unbundling provisions and, thus, on ongoing regulation. They also leave ILECs with little incentive to develop new capabilities, because these advances would have to be shared with competitors.

The FCC should use sunset clauses that make CLEC access to certain network elements, particularly switches, temporary. This sends the right message to would-be competitors: Develop your own facilities if you want to stay in business. Because delay tactics can subvert sunset rules, mechanisms for rapid dispute resolution and enforcement have to be in place.

Any new technologies developed by the ILECs should be exempted from unbundling provisions. Critics say the ILECs then could move their own customers over to the new network elements and let the facilities that include the unbundled elements fall into disrepair. However, the rules could require that the ILECs maintain old facilities at the same level as before or divest them and let someone else take them over. The FCC also needs to resolve the issue of stranded costs, which are not included in its Total Element Long Run Incremental Cost formula for calculating prices of unbundled elements.

Delay tactics

It is easy to cast ILECs as the villains in this drama, but they were created in another era by government policies that viewed telephony as a natural monopoly, a service that can be provided most efficiently by a single company. Conse-quently, their core competence is manipulating the regulatory process, not technology advancement.

When faced with competition, such companies respond first with lobbying and litigation, not R&D and network build-out. After all, the monopoly position itself is a major part of the ILECs' equity and has to be protected like any other asset.

"When you end a monopoly, no business with one is going to just hand it over. The RBOCs are saying, 'You'll have to take it from me,' " says Doug Kinkoph, director of regulatory and legislative affairs for LCI International, Inc. of McLean, Va. "And they should. They are public companies with shareholders' interests to protect."

Consequently, every significant FCC rule is being appealed, and many state actions are being challenged. At the beginning of October, FCC lawyers counted 105 cases that had been filed this year in federal district courts around the country by ILECs attempting to vacate interconnection agreements hammered out in state arbitration proceedings.

"Getting an interconnection agreement signed is just the beginning," says Genevieve Morelli, executive vice president and general counsel for the Competitive Telecommunica-tions Association in Washington, D.C. "It's a fight every day to get the terms of the agreement implemented."

Streamlining legal procedures

If the FCC waits for issues to wind their way through the legal process in traditional fashion, competition will be delayed for years.

"The lack of swift, certain and affordable dispute resolution is one of the greatest shortcomings we see in the competitive-access market," says Manning Lee, vice president of regulatory affairs at Teleport Communications Group, Inc. "It is just too expensive and time-consuming for small competitors to get regulators to make the ILECs behave. They can outspend anybody and delay competition indefinitely."

And quick dispute resolution "needs to be backed up by very prompt enforcement with significant penalties," adds Andy Lipman, a Wash-ington, D.C.-based attorney who represents WorldCom, Inc.

The inherent inefficiency of legal processes is being compounded by venue shopping as plaintiffs look around for courts that might give them an advantage. There are 93 federal district courts and 12 appellate courts that have jurisdiction over some aspects of the telecom act.

The district courts handle appeals from state regulatory bodies and constitutional challenges, while the appellate courts review FCC rules. The ILECs and state regulators chose the 8th U.S. Circuit Court of Appeals in St. Louis because of its reputation for backing states' rights.

With so many different courts grinding their way through the telecom act, inconsistent decisions and duplication of effort seem assured. To simplify matters, all appeals of FCC and state commission decisions should be consolidated in one district and circuit.

On Sept. 17, Sen. Herbert Kohl (D-Wis.) introduced legislation, the Court Consistency in Communications Act, which would do just that. His bill specifies the Washington, D.C. courts as the one venue that should hear all appeals of FCC and state commission decisions.

"This bill should create the necessary framework for predictability in the courts so that companies can shift their rivalry from the courtroom to the marketplace," Kohl says.

The Washington, D.C. Circuit court has reviewed more FCC decisions than any other court and has the most expertise in telecommunications and administrative law. The IXCs and CLECs tend to favor Kohl's proposal, but some lawyers are worried about giving the FCC such a home-court advantage.

"There is a very real danger that the local court could gradually get captured by the agency," says Robert Corn-Revere, a former FCC chief counsel and now a partner at Hogan & Hartson in Washington, D.C.

But if regulation is truly being phased out with an explicit endgame that includes sunset rules and other provisions, there wouldn't be much to capture.

Lessons from abroad

Telecommunications deregulation is a global movement, and there is a lot to be learned from the experiences of other countries. Some are further along than the U.S. and provide interesting case studies for FCC policymakers.

Pablo Spiller, a professor of international business and public policy at the University of California, Berkeley, has compared deregulation efforts in Australia, Chile, Guatemala and New Zealand. He found that facilities-based competition can develop in a variety of circumstances as long as basic interconnection rights exist and are enforced.

Before the U.S. telecom act was ever passed, the record in Chile and New Zealand already showed that using the courts to resolve interconnection disputes was too slow and unpredictable. Australia and Guatemala have had much better results with binding arbitration.

Guatemala should make an interesting contrast to the U.S. over time because its new telecommunications law also was enacted in 1996. Its interconnection rules guarantee cost-based access to certain specific services that can't be extended as new technologies develop and include limited unbundling provisions that expire according to a sunset clause.

"It's very striking how simple the rules are compared to the U.S. telecom act," Spiller says.

Canada and the U.K. also are taking different approaches from the U.S., particularly with regard to unbundling. The U.K. is seeing significant facilities-based competition with no unbundling at all, although this is partly because its cable TV operators are forced to offer telephony services.

Canada makes a better contrast because its infrastructure is so similar to the one in the U.S. There are no local resale discounts, so Canadian CLECs have to pay retail rates for any services they want to use.

Only three network elements - access to numbers, access to directory listings and local loops - have to be unbundled by ILECs, and all local loops that are not in "high-cost areas" will be exempted after five years.

As in the U.S., prices for unbundled elements are based on long-run incremental costs. However, the Canadians add a 25% premium to cover the incumbent's joint and common costs, a major sticking point for U.S. ILECs.

Also, Canadian CLECs don't get access to the incumbent's operation support systems, something a lot of U.S. CLECs say they can't do without. And unlike most states, Canadian regulators have been willing to bring residential rates up to market levels.

"We thus have a competition here between national telecommunications policies," says Henry Geller, a former FCC general counsel who is now a communications fellow at the Markle Foundation. The Canadian interconnection rules go into effect on Jan. 1, 1998. The FCC would do well to keep a close eye on how they play out.

The sun is setting

Businesses and even consumers are getting increasingly impatient as they see the growing gap between the telecommunications services they could have and the ones they have to settle for. Entrepreneurs are champing at the bit, eager to implement their inventions and ideas, and investors are standing by, ready to back them.

A regulatory regime designed for a long-gone era blocks the way.

"We created a free-market policy [in the telecom act], but we left the old monopoly agency in place," laments Rep. Billy Tauzin (R-La.), chairman of the House telecommunications subcommittee.

However, the telecom act authorizes the FCC to do what is necessary to promote the deployment of advanced services, even if it means overriding other provisions of the act. For example, the FCC could start on a new deregulatory course by forbearing on Section 214, which forces carriers to receive FCC authorization before they can offer innovative new services.

The sun is going to set on the FCC in any case, because rapid technology advances are making regulation increasingly futile and dangerous.

"It is inconceivable that any government agency can keep up with all these developments and not hold things back," Gasman says. "The FCC is a drag on the marketplace and will continue to be as long as it stays in its current form."

If the FCC persists on its present course, the sheer momentum of technology advancement will take the industry beyond its grasp.

"We're going to see regulatory bypass, the way we did with the Internet," says William Frezza, a general partner with Adams Capital Management, of Yardley, Pa. "There's no way government agencies can keep their arms around all this. The FCC is busy regulating horses and buggies, while we've moved on to something else."