Lessons from the Meltdown of U.S. Telephone Industry - Giving Top Priority to the Internet

[Dave Farber <dave () farber net>]

[ I personally am distressed with the Prof. Noam proposal to allow cartels
during recessions to "save" the industry. Djf]

Lessons from the Meltdown of U.S. Telephone Industry - Giving Top Priority
to the Internet

Shumpei KUMON (Executive Director and Professor, GLOCOM JP)
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Beginning of a Telecom Meltdown

The telephone industry in the U.S. is in a state of "utter crisis" (Michael
Powell, Chairman, U.S. Federal Communications Commission) and the collapse
of the industry would be "probably the largest single meltdown in a defined
industry" (L. William Seidman, former chairman, U.S. Federal Deposit
Insurance Corporation). The telephone industry became a major topic of
conversation when The New York Times reported that 24 out of 29 existing
telephone companies might fall and seek protection under the bankruptcy act
within a few months.

At the time, however, it was believed that the Baby Bell telephone
companies, which provide local exchange networks and which were considered
healthy, would extend their resources to save the industry. But as it has
become clear that the Baby Bells are also facing significant revenue
decreases due to losing support for fixed-line telephones and surmounting
interest expenses on debts derived from huge capital investments. Critics
such as Eli Noam, professor of Columbia University, have begun to point out
that recently introduced policies such as inducing competition, reducing
interconnection charges, and unbundling network elements were based on a
wrong premise, and that it has become necessary to allow cartels to be
established in order to maintain a healthy price level on their services
during a recessionary period.

Bob Frankston, who is now at the forefront of promoting Weblogs as a new
type of journalism on the Internet, opposes that approach and presents his
views using an interesting metaphor. In the nineteenth century, the task of
delivering ice formed in a nearby lake to houses was big business. But ice
delivery became extinct upon the arrival of electric refrigerators, which
enabled each household to produce ice on their own.

Telephony is the same, says Mr. Frankston. When it becomes possible for
people to communicate with one another bypassing the switches sitting in
telephone companies, the services provided by those companies will become
unnecessary. He says the basic cause of the recent fall of telephone
companies lies in this structural shift.

Not Much Hope for "Content" Services

To be in business by providing only a simple Internet connection service is
not an easy task. There is no guarantee that offering convenient services
such as network infrastructure to the public can sustain a viable business.
This is what David Isenberg calls "The Paradox of the Best Network." If this
premise stands, it would mean that fiber and wireless IT infrastructure must
initially be built by users themselves through collaboration among local
communities, local industries, and local residents, perhaps employing the
services of telephone or electric companies. Then these local networks could
be mutually connected for the whole network to grow.

The same could be said about the so-called content services on the network,
where movies, music, and software are provided online. As the Internet
becomes an infrastructure in a true sense, most of the contents, such as
video streams of conferences that flow through the system will be created
and shared by users themselves. Present e-mail and websites can be
considered primitive forms of this trend. Accordingly, there are few
prospects for telephone companies venturing into this form of service, while
broadcasting business also will become a depressed industry in the same
context.

Still a Chance for Japan's Telephone Companies

It is widely acknowledged that the IT network system in the Internet age
will have three layers; physical, code, and content. As it is evident from
what we have seen that the physical layer at the bottom and the content
layer at the top both will become unpromising as businesses, the IT industry
in the future should look to the middle code layer to perform as a provider
of applications and services in supporting the lives and works of
individuals, businesses and various groups. The code layer is indeed the
most promising area in which these companies should seek new businesses.

Regulations on Japan's telecommunications exercised by the then Ministry of
Post and Telecommunications was for a long time governed by the supreme
doctrine of "managed competition" which resulted in postponing of major
policy issues and the beauty-contest model adopted in spectrum allocation.
It is an irony that because of this controversial policy telephone companies
in Japan have not experienced the hardships of their American counterparts.
One might also point out that, in stark contrast to its American
counterparts NTT has been quite collaborative with the MPT and the U.S.
government in reducing interconnection charges, opening up their networks,
and laying fiber to the home.

But now is the time to take a new course of action in Japan. The Japanese
government should adopt the following set of telecom policies. One is to
refrain from policy measures that may discourage further growth of the
Internet, especially in the physical and content layers where new forms of
businesses are currently emerging, while restricting the closed and
exclusive operation of the existing network. A very cautious approach is
necessary in assessing policies that would strengthen intellectual property
rights, as are being promoted by the U.S. Congress and content providers in
the U.S. It would in fact be beneficial for Japan as well as other countries
to be critical toward the stance the U.S. is forming in this field.

The other is to transform the business styles of telephone and broadcasting
companies smoothly, during which a certain level of government intervention
might be warranted. Measures like the precautionary nationalization of
telephone and analog broadcasting operations, which are presently in the
process of decaying into non-performing assets, should not be left out of
consideration.

(English translation of the original Japanese article that appeared in the
"Seiron" section in Sankei Newspaper on August 22, 2002)

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