Regulatory Treatment of New Investment by ILECs

The conference devoted substantial time to the way regulation affects investment by ILECs. Investment in innovative technologies and services by these dominant local carriers can obviously provide great benefits to society. but many participants voiced concern about ILECs leveraging their market power in the traditional local exchange market to the disadvantage of competitors and consumers alike. The same worry motivated many of the provisions in the 1996 Act, including the requirement that incumbents unbundle network elements and sell them at marginal cost to competitors. The next section of this report takes up the matter of pricing the unbundled elements. In this section the focus is on the scope of the unbundling and on other aspects of regulating the ILECs' new market activities.

Henry Geller, communications fellow at The Markle Foundation, after analyzing the federal regulatory scheme's impact on investment, proposed that a separation be enacted into policy between existing and new network components installed by the ILEC. He suggested that the unbundling requirements, which are embedded within Section 251(c) of the Act, should apply only to the existing network. To further Section 706, these requirements would not apply to future advanced telecommunications capabilities created by the ILEC.

How any demarcation of new from old network investment would work in practice generated substantial discussion. Geller suggested defining the existing network as of a certain date. Additions to facilities after that would not be made available to competitors under the Section 251 regime. As an example he cited asynchronous digital subscriber lines (ADSL), which will enable the ILEC to offer high-speed Internet access. In the current situation, he asserted, the incumbent has little incentive to bear the necessary cost to upgrade the network since it would immediately have to make the ADSL capacity available to competitors at regulated wholesale rates. For that very reason, CLECs may also have little incentive to invest in ADSL facilities, since they could procure the capacity from the incumbent without risking much capital. The Geller reform would augment the incentives of both sides to install ADSL capacity themselves. In Geller's view, this reform would put into place win-win incentives for both ILECs and CLECs. Geller further argued that governments could implement this treatment of the ILEC without any new legislation.

Although nobody quarreled with the basic idea of improving incentives for new investment by the incumbent and competitive carriers, questions arose about possible drawbacks. Geller said the ILEC could separate its operation into two parts. One would provide local loop, remaining subject to Section 251. The other would be a separate, subsidiary CLEC using its own switches or other facilities to provide advanced services, such as video distribution or enhanced Internet connections. Regulators could treat an ILEC subsidiary engaged in broadband services as they would any other CLEC.

Jonathan Sallet, chief policy counsel for MCI, suggested applying to the ILECs' activities a standard of market power. Geller maintained the ILEC has no market power in such areas as video distribution and high-speed Internet connection, where it will face competition from several competitors, especially cable. Dan Reingold, first vice president for global telecommunications research at Merrill Lynch, responded that if the incumbent carrier installs ADSL, it would indeed have market power wherever cable is not offering broadband, and that discouraging such entry by the incumbents would rob consumers of access to innovative technology and services. Robert Crandall, a senior fellow in economic studies at the Brookings Institution, sharpened the focus by suggesting an antitrust standard rather than market power, since the former means government will look for and prevent any use of the market power to impede competition. Endorsing this idea, Commissioner Steven Wallman of the Securities and Exchange Commission said, "If the incumbent local exchange carrier has clear market power we don't want to prevent it from investing, just from using that power to advantage its new services."

Larry Strickling, Ameritech's vice president for public policy, seemed comfortable with this concept. He said that he could readily agree to policies that ensured ILECs would not discriminate in favor of their own CLEC affiliates or in favor of any particular technology that helps its affiliates. However, David Turetsky, vice president of law and regulatory policy at Teligent, asserted that this guarantee would not prevent the ILECs from deliberately allowing their older facilities to deteriorate, especially when wholesaling them to competitors. Even if there is no overt discrimination, the ILECs might put the bulk of their corporate energies and the best people into the new subsidiary. Strickling countered that the new entity would be buying loops from the incumbent, so the incumbent's own CLEC would actually constitute an important source of demand for high-quality local loops. Unsatisfied, Turetsky pointed to the precedent of regional Bell operating companies discriminating against long-distance companies after the divestiture of AT&T, even when the Bell companies had no stake in the long-distance market themselves. Here their incentive to discriminate would be far greater since they would be serving direct competitors. Compounding problems with the idea, Ron Binz, president of the Competition Policy Institute, predicted that the old bugaboo of joint and common costs would rear its head in any scheme to operate a truly separate subsidiary. Charles Firestone, director of the Communications and Society Program at The Aspen Institute, suggested that regulators might alleviate concerns about degradation in the ILECs' networks, and about discrimination against competitive carriers, by requiring ILECs' subsidiary CLECs to buy their local access from their parents.

There were suggestions at the conference, some veiled and some quite direct, that it might be time to consider a "Divestiture II." Such a policy must navigate between the Scylla of discouraging new investment by ILECs, the largest firms in the industry, and the Charybdis of allowing them to enter and perhaps either extinguish competition or severely limit its scope. In the divestiture scenario, the ILECs might be split into two independent firms, with one providing (what is likely to remain for the foreseeable future) the bottleneck local loops, and the second competing with other CLECs to offer advanced and traditional telecommunications services. Gail Garfield Schwartz, vice president for public policy and government affairs of TCG Teleport Communications Group, suggested explicitly that the ILECs might follow the lead of the smaller incumbent local carrier, SNET, of voluntarily splitting wholesale and retail operations. The goal would be for the ILECs' retail services to operate on an equivalent footing with the CLECs. She predicted this would induce the ILECs not only to provide bottleneck facilities such as local loops in a nondiscriminatory fashion, but also to terminate all traffic without discrimination. She suggested that traffic termination might be the ultimate bottleneck function since eventually even local loops will be competitively supplied. Divestiture of the ILECs did not generate sufficiently careful attention at the conference to merit further discussion here.

Send comments or questions to tricia.kelly@aspeninst.org