Summary – the FCC should limit subsidies for broadband services to IP systems that would not otherwise be viable without the subsidy and where the benefits of the positive externalities from the broadband services exceed the size of the subsidies needed to provide broadband coverage.
- Introduction – Taking the First Step in the Right Direction
The $7.2 Billion subsidy of the 2009 Recovery Act has rekindled excitement in broadband communications. Nevertheless, given the speed in which the Act was enacted and its bare bones structure, the FCC has an important role to play in advancing an effective framework for the implementation of the Act and its related subsidies.
Without a sound footing, the program can go off track. For example, the PCS C Block auction resulted in widespread bankruptcies and severe delays in service to the public – despite the provision of low-cost loans to the bidders.
To avoid similar mistakes in the implementation of the Recovery Act, the FCC’s first step should be to gain an understanding of the economics that the operators will be facing in addressing the broadband opportunity in underserved and unserved areas.
More specifically, the FCC should put together (or purchase) a business model that forecasts economic returns for broadband deployment under different conditions such as population density. The output of that model for specific target markets should then be assessed by an independent investment bank for its attractiveness in financial markets.
In other words, the FCC should not assume that the market will automatically solve its current shortcomings with the addition of the government subsidies. Unless the FCC and the potential operators can document a viable business plan for broadband deployment for each target market, the goals of the broadband legislation will not be met.
- Putting the Broadband Program on Sound Footing
Congress has mandated significant subsidies for broadband deployment. In a broader context, these subsidies are adding to the already large and growing federal deficit. In this light, why should the government subsidize broadband at all, or conversely, why should it not subsidize a myriad of other goods and services?
The answer lies in the economics of positive externalities for broadband communications. That is, the benefit from additional broadband users goes beyond the benefits to those individual users and flows to society as a whole because of the enhanced communications, productivity and commerce in the economy afforded by broadband connectivity.
Given the positive externalities from broadband deployment and usage, three factors come into play for the FCC’s consideration. First, the FCC should identify the type of broadband infrastructure that provides these externalities and recommend that the broadband subsidies be prioritized for this infrastructure. In particular, the FCC should recognize the advantages of IP communications in producing positive externalities, as discussed below.
Second, with the positive externalities generated by adding broadband users, all users of IP communications would be better off – even if they paid for the subsidies of the broadband initiatives through taxes. Hence, the FCC should seek to collect the mandated broadband subsidies from all providers of IP communications, who could then pass these taxes onto their customers.
Third, at some point in the curve of diminishing population density, the size of the subsidies needed to provide broadband coverage will exceed the benefits of the positive externalities. The FCC should seek to approximate the point in population density where subsidies are no longer warranted, and recommend that limits be established accordingly.
- Identifying the Infrastructure That Maximizes Consumer Welfare
The world is moving toward a communications infrastructure based on Internet Protocol (IP), which in turn allows the sort of broad-based applications that create positive externalities. This framework is not equivalent to the “Internet” as accessed by an end user from an Internet Browser. Rather, IP communications utilizes a specific standard that allows connection and transfer of all forms of communications, including voice, video and data between endpoints. As mentioned previously, the FCC should seek to have broadband subsidies targeted to providers of IP communications given the positive externalities of shared applications derived from such a system.
Another significant factor for the FCC to consider is that 4G wireless technology has standardized on the Internet Protocol (IP). The implication is that 4G technology – today WiMax and LTE in the future – can offer broadband service that can work seamlessly with terrestrial IP networks (e.g., sharing applications), thereby further advancing positive externalities from more widespread usage.
- The Capital Costs of the Competing Technologies
4G wireless networks can be built in low-density areas at a small fraction of the cost per potential customer than line-based systems that utilize fiber, coaxial cable or copper wire. For example, studies in Australia show that the cost of fiber in low-density areas to be four times the cost of WiMax. This effect becomes more pronounced as population density decreases.
Looking at the opportunity of serving new areas, a standalone operator would choose wireless technology based on the capital cost disparity – given that 4G technology has the potential to generate comparable revenue at a comparable operating expense. Therefore, the FCC should not embrace subsidies for line-based IP systems in low-density areas unless they are supported by a standalone business plan that requires similar or less subsidy than the alternatives.
Similarly, given the incentive of the monopoly telephone and cable company to suppress competition through cross-subsidization, these companies should be required to form a separate subsidiary and be subject to public audits in order to qualify for a government subsidy.
- The Business Model Should Be Consumer-Focused, Not Carrier-Centric
The long-term vision of the telephone and the cable companies is to deliver voice, Internet and a plethora of video channels to a set-top box. However, consumers do not want hundreds of video channels simultaneously delivered around the clock to their living rooms, nor should they be forced to subsidize this model.
In contrast, consumers want to be able to instantaneously search and engage the video, audio, text or voice message of their choice at minimal cost over a single channel at any time from any location. They also want to be able to produce and send information in any form from any place at any time.
To meet these requirements, IP networks will have to be open, allowing access by any device on an unrestricted basis. Devices will have to cater to the specific requirements of the consumer, whether multipurpose or specific to unique applications.
Can any technology accommodate this vision today? Yes, 4G wireless systems can accommodate all of these customer requirements – with two important caveats. First, the FCC must authorize licensed spectrum of sufficient magnitude to allow high-quality video channels to be delivered to a majority of users in the service area. Licensed spectrum is required because video must be provisioned with a prioritized grade of service to provide a user-friendly service.
While spectrum is generally thought to be scarce, it is not currently used anywhere near capacity in low-density areas. The FCC can carve out spectrum from existing licensees on a geographic basis and require certain techniques such as directional antennas to be deployed by the new operators to avoid interference. Such an approach would greatly improve the revenue capability and viability of 4G wireless services in rural areas, and address the Act’s requirements for service to unserved and underserved areas.
Second, the 4G industry must work out the legal and operational challenges of IPTV. While this is not a traditional FCC issue, the seamless provision of IPTV by 4G operators is crucial to improved business plans in rural areas – so the FCC should carefully monitor and participate in industry IPTV forums to foster rapid adoption.
By providing additional spectrum in targeted areas and encouraging the provision of IPTV, the FCC will dramatically improve the business prospects for broadband coverage by enabling operators to raise additional revenue by satisfying customer demand.
- The Definition of Broadband Should Support Public Policy Objectives
As previously explained, to improve the deployment of broadband to underserved and unserved areas, the business model for broadband service needs to improve. With the availability of 4G technology, substantial improvements in coverage, cost and functionality are now available using the worldwide Internet Protocol. The remaining challenge is to increase revenue per potential customer.
The primary service offered by IP networks today is Internet access. Internet access is provided on a subscription basis, and content is generally provided on an advertiser-supported basis. The willingness of consumers to pay for Internet access and associated content relates to the quantity and quality of services provided.
The quality of Internet access relates primarily to speed, which is determined by capacity. The FCC’s current definition of broadband at 200 Kbps is the minimum capacity necessary to warrant an increased payment over dial-up service. As the capacity reaches 2 Mbps, additional content including graphics and streaming video can be offered improving the user experience and enhancing the content provider’s ability to derive greater advertising revenue.
At approximately 8 Mbps, high-quality video can be offered, enabling increased subscription revenue generation. In essence, the IP communications provider can offer Internet access, voice, and TV service – enabling maximum revenue generation. Moreover, 4G systems can offer these services on a mobile basis.
Therefore, the FCC should expand its definition of broadband service to include the following tiers of service (based on average throughput):
Tier 1: 200Kps to 2 Mbps – minimum broadband capacity consistent with an acceptable user experience
Tier 2: 2 Mbps to 8 Mbps – capacity consistent with an enhanced ability to provide advertiser-supported applications that produce positive externalities
Tier 3: 8 Mbps and up – full capability to provide voice, data, and video (TV) service enabling improved broadband viability and coverage
The focus of the subsidies for broadband service should be on delivering more than 2 Mbps of capacity (Tiers 2 and 3) in order to drive the provision of more valuable services to consumers and to generate additional positive externalities to society.
The FCC can and should play a prominent role to ensure that the taxpayers’ money for broadband deployment is well spent and that the objectives of 2009 Recovery Act are achieved.
As explained in this comment, the FCC should:
1) specify that broadband – for purposes of the maximizing consumer welfare encompasses IP communication services;
2) establish the following tiers of broadband service:
a) 200Kps to 2 Mbps – minimum capacity consistent with an acceptable user experience
b) 2 Mbps to 8 Mbps – capacity consistent with an enhanced ability to provide advertiser-supported applications that drive positive externalities
c) 8 Mbps and up – full capability to provide voice, data, and video (TV);
3) recommend that subsidies flow on a priority basis to IP communications systems that provide at least 2 Mbps;
4) focus on improving operator viability by increasing the availability of licensed spectrum in low-density areas and fostering the provision of IPTV over broadband networks; and
5) encourage subsidies for operators with business plans that would be viable except for the capital cost inefficiencies attributable to low population density. In other words, the company’s operating plan needs to be cash flow positive on discounted basis to qualify for subsidies, and the subsidies should be shown to overcome the capital inefficiency barriers.
Finally, the FCC should not support subsidies for line-based IP systems unless: 1) a standalone business plan shows how each system becomes viable with the subsidy, 2) the subsidy is equal or less than that required by alternative technologies, 3) the subsidized system is provided in a separate subsidiary and 4) the financial records of the subsidiary are subject to public audits.