Telco Innovation

In an essay for Business Week, Mark Gimein quotes a former industry source who says, “[The telcos] do very little fundamental research and very little advanced development.” Gimein claims that the only example of innovation he could find in San Antonio (home of AT&T) is a feature which allows Homezone (the service that combines DSL with satellite TV service) to play music on a television set. Then, he condescendingly suggests that AT&T ought to look, in this trivial feature, for “a hint of what AT&T might achieve if it spent on research and development even half of what a company like Intel does.” Wade Roush makes a similar argument in Technology Review (“compared with the computing industry, telecoms invest little money in actual research and development”).

To understand what is happening, first you could ask yourself why did the cable industry invest $100 billion in broadband networks over the past 10 years while the telephone coompanies didn’t? Answer: The 1996 Telecom Act deregulated cable and allowed the FCC to micro-manage the phone companies. 

The impact of regulation on the companies can also be seen in their stock performance. If you bought a share in Bell Atlantic (now Verizon) in 1996, you would have paid $66. There was a 2 for 1 split in 1998 and one share is worth $33 today. Therefore, your investment is worth the same today as it was then (excluding dividends, which amounted to approx. $1.50 per share, per year). Most likely, you would have been better off investing in government savings bonds. On the other hand, if you invested in Comcast your investment would have doubled.

The telephone industry used to lead innovation. Remember that the computer revolution began at Bell Labs, as George Gilder pointed out to one of the writers. Wil Lepkowski, among others, have chronicled the amazing achievements of the Bell Labs scientists. According to Lepkowski, 

Digital computer technology was invented at Bell Labs for its own internal use in switching, along with the information theory that formed the basis of clear voice communication. Transistors and semiconductors had their functional birth there, along with the laser and fiber optics. Cellular telephone technology also had its start at Bell Labs. Linux, the operating system that serves as the basis of Internet content rose from Bell Labs, as did, earlier the coaxial cable and millimeter wave guides. 
Lepkowski laments the demise of Bell Labs, but he also notes that divestiture in 1984 and the Telecom Act of 1996 both played a significant role. Prior to divestiture, the government encouraged generous subsidies for Bell Labs and guaranteed that AT&T could recover the amounts spent there. Although, the government didn’t aways encourage applications, because it wanted to keep phone rates low and because, after all, the phone network was regarded as the best in the world, a national asset. But then, as Bell Labs discoveries made it possible for competitors to enter telecommunications and offer steeply lower prices, the government changed its mind. AT&T was broken up, and line-of-business restrictions were imposed on the Baby Bells. They couldn’t cross LATA boundaries or engage in electronic publishing, equipment manufacturing or even alarm monitoring. If you had been running one of these companies at the time, you would have asked what’s the point of investing in innovative services if it would be illegal to bring them to market?

The line-of-business restrictions eventually got peeled away, but the micro-management of the court that supervised the breakup and by the FCC in the name of promoting competition, required the Bells to seek prior approval for anything of significance. Under Chairman Kevin Martin, the FCC recently eliminated two pro-competition mandates — the requirements to share fiber optic deployements and DSL with rivals at government-imposed discounts (both of these mandates could be characterized as forms of net neutrality regulation). These deregulatory initiatives have led to renewed investment by AT&T, Verizon and BellSouth. But there’s still lots to be done. A prime example is the requirement that the phone companies negotiate with 33,000 cable franchise jurisdictions, all of whom want to micro-manage the advanced network deployments and seek costly concessions on top of 5% of gross revenues. 

The argument that net neutrality regulation couldn’t possibly deprive of us of any innovation because the phone companies don’t invest anway is invalid, and the bottom line is that innovation is needed in content and delivery — as I and many others have repeatedly noted. Net neutrality regulation would subsidize innovation in content and starve innovation in delivery. The free market, on the other hand, would allocate resources for innovation to where they would generate the highest return, which is the same thing as where innovation is most needed. 

See: “The Phone Companies Still Don’t Get It,” by Mark Gimein, Business Week, Jul. 31, 2006

See: “Net Neutrality: Lessons From The Past,” by Wade Roush, Technology Review, Aug. 3, 2006

See: “The Once and Future Lab,” by Wil Lepkowski, Consortium for Science, Policy, and Outcomes at Arizona State University, Jun. 10, 2003