The Broadband Problem: Anatomy of a Market Failure and a Policy Dilemma

Chapter 3. Technological Performance

57 3 Technological Performance Upon examination, the incumbent local exchange carriers emerge as slow-moving and inefficient, their primary concern in markets and in politics being to preserve their monopoly positions and existing businesses, in part by resisting improved technology. While this strategy succeeded for a long time, the ILECs’ inefficiencies have begun to adversely affect their financial performance, which has been deteriorating since 2001. Even with the collapse of most local competitors, they are gradually losing business, primarily via substitution effects produced by other technologies—such as cell phones, Internet telephony, and e-mail. Like IBM in the early 1990s, the ILECs may eventually face financial and business crisis if they maintain their prices and margins but fail to improve their technology. Unfortunately, because the ILECs retain considerable monopoly power and because substitution can therefore occur only slowly, the U.S. economy could pay an enormous price in the meantime. The ILECs have a poor record in innovation, R&D, the standardization and deployment of new technologies, investment in network modernization, delivery of price-performance improvements to customers, quality of customer service, development and deployment of open-systems architectures, success in real competition, and internal use of modern technologies and services. Because growth opportunities based on price and performance tend to be rather low priorities, the ILECs appear more interested in retarding technical progress than in promoting it. 1901-03_CH03.qxd 03/03/04 10:57 Page 57 58   As a result, for the past decade or more the price-performance ratios of ILEC services—including both voice services and data services such as integrated services digital network architecture (ISDN), T-1, T-3, and even DSL—have improved at best quite slowly, in other cases have stagnated , and in some cases have even deteriorated. Contrary to popular belief, the rapid growth of residential ADSL deployment since the late 1990s has not greatly altered this pattern. In fact, as discussed later in this chapter, the price-performance improvement rate delivered via ILEC ADSL service hovers around 15–20 percent a year, if not less. Even this rate may have declined, since the prices and performance levels of ILECdelivered ADSL remained flat between 1999 and 2003. (Some price cuts were announced in mid-2003.) Furthermore, the price-performance trajectory of other major ILEC-delivered services—including business voice, residential voice, and business data services (such as T-1 and T-3)—is even worse than residential Internet access. ILEC revenues, both overall and in data services, have also grown slowly in comparison with those of related competitive industries such as Internet access and corporate data networking, owing in part to the high costs and low rates of technical improvement of ILEC services. This lag is indeed astonishing, given that the technologies underlying these services improve at least 50 percent per year. The ILECs’ conduct and performance suggest that their core strategy is to use their power to perpetuate their monopoly status, the profitability of their established businesses , and the positions of their incumbent management. The ILECs quite literally appear to invest more every year in lobbying, political contributions , litigation, and similar activities than in R&D. Similarly, despite many announcements to the contrary, the ILECs actually reduced their capital investment in the U.S. local network for most of the 1990s. The real capital stock of the U.S. local telecommunications industry was flat from the late 1980s until the late 1990s.1 Inflation-adjusted ILEC capital investment peaked in 1985 at $20 billion (in 1987 dollars), declining to $16.8 billion by 1994; during this period, ILEC capital investment declined from 70 percent to 60 percent of total telecommunications investment , because the long-distance industry invested heavily in the face of increasing competition.2 Then, starting in the late 1990s, for approximately two years, the ILECs increased network capital investment significantly, apparently the combined result of increased demand and of the competitive threat posed by AT&T,WorldCom, and emerging CLECs. Following the collapse of the NASDAQ bubble and of the CLECs, however, the ILECs again 1901-03_CH03.qxd 03/03/04 10:57 Page 58   59 reduced network capital investment sharply between 2001 and 2003. Consequently over the past dozen years, even with the Internet revolution under way, both R&D spending and capital investment per local access line have been flat or declining in the United States, and capital investment as a percentage of data revenues and traffic has declined sharply. ILECs have...