On October 7th, the Federal Communications Commission issued a summary of Chairman Tom Wheeler’s proposed business data services (BDS) order. Perhaps the most interesting thing about this fact sheet is its admission that ex ante rate regulation is harmful to investment. Despite this understanding of the potential consequences, the proposed order would drain free cash flow from broadband providers — primarily incumbents, but also some of their facilities-based competitors.
The summary explains that “to promote continued investment in packet-based BDS, no price caps, benchmarking, or other forms of ex ante pricing regulation will apply.”
The proposal does, however, apply ex ante price regulation to low-speed TDM (circuit-switched) BDS, whose infrastructure is provided largely by incumbent broadband providers and competitive fiber providers (CFPs) and resold by others. Business customers have been migrating away from TDM to the more technologically advanced packet-switched services, but lowering TDM’s price can only slow that migration because of the mixed signals it creates for providers versus customers.
Even if the desire to be free of regulation incents TDM providers to try to reduce sales of this obsolete service, they are helpless to do so. The mandatory lower prices encourage customers to stay with the legacy service. Moreover, the signal the FCC is sending about packet-based BDS to the providers is confusing. While the proposal does not apply ex ante regulation to packet-based services today, it does sweep them under Title II and proposes far-reaching ex post regulation of competitive providers as well as incumbents. INCOMPAS has already come back and demanded that the FCC apply ex ante regulation to Ethernet at speeds below 50 megabits per second.
Not only will the proposed order make it harder for providers to wean customers from TDM services, the price cuts will also deprive the incumbents of cash flow that could be reinvested in the packet-based portion of their infrastructure. Based on the model described in my recently published a paper, “Business data services: the harm to competitive facilities deployment,” which can be found here, I estimate that if the proposed order were implemented, it would lower the free cash flows of incumbents by as much as $2 billion just over the first three years that constitute the phase-in of the order. The bleeding would, of course, continue past the phase-in period, as the price cuts are designed to deepen each year.
Facilities-based fiber providers are likely to be deprived of free cash flow as well because they have to mirror the rates of the incumbents. That is likely to affect both their own TDM services and the low-speed Ethernet services that are their substitutes. Indeed, best-efforts Internet, a service that the cable industry is selling to small businesses in direct competition with TDM, is also likely to feel the pain, as the FCC-mandated prices will induce those businesses to stay with TDM.
Bottom line — an order that purports to “promote continued investment in packet-based BDS” is actually, albeit not intentionally, designed to steer customers away from low-speed packet-based BDS and decrease the funds available for network-investment by both incumbents and competitors who are attempting to migrate customers away from legacy services. Not surprisingly, several Democratic senators and at least one governor from a rural state have already responded to this proposal. They have cautioned the FCC to tread carefully, lest it choke investment in the broadband their states desperately need.
The FCC is to be commended for recognizing that rate regulation is a disincentive to investment. It now needs to consider carefully the unintended but obvious consequences of applying it to TDM — a revival of this legacy technology at the expense of the modern technologies the FCC wants to foster.
Anna-Maria Kovacs, Ph.D., CFA, is a Visiting Senior Policy Scholar at the Georgetown Center for Business and Public Policy. She has covered the communications industry for more than three decades as a financial analyst and consultant.
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