Solving the Broadband Paradox

ADAM D. THIERER

Solving the Broadband Paradox

The technology is ready, but the market is not. Deregulation, not subsidies, will speed adoption.

If The Graduate were being filmed today, the one-word piece of advice that young Benjamin Braddock would hear is “broadband.” Most simply defined as a high-speed communications connection to the home or office, broadband offers Americans the promise of faster Internet access, rapid data downloads, instantaneous video on demand, and a more secure connection to a variety of other cutting-edge technologies and services.

If it were to become ubiquitously available throughout the United States, broadband communications services might finally make possible some long-dreamed-of commercial applications, including telecommuting, video conferencing, telemedicine, and distance learning. Beyond transforming the workplace, broadband could open new opportunities in the home for activities such as electronic banking, online gaming, digital television, music swapping, and faster Web surfing in general.

For these reasons, a growing number of pundits and policymakers are saying that Americans need broadband and they need it now. Moreover, assorted telecom, entertainment, and computer sector leaders are also proclaiming that the future of their industries depends on the rapid spread of broadband access throughout the economy and society. For example, Technology Network (Tech Net), one of the leading tech sector lobbying groups, is asking policymakers to commit to a JFK-esque “man on the moon” promise of guaranteeing 100 megabits per second (Mbps) connections for 100 million U.S. homes and small businesses by the end of this decade. This represents a bold–some would say unrealistic–vision for the future, considering that most Americans today are using a 56K narrowband modem connection and balking at paying the additional fee for a 1.5-Mbps broadband hookup.

What exactly is holding back the expansion of broadband services in America? Is a 100-Mbps vision within 10 years just a quixotic dream? What effect has regulation had on this sector in the past, and what role should public policy play in the future?

A digital white elephant?

As interesting as these questions are, the most important and sometimes forgotten question we should be asking first is: Do consumers really want this stuff? In the minds of many industry analysts, consumer demand for broadband services is simply taken for granted. Many policymakers see an inevitable march toward broadband and want to put themselves at the head of the parade. They have adopted the Field of Dreams philosophy: “If you deploy it, they will subscribe.”

But is this really the case? Are Americans clamoring for broadband? Are the benefits really there, and if so, do citizens understand them?

The answers to these questions remain surprisingly elusive for numerous reasons. This market is still in its infancy, and statistical measures are still being developed to accurately gauge potential consumer demand. Thus far, the most-quoted surveys have been conducted by private consulting and financial analysis firms. The cited results are all over the board, and critical evaluation is difficult because the full detailed analysis is available only to those who pay the hefty subscription fees. However, when one looks at government statistics about actual broadband use, it seems clear that the public has not yet caught broadband fever. According to the Federal Communications Commission (FCC), only 7 percent of U.S. homes subscribe to a high-speed access service connection, even though broadband access is available to roughly 75 to 80 percent of U.S. households. A clear paradox seems to exist in the current debate over this issue: Everyone is saying the public demands more broadband, yet the numbers don’t yet suggest they really do. What gives?

The FCC’s recently issued Third Report on the Availability of High Speed and Advanced Telecommunications Capability concluded that broadband was being made available to Americans in a “reasonable and timely fashion.” The report noted that over 70 percent of homes have cable modem service available to them, 45 percent have telco-provided digital subscriber line (DSL) service available, 55 percent of Americans have terrestrial fixed wireless broadband options, and almost every American household can purchase satellite-delivered broadband today.

Importantly, however, the FCC concluded that although broadband was within reach of most U.S. homes, most households were not yet subscribing. The FCC report notes that, “cost appears to be closely associated with the number of consumers willing to subscribe to advanced services.” It cites one private-sector survey that revealed that 30 percent of online customers were willing to pay $25 per month for broadband, but only 12 percent were willing to pay $40. Broadband service currently costs $40 to $50 per month on top of installation costs. This is a lot of money for the average household, especially when compared to other monthly utility bills.

And therein lies the real reason why broadband subscribership remains so sluggish: Most Americans still view broadband as the luxury good it really is instead of the life necessity that some policymakers paint it to be. Not every American needs, or even necessarily wants, a home computer or a connection to the Internet. This is especially the case for elderly households and households without children. In fact, children are a critical source of demand for the Internet and for broadband.

The National Telecommunications and Information Administration (NTIA) recently issued a report, A Nation Online: How Americans Are Expanding Their Use of the Internet, which found that a stunning 90 percent of children between the ages of 5 and 17 now use computers and that 75 percent of 14-to-17-year-olds and 65 percent of 10-to-13-year-olds use the Internet. Moreover, households with kids under 18 are more likely to access the Internet (62 percent) than are households with no children (53 percent).

Most Americans still view broadband as the luxury good it really is instead of the life necessity that some policymakers paint it to be.

The moral of the story is that to the extent that there is any sort of “digital divide” in this country, it is between the old and the young. We may just need to wait for the younger generation to grow up and acquire wallets and purses before broadband demand really intensifies.

But beyond the generation gap issue, other demand-side factors are holding down broadband adoption rates. For example, residential penetration rates are being held down by the fact that broadband access in the workplace is often viewed as a substitute for household access. If I can get online at work for a few minutes during the lunch hour each day and order goods from bandwidth-intensive sites such as Amazon.com, JCrew.com, or E-Bay, why do I really need an expensive broadband hookup at home at all? A narrowband dialup connection at home will give me easy access to e-mail and even allow me to get around most Web sites without much of a headache. I’ll just have to be patient when I hit the sites with lots of bells and whistles.

Another important demand-side factor that must be taken into account is the lack of so-called “killer aps,” or broadband applications that would encourage or even require consumers to purchase high-speed hookups for their homes. Although it makes many people (especially policymakers) uncomfortable to talk about it, the two most successful killer aps so far have been Napster and pornography. Like it or not, the illegal swapping of copyrighted music and the downloading of nudie pics has probably done more to encourage broadband subscription than any other online application thus far. While politicians work hard to rid the world of online file sharing and porn, they may actually be eliminating the only two services with enough appeal to convince consumers to take the broadband plunge.

But this certainly doesn’t count as the most serious obstacle policymakers have created to the growth of broadband markets. Regulation has played, and continues to play, a very important role in how service providers deploy broadband.

Regulatory roulette

Beyond the question of how much demand for broadband services really exists in the present marketplace, important supply-side questions remain the subject of intense debate as well. Many policymakers and members of the consuming public are asking why current providers are not doing more to roll out broadband service to the masses.

Regulation is certainly a big part of the supply-side problem. The primary problem that policymakers face in terms of stimulating increased broadband deployment is that the major service providers have decidedly different regulatory histories. Consider the radically different regulatory paradigms governing today’s major broadband providers.

  • Telephone companies have traditionally been designated as common carriers by federal, state, and local regulators. As common carriers, they have been expected to carry any and all traffic over their networks on a nondiscriminatory basis at uniform, publicly announced rates. At the federal level, the regulation of telephone companies generally falls under Title II of the Communications Act, and this regulation is carried out by the Common Carrier Bureau at the FCC. Today, telephone companies provide broadband service to Americans through DSL technologies that operate over the same copper cables that carry ordinary phone traffic. Telephone companies account for almost 30 percent of the current marketplace.
  • Cable companies have traditionally been more heavily regulated at the municipal level, because each cable company was quarantined to a local franchise area. Although they gained the exclusive right to serve these territories, many rate controls and programming requirements were traditionally required as well. But cable has not been treated as a common carrier. Rather, the industry has been free to make private (sometimes exclusive) deals with content providers on terms not announced to the public beforehand. At the federal level, cable regulations fall under Title VI of the Communications Act and are usually managed by the Cable Services Bureau at the FCC. Cable companies provide broadband service to Americans through cable modem technologies and are the leading provider of broadband, accounting for just under 70 percent of current users.
  • Satellite and wireless providers have been less heavily regulated than telephone and cable carriers, but many rules still govern the way this industry does business. The federal regulations these carriers face are found in various provisions of the Communications Act and subsequent statutes, but most oversight responsibilities fall to the Cable Services Bureau, which is ironic given the wire-free nature of satellite transmissions. The FCC’s Wireless Bureau also has a hand in the action. Like cable providers, satellite companies are considered private carriers rather than common carriers. Unlike cable and telephone companies, wireless carriers have not encountered as much direct regulation by state or local officials, given the more obvious interstate nature of the medium. (The exception to this is municipal zoning ordinances governing tower antenna placement, which continue to burden the industry.) Today, wireless providers offer broadband service to the public through a special satellite dish or receiving antenna and set-top box technologies. With the highest monthly subscription fees and the most expensive installation and equipment charges, satellite companies have captured less than 2 percent of the market.

These three industry sectors–telephony, cable, and satellite–are the primary providers of broadband connections to the home and business today. Although they use different transmission methods and technologies, they all essentially want to provide consumers with the same service: high-speed communications and data connectivity. And yet these providers are currently governed under completely different regulatory methodologies. FCC regulations are stuck in a regulatory time warp that lags behind current market realities by several decades, and regrettably the much-heralded Telecommunications Act of 1996 did nothing to alter the fundamental nature of these increasingly irrelevant and artificial legal distinctions.

The current regulatory arrangement means that firms attempting to offer comparable services are being regulated under dissimilar legal standards. It betrays the cardinal tenet of U.S. jurisprudence that everyone deserves equal treatment under the law, and the danger is that it could produce distorted market outcomes. Can these contradictory regulatory traditions be reconciled in such a way that no one player or industry segment has an unfair advantage over another? In theory, the answer is obviously yes, but in practice it will be quite difficult to implement.

Most favored nation

The public policy solution is to end this regulatory asymmetry not by “regulating up” to put everyone on equally difficult footing but rather by “deregulating down.” That is, to the extent legislators and regulators continue to set up ground rules for the industry at all, they should consider borrowing a page from trade law by adopting the equivalent of a “most favored nation” (MFN) clause for telecommunications. In a nutshell, this policy would state that: “Any communications carrier seeking to offer a new service or entering a new line of business should be regulated no more stringently than its least-regulated competitor.”

Such an MFN for telecommunications would ensure that regulatory parity exists within the telecommunications market as the lines between existing technologies and industry sectors continue to blur. Placing everyone on the same deregulated level playing field should be at the heart of telecommunications policy to ensure nondiscriminatory regulatory treatment of competing providers and technologies at all levels of government.

So much for theory. In practice, the difficulty is that deregulation of this industry is not popular with policymakers these days. In fact, the recent debate over broadband deregulation in Congress has been an incredibly heated affair, with all the industry players and special interests squaring off over the Internet Freedom and Broadband Deployment Act of 2001 (H.R. 1542). Sponsored by House Energy and Commerce Chairman Billy Tauzin (R-La.) and ranking member John Dingell, (D-Mich.), the Tauzin-Dingell bill would allow the Baby Bell companies, which offer local phone service, to provide customers with broadband services in the same way that cable and satellite companies are currently allowed to, free of the infrastructure-sharing provisions of the Telecom Act of 1996.

The Baby Bells are reluctant to make a large investment in broadband infrastructure if they will be forced to let their competitors use that infrastructure. In addition, under the current regulatory regime the Baby Bells are not certain whether or not they can offer broadband services to customers outside their local service areas. (They are clearly forbidden to offer phone services outside these areas.) Passage of the Tauzin-Dingell bill would resolve both of these questions and clear the way for the Baby Bells to make a major commitment to broadband service.

Cable companies, the large long-distance telephone companies, and small telecom resellers vociferously oppose the Tauzin-Dingell measure, arguing that it would represent the end of the road for them. These companies would prefer not to have to compete head-to-head with the Baby Bells or to have to invest in their own infrastructure. An intense lobbying, public relations, and advertising campaign was initiated to halt the measure, and the Bell forces responded in kind with stepped-up lobbying and ads of their own. On February 27, after months of acrimonious debate, the House of Representatives passed the Tauzin-Dingell measure with some last-minute modifications. But it will likely prove to be a Pyrrhic victory for the Bells, because of the bill’s limited support in the Senate. Sen. Ernest Hollings (D-S.C.), a longtime enemy of the Baby Bells and deregulation in general, has vowed to kill the bill when it enters the Senate Commerce Committee, which he rules with an iron hand.

The bottom line is that deregulation has a very limited constituency in today’s Congress. Even proposals aimed at leveling the playing field for all providers, which is essentially what the Tauzin-Dingell bill does, have very limited chances of achieving final passage in today’s legislative environment. This is especially the case given that carriers seem unwilling to forgo the insatiable urge to lobby for old and new rules that hinder their competitors at every turn. Remember Cold War-era “MAD” policy? The escalating lobbying and public relations battles have become the telecom industry’s equivalent of Mutually Assured Destruction: If you screw us, we’ll screw you.

What Congress might do

Although it appears increasingly unlikely that Congress will take the steps needed to clean up the confusing and contradictory legal quagmire the industry finds itself stuck in, a new class of broadband bills is simultaneously being considered that would authorize a variety of promotional efforts to spur broadband deployment. For example, Senate Majority Leader Tom Daschle (D-S.D.) has argued that government “should create tax credits, grants, and loans to make broadband service as universal tomorrow as telephone access is today.” And even though recent government reports such as the NTIA and FCC studies cited above illustrate that computer and broadband usage rates have been increasing, Sen. Patrick Leahy (D-Vt.) reacted to this news by noting, “I suspect we have to add money in the Congress” to boost the availability of these technologies.

Daschle and Leahy are not along in calling for government to take a more active role in promoting broadband use. In fact, one bill, the Broadband Internet Access Act (S. 88, H.R. 267) has attracted almost 200 sponsors in the House and over 60 in the Senate. The bill would create a tax incentive regime to encourage communications companies to deploy broadband services more rapidly and broadly throughout the United States. The measure would offer a 10 to 20 percent tax credit to companies that roll out broadband services to rural communities and “underserved” areas.

Policymakers need to undertake some much-needed regulatory housecleaning by removing outmoded rules and service designations from the books.

Whereas the Broadband Internet Access Act would represent an indirect government subsidy, more direct subsidization efforts are also on the table. Last fall, the bipartisan duo of Rep. Leonard Boswell (D-Iowa) and Rep. Tom Osborne (R-Neb.) introduced the Rural America Technology Enhancement (RATE) Act (H.R. 2847), which would authorize $3 billion in loans and credits for rural broadband deployment programs and establish an Office of Rural Technology within the Department of Agriculture to coordinate technology grants and programs. And these bills are just the tip of the iceberg; there are dozens more like them in Congress.

Welcome to the beginning of what might best be dubbed the “Digital New Deal.” In recent years, legislators and regulators have been promoting a veritable alphabet soup of government programs aimed at jump-starting the provision of broadband, especially in rural areas. Although only a handful of such programs have been implemented thus far, many of these proposals could eventually see the light of day, because so many policymakers seem eager to do something to put themselves at the front of a technological development that they see as inevitable. Deregulating the market so that this development can follow its own course apparently will not enable them to take credit for what happens.

The problem, however, is that Washington could end up spending a lot of taxpayer money with little gain to show for it, because it is unlikely that tax credits or subsidies would catalyze as much deployment as policymakers imagine. In the absence of fundamental regulatory reform, many providers are unlikely to increase deployment efforts significantly. Although a 10 to 20 percent tax credit may help offset some of the capital costs associated with network expansion, many carriers will still be reluctant to deploy new services unless a simple and level legal playing field exists.

If legislators sweetened the deal by offering industry a 30 to 50 percent credit to offset deployment costs, it might make a difference. But if subsidy proposals reached that level, it would beg the question: Why not just let government build the broadband infrastructure in rural areas itself? Ironically, that is exactly what a number of small rural municipal governments are proposing to do today. Frustrated with the slow pace of rollout by private companies, some local authorities are proposing to turn broadband into yet another lackluster public utility. Private companies are fighting the proposal, of course, but consumers should also be skeptical of efforts by city hall to model their broadband company after the local garbage or sewage service. Is that really a good model for such a dynamic industry? Fortunately, these broadband municipalization efforts have not made much progress. Most legislators still want to begin by jump-starting private-sector deployment through promotional efforts.

In the end, perhaps the most damning argument against a tax credit and subsidy regime for broadband is the threat of politicizing this industry by allowing legislators and regulators to become more involved in how broadband services are provided. By inviting government in to act as a market facilitator, the industry runs the risk of being subjected to greater bureaucratic micromanagement. Experience teaches us that what government subsidizes, it often ends up regulating as well. It is not hard to imagine that such tinkering with the daily affairs of industry might become more commonplace if Washington starts subsidizing broadband deployment. That explains why T. J. Rodgers, president and CEO of Cypress Semiconductor, has cautioned the high-tech industry about “normalizing relations” with Washington, D.C. As Rodgers says, “The political scene in Washington is antithetical to the core values that drive our success in the international marketplace and risks converting entrepreneurs into statist businessmen.”

Solving the broadband paradox will require steps by policymakers, industry providers, and consumers alike if the dream of ubiquitous high-speed access is to become a reality. Policymakers need to undertake some much-needed regulatory housecleaning by removing outmoded rules and service designations from the books. New spending initiatives or subsidization efforts are unlikely to stimulate much broadband deployment. What companies, innovators, and investors really need is legal clarity: an uncluttered, level playing field for all players that does not attempt to micromanage this complicated sector or its many current and emerging technologies.

Industry players will need to undertake additional educational efforts to make consumers aware of what broadband can do for them. Ultimately, however, as important as such educational efforts are, there is no substitute for intense facilities-based investment and competition to help drive down cost, which still seems to be the biggest sticking point for most consumers. New killer aps will hopefully also come along soon that can help drive consumer demand in the same way that Napster and the brief file-sharing craze did before litigation shut down this practice.

Finally, consumers will need to be patient and understand that there is no such thing as a free broadband lunch. It will take time for these technologies to spread to everyone, and even as they become more ubiquitously available, they will be fairly expensive to obtain at first. Cost will come down with the passage of time (if demand is really there), but you’ll still need to shell out a fair chunk of change to satisfy your need for speed online.

Recommended reading

A Nation Online: How Americans Are Expanding Their Use of the Internet (Washington, D.C.: National Telecommunications and Information Administration, U.S. Department of Commerce, February 2002).

A National Imperative: Universal Availability of Broadband by 2010 (TechNet, January 15, 2002).

Computer Science and Telecommunications Board, National Research Council, Broadband: Bringing Home the Bits (Washington, D.C.: National Academy Press, 2001).

Federal Communications Commission, Third Report Concerning the Deployment of Advanced Telecommunications Capability, CC Docket 98-146, February 6, 2002.


Adam Thierer (athierer@cato.org) is the director of telecommunications studies at the Cato Institute in Washington, D.C.