Washington’s Bogeymen

Big Government and Mass Media always feed on fear of monsters. While politicians promise to protect the people from the dreaded private sector, leading newspapers such as the Washington Post and network shows such as “60 Minutes” chime in with continuing reports on the economy as seen from the shores of Loch Ness. Peering through the shifting, inscrutable murk of the marketplace, pundits both private and public can descry beneath every ripple of industrial change the spectral shape of some circling shark or serpent from which only a new bureaucracy or liberal constabulary can save us.

There are always many witnesses to the threat. In his campaigns of creative destruction, any great capitalist provokes enough panic in the establishment to fuel the beadles who would bring him down. Losing competitors, whether in oil or software, are always in the vanguard of the monster hunt, which is therefore usually launched in the name of “competition” and is designed to stop it in its tracks before anyone wins.

In the industrial era it was the so-called Robber Barons — creators of the great industries of oil, steel and finance — who greased the growth of government with their chimerical menace. Radically reducing the prices of their products, such leaders as Rockefeller, Carnegie and Morgan expanded the economy to serve middle- and lower-income customers and laid the foundation for the American industrial leadership that triumphed in two world wars. But at the same time, charged with predatory pricing, collusive marketing dumping and other competitive violations, Rockefeller, Carnegie and Morgan emerged as the monsters of monopoly who fueled the growth of government through the first 40 years of the century.

Now, with information technology driving private sector wealth and power, there is a need for new monsters to fuel new sieges of government and regulatory growth. This time the monsters bear the names of Milken, Gates and Malone — new trolls to terrify little children and cause competitors to cozen Washington and judges to reach for their RICO bludgeons and commissioners to salivate and shuffle subpoenas and senators to tremble and wreak new tomes of law and bureaucrats to sow the economy with minefields of abstruse new rules.

Of the three new monsters, big government managed to deliver us first from Michael Milken, depicted as a Banker Shark. But Milken’s vision impregnably survives in the form of the industries and infrastructures he financed, chiefly cellular phones, fiber optics and cable television — the forces that laid the foundation for a new broadband economy.

With Milken laid low by cancer and the courts, Washington needed new monsters for the 1990s. After serious and continuing contemplation of Bill Gates as a possible MicroShark hidden amid the mazes of Windows and DOS, Washington recently has focused on the formidable visage of John Malone.

As the titan of cable and leader of Tele-Communications Inc., better known as TCI, he was a billion-dollar beneficiary of Milken’s bonds. At a time when governments everywhere covet the huge, new wealth emerging from information superhighways, Malone has become the favored target of the Loch Ness news hounds and public-law pinstripes: an Abominable Snowman ranging down from the Rockies to raid and ruin rival companies, terrorize politicians and gouge his 21 million customers. Or, in the words of then Senator Albert Gore, Malone is Darth Vader himself.

This particular monster hunt, however, could not be more ill- timed. There is no way that this administration can demonize the cable industry and micromanage telecom without direly damaging all its hopes for an information superhighway and thus the best prospects for the future of the U.S. economy. Just as the automobile industry was the real heir to the triumphs of the “robber barons” in oil, steel and finance, so the computer industry — the core of U.S. world industrial leadership — will be the chief beneficiary of cable and telecom ventures in broadband networks.

The U.S. now commands global dominance in computer technology. But as Andrew Grove told Forbes ASAP, “infinite processing power will only get you so far with limited bandwidth.” The next generation of computer progress depends upon the efficient use of cable bandwidth to homes and home offices, which comprise a fist-growing 60 percent of the current market for computers. Even if computer executives fail to see the threat, the monster hunt against cable thus jeopardizes the supreme achievement of the American economy over the last decade — its global lead in computers.

The U.S. government constantly reiterates its desire for information superhighways. The problem is that punctuating the call for broadband nets is an insistent mantra of “competition” that reverberates through the speeches of nearly all participants in the debate. As Ward White, vice-president of government affairs for the U.S. Telephone Association, points out, however, this mantra of competition “disguises a new scheme of market allocation run by the regulators.”

In this competition no one can win or make any money. The $ 10 billion in profits claimed by the Baby Bells still under the Greene thumb are highly questionable. Most of their copper wires and narrowband switches — rapidly obsolescing by any objective standard — are being written off over decades. That means the real costs of the Bells should be much higher than their announced costs, which do not adequately reflect the fact that their $ 300 billion worth of plant and equipment is rapidly losing market value. As TCI’s sharp and salty young COO, Brendan Clouston, points out, telephone companies are used to pretending to make money under rate-of-return regulations when they are really losing it.

Cable companies, by contrast, are used to pretending to lose money when in fact they are raking it in. A standing joke around the offices of John Malone’s cable empire, which comprises TCI and Liberty Media, asks what Malone will do if the firm ever reports a large profit. The answer: Fire the accountant. Indeed, TCI did not report even a cosmetic profit until the first quarter of 1993. Cable firms were financed with junk bonds and other debt that allows investors to be paid off with tax- deductible interest payments rather than double-taxed dividends and capital gains favored by the telcos.

Michael Milken, the financial father of the cable industry, channeled some $ 10 billion in high-yield securities to TCI, Time Warner, Turner, Viacom and other cable firms at a time when they were struggling for survival. As a result, the cable companies are eight times more leveraged in their debt-equity ratios than telephone companies are. But driven by the demands of debt, the cable firms use their capital some two-and-a-half times more efficiently. Generating $ 20 billion in revenues, one-fourth as much as the telcos, cable firms use just one-tenth the capital.

The cable companies are leveraged at a rate of between seven- and ten-to-one on their cash flow. Moreover, some 60 percent of cable company assets are “good will.” Included in the purchase price of new acquisitions, “good will” represents the intangible value of cash flows and synergies expected from new technologies and programming.

Built on vision and debt, such entrepreneurial companies cannot invest without the possibility of large returns. Attack the cable industry’s cash flow and prospects, and you attack its lifeline. Attack the cable industry’s cash flow and prospects, and you reduce its available investment by a factor of five or more. Bell Atlantic was originally willing to pay for TCI nearly 12 times its cash flow.

The Real Monster: Government

In this highly leveraged arena government itself is the real monster: an 800-pound gorilla. Where does the 800-pound gorilla sit? Wherever it wants. Early in April of this year it chose to sit on the cable industry. More specifically, it plumped down in the middle of Brendan Clouston’s desk in the form of a 700-page FCC document reregulating the cable industry. It was full of detailed regulations on everything from how fast he must pick up his phones for customer complaints and what he should charge for each tier of service and for each component of cable gear, to how large, implicitly, his return on investment can be (about 11.5 percent). He faced the mandate to adjust nearly every price and policy in the company within six weeks and to justify each price by filling out 60 pages of forms. In a menacing note for the future portending new government plans for redistributionist pricing, he is required to report the median income in each of his service areas.

The FCC is not really to blame for this onslaught, since it resisted the new congressional power grab. In any case, this agency is only part of Clouston’s problem. He also faces an aggressive new spirit at the Federal Trade Commission, at the Department of Justice and in Congress, which permits him to collaborate with any company as long as it is not a telephone firm with useful fiber networks and switching systems in TCI’s own regions. Full of rhetoric inviting every industry from the telcos to the power companies into the cable trade, many of the legislative proposals, FTC policies and FCC ukases converging on Clouston’s desk seem to be intended to transform cable from a galvanizing entrepreneurial force in the U.S. economy into a sleepy-time public utility run by lawyers. At stake is the future of the information superhighway and thus the future of the U.S. economy.

Superhighway Hype is Understated

Information superhighways are one of those rare technologies that are actually far more powerful and promising than the hype surrounding them. The first fruits of this development are already evident, as the U.S. has led the world in deploying computer networks. Over the next five years broadband networks can transform the entire economy, projecting it onto a higher plane of growth and productivity.

For the last decade the performance of the economy has perplexed the economics profession. Throughout the 1980s most economists predicted that U.S. interest rates would soar as a result of world-lagging rates of personal savings. When interest rates instead dropped, economists pointed to a “dangerous dependence” on foreign sources of capital such as Japan, which were investing close to $ 100 billion annually in the U.S.

Today, adverse tax and regulatory policies in the U.S. have entirely reversed capital flows, with funds now leaving the U.S. for foreign markets at an annual rate of $ 80 billion. Meanwhile, as Federal Reserve Governor Lawrence Lindsey has warned, personal savings have plunged to all-time lows. By every rule of economics, interest rates should soar or growth should collapse.

Yet despite a slight upward drift in recent months, U.S. interest rates remain low by historic standards, and the U.S. continues to lead the major powers in economic growth and has extended its lead in productivity. As Michael Jensen of Harvard Business School has shown, a close analysis of the figures from U.S. corporations now reveals a historic acceleration of U.S. productivity growth during the 1980s. According to an analysis by Morgan Stanley, between 1987 and 1992 U.S. corporations captured some 47.7 percent of global profits and 37.4 percent of global sales. Continued slumps in Europe and Japan combined with reviving growth in the U.S. indicate that U.S. market share is still rising.

This record of supremacy is entirely baffling to the economics profession and its megaphones in the media. Focusing on the Loch Ness news, they have spent a decade in lamentations over the prospects of the U.S. economy, reaching a pitch of funereal keening during the 1992 election campaigns. But to analysts focused on the ever-growing U.S. lead in technology, these results are no mystery at all.

U.S. supremacy is focused on information tools and spearheaded by computer networks. U.S. companies command some two-thirds of the world’s profits in information technology, hardware and software, and entirely dominate world markets in computer networks. Half the world’s 110 million personal computers are in the U.S., and between 1989 and 1993 the share connected to networks rose from less than 10 percent to more than 60 percent.

The ultimate information industry is finance. During the last decade the U.S. employed information technology to transform its financial system. Spearheaded by Milken and a $ 200 billion junk bond market, the U.S. drastically reduced the role of banks and proliferated an array of more flexible and specialized financial agencies. While over the last 12 years banks’ share of private credit for non-financial companies dropped from two- thirds to less than 20 percent, the U.S. surged into global leadership in applying information technology to the field of financial innovation.

In essence, the law of the microcosm shattered the financial system into silicon smithereens and vastly enhanced its productivity. As the late Warren Brookes has written, “If every bank is nothing more than an information system, then by definition every information system has the capacity to be a bank, and every owner of an information system, from a desktop computer to a mainframe terminal, can be a banker.” What happened was that thousands of brokers, mathematicians, financial consultants, insurance salespeople, credit card merchants and bonds traders took this opportunity to break into the field of financial entrepreneurship.

As a result, the U.S. set an entirely new world standard for capital efficiency, generating far more economic growth per dollar of savings than any other country. As explained two centuries ago by Adam Smith, key to productivity growth is the refinement of the division of labor, the expansion of specialization, the breakdown of functions into subfunctions and niches. The key force fostering specialization in the U.S. is computer networks.

Over the next decade computer networks will expand their bandwidth by factors of thousands and reconstruct the entire U.S. economy in their image. TV will expire and transpire into a new cornucopia of choice and empowerment. Great cities will hollow out as the best and brightest in them retreat to rural redoubts and reach out to global markets and communities. The most deprived ghetto child in the most blighted project will gain educational opportunities exceeding those of today’s suburban preppie. Small towns will become industrial centers in the new information economy. Hollywood and Wall Street will totter and diffuse to all points of the nation and the globe. Families will regroup around the evolving silicon hearths of a new cottage economy. Video culture will transcend its current mass-media doldrums, playing to lowest-common-denominator shocks and prurient interests, and will effloresce into a plethora of products suggestive of the book industry.

In essence, people will no longer settle for whatever or whoever is playing on the tube or down the street or in their local office or corporation. Instead, they will seek out and command their first choices in employment, culture, entertainment and religion. They will reach out across the country and around the world to find the best colleagues for every major project. Productivity and efficiency will inexorably rise. A culture of first choices will evince a bias toward excellence rather than a bias toward the mediocre, convenient or crude.

The entire centralizing force of the Industrial Revolution, which brought capital and labor together in vast pyramidal institutions and reduced workers to accessories of the machine and the tube, will give way to the explosive centrifuge of the microcosm and telecosm. Yielding single-chip supercomputers linked in global broadband networks, these technologies fling intelligence beyond the boundaries of every top-down institution and Machine Age social system.

The vision of information superhighways revitalizing the American economy and culture is far more true and compelling than even its advocates comprehend. People who underestimate the impact of bandwidth will miss the supreme investment opportunities of the epoch.

Decline and Rise of the Malone Model

Dominant in the industry are two essential models for fulfilling the promise of the superhighway. One scheme, long associated with John Malone and other cable executives, is the monster model: combining content and conduit in order to gain monopoly rents.

Because it reaches more than 20 percent of all cable customers, access to the TCI conduit can heavily influence the success or failure of any content venture. As Andrew Kessler, partner and multimedia guru at Unterberg Harris and Forbes ASAP columnist, puts it, “If you want to create a cable channel, you may have to send it through Malone’s bottleneck — a satellite dish farm outside Denver. I suspect that could cost you some $ 4 million in cash, or, alternatively, you can give Malone 30 percent of your company.”

This monster model is in essence the way Malone built up Liberty Media and the content side of TCI, which together own parts of TNT, the Discovery Channel, American Movie Classics, Black Entertainment TV, Court TV, Encore, Starz, Family Channel, Home Shopping Network, QVC, Video Jukebox and an array of regional sports networks. It has been widely reported that AT&T and financier Herbert Allen are creating a new classic sports network and will give a chunk of it to Liberty in exchange for access to Malone’s conduit.

The other model is that of the common-carrier, upheld both by the telephone companies and by Internet. In this model you build an open conduit and exercise virtually no influence on content. Using the phone system or Internet, people can communicate anything they want as long as they observe the protocols of the public switched telephone network or of Internet’s TCP/IP. Extended to images, this model suggests a “video dial tone.” You can dial up any other machine connected to the network and download or upload any films, files, documents, pictures or multimedia programs that you wish. Although telephone companies or Internet providers may own content. they cannot privilege their own programming. Their content has to compete for customers freely with all other content available on the network.

The notoriety of the Malone model and the resentment it arouses far and wide explain much of the hostility toward the cable industry and John Malone. This may even explain the current rage to reregulate the industry. The great irony today is that Malone and the rest of the cable leaders were in the process of abandoning the Malone model at the very moment that many telephone executives seemed to adopt it.

It was Malone, after all, who was willing to sell his content to Bell Atlantic, and it was Raymond Smith, above all, who insisted on acquiring the assets of Liberty Media. It was Bell South that was willing to pitch in some $ 2 billion to QVC’s bidding for Paramount when John Malone left Batty Diller high and dry. Ameritech, too, was reported to be preparing a pitch for Paramount.

Malone was right in his attempt to sell out at the top to Bell Atlantic. The idea of combining conduit and content was valid in a regime of bandwidth scarcity. In a regime of broadband information superhighways, however, content providers will want to put their programming on everyone’s conduits, and conduit owners will want to carry everyone’s content. In a world of bandwidth abundance Paramount will not want to restrict its films to Bell South’s network any more than Bell South will exclude films from other sources.

The key condition for the success of the open model and the eclipse of the Malone model, however, is real bandwidth abundance. If the federal government prohibits the interconnection of conduits, then the Malone model gains a new lease on life. In a world of bandwidth scarcity the owner of the conduit not only can but must control access to it. Thus, the owner of the conduit also shapes the content. It does not matter whether the conduit company is headed by a scheming monopolist or by Mitch Kapor and the members of the Electronic Frontier Foundation. Bandwidth scarcity will require the managers of the network to determine the video programming on it.

In a world of information superhighways, however, the most open networks will dominate, and the proprietary networks will wither. Malone’s understanding of this fact — that his own model would soon expire in an environment of bandwidth abundance — motivated his effort to merge with Bell Atlantic.

The law of the telecosm inexorably dictates mergers not between content and conduit, but between conduit and conduit. In particular, today it mandates the merger of the huge fiber resources of the telephone companies — which are nine times as extensive as cable industry fiber and are estimated to rise to 2.7 million lines by next year — with the huge asset of 57 million broadband links to homes commanded by the cable industry. Obstructing such mergers in the name of competition, or antitrust, or regulatory caprice, is wantonly destructive to the future of the economy.

The Siren Call From Foreign Shores

Most of the gains of the telecosm depend on government willingness to allow the creation of coherent broadband networks with no prohibitions against the convergence of cable and telco systems. For a while it appeared that the Clinton administration was willing to accommodate this development. Now it appears that it prefers to lead the U.S. government into a private-sector monster hunt. Rather than releasing America’s cable and telco firms to build this redemptive infrastructure, Washington leaders seem chiefly concerned with assuring themselves that no one will make any money from it. As a result, with some $ 1 billion in annual funding from Wall Street, cable and telephone firms are increasingly moving abroad to fulfill the promise of information superhighways.

TCI and U.S. West, for example, are serving some quarter- million British citizens with combined telephone and cable functions over a hybrid network of coax and fiber. The current regulatory climate dooms the proposed merger of Southwestern Bell and Cox Cable and their plans to launch information highways in Phoenix and Atlanta. But these companies continue to expand their hybrid cable and phone networks In Liverpool and Birmingham in England. In the U.S. NYNEX has been one of the most sluggish Bells in information superhighway projects. But from Gibraltar to Bangkok, it is supplying an array of wireless and wireline services. In the U.K. NYNEX Cablecomm holds 17 cable franchises passing 2.5 million homes and plans some $ 2 billion in future investments. In the wake of the new regulations Bell Canada International (BCI) reduced its offer for Jones Intercable by five percent, but the two companies are barging ahead in East London, Leeds and Aylesbury. Time Warner, Ameritech and other cable and telephone companies are also rushing to less regulated realms to lay information infrastructure everywhere from Scotland to New Zealand.

In the U.S. such collaborations of cable and telephone companies would be paralyzed by litigation and bureaucracy. It appears increasingly possible that despite the huge lead created by the U.S. cable industry, which, unique in the world, has extended broadband access to some 95 percent of American homes, broadband networks will first be built outside the U.S.

American politicians must face reality. With cable, the U.S. is far and away the world leader in broadband technology. With cable, the U.S. can have a national network reaching every American community by the year 2000. Without cable, however, the U.S. can forget the idea of building a national system of information superhighways in this decade. Without cable, the global race is even, and several European and Asian countries command a significant edge as a result of their integrated cable and telephone firms.

The U.S. panacea of “competition” without winners may work for commodity markets, which require low levels of incremental investment and offer returns commensurate with the rate of interest. Governing technological progress, though, is the very different regime of dynamic competition and creative destruction.

Impelling most technology investment is the pursuit of transitory positions of monopoly that may yield massive profits. That’s why in the late 1970s and early 1980s Milken directed some $ 17 billion to the cable TV, fiberoptic telephony and cellular telephone industries, giving the U.S. a decisive lead in all these areas. That’s why Intel Corp. has been investing $ 2 billion a year in new wafer fabrication capacity to secure its global edge in microprocessors. That’s why Microsoft invests $ 1 billion a year or more (depending on definitions) in new software technology to integrate ever-new functions into its dominant operating systems. And that’s why Bell Atlantic contemplated investing what amounted to some $ 33 billion in John Malone’s company, TCI.

Until replaced by a better system, every innovation gives its owner a temporary monopoly. Otherwise it is not a true innovation. Today, whether anyone likes it or not, the cable industry has a temporary monopoly on broadband links to the home. By interconnecting these links to the fiber networks of the phone companies, the two industries together can create a national information superhighway some five or 10 years sooner than can Japan or Europe.

Some 79 percent of the costs of a network come in the final connections to homes: the distribution and drops that the cable industry has installed over the last 25 years. Joined with the telephone industry’s fiber optics — nine times more extensive than the cable industry’s fiber deployment — this hybrid cable-telco network would represent an authentic innovation and would trigger a flood of real competition supplying a huge array of powerful new broadband communications services. According to authoritative estimates cited by Vice-President Gore and the FCC, these innovations would increase U.S. productivity growth by 40 percent over the next decade. This immense undertaking would also yield huge profits for as long as a decade to some of the companies that master it.

The government might regard these profits as “obscene.” But they will be indispensable both to pay for the transformation of American media and to attract the next generation of competitors into the business. These rivals are already on the way: Direct Broadcast Satellite (DBS), wireless cellular “cable” at 28 gigahertz, low-earth-orbiting satellites such as the Gates-McCaw Teledesic, all-fiber “Internets” and the array of passive fiber- to-the-home technology summed up as the fibersphere. Even broadcasters and utilities will enter the field. In a world where the government micromanages communications in the name of “competition,” however, all these capital-hungry competitors will languish.

Dynamic Competition or Static Competitors?

The dynamics of competition on the information superhighway repeats the previous dynamics of competition in computers. Preventing the dominance of successful technologies — sustaining an artificial diversity — is anticompetitive. If in the early 1980s the Department of Justice had ruled against the Microsoft and Intel standards, for example, and had required a variety of microprocessor instruction sets and operating systems, the result would have been less competition in computers, not more. Perhaps Pick, Quarterdeck, Digital Research and others would have gained share against Microsoft. But the applications software business, with its floods of real competition in new programs for everything from financial management to videogames, would have languished, along with the parallel markets in hardware peripherals.

The fact is that Microsoft faces antitrust pressure at the twilight of its dominance. Impelled by the new markets for multimedia and handheld communicators, the industry is on the cusp of an entirely new landscape of competition. In this new arena Microsoft’s present market share and installed base are barriers to entry for Microsoft rather than for its rivals. If Microsoft is to prevail in these new areas, it must cannibalize its own systems and compete on an equal basis with everyone else.

The laws of dynamic competition apply just as forcefully to networks as to computers. Just as the time arrived when text editing and disk utilities would be integrated into operating systems — or floating point computations would be integrated into microprocessors — broadband cable services now must be integrated into the public switched telephone network (PSTN), not segregated from it. Despite the “competitive” access dreams of politicians and regulators, true competition requires that the “two-wire model” of home communications give way to a broadband, one-wire system.

The best and most cost-effective network practicable today is a combination of telco fiber and cable coax. Even the telephone industry agrees. U.S. West, Pacific Telesis and Bellcore all have resolved on the same hybrid system that TCI, Time Warner and Cablelabs have pioneered. Without mergers with cable firms, the telcos in essence will try to rebuild cable networks.

Attempting to duplicate the connections to homes built by the cable industry over the last 25 years, however, the telephone industry would have to spend some $ 200 billion. It would have to sustain this level of new investment while maintaining its existing plant and expanding into long-distance and other services. It would have to summon large incremental capital in the face of continued competition from the cable industry’s taking of many of the most profitable markets.

The telcos currently declare they are willing to make these investments. They tell Washington regulators and politicians that all will be fine as long as they are allowed to own programming and information services and build equipment. But the message from the markets is clear and to the contrary. At the very time that telco executives were intoning their bold plans, telephone and cable share prices were plunging toward new lows. Now Raymond Smith of Bell Atlantic is announcing a half-billion- dollar reduction in infrastructure outlays. Southwestern Bell is giving up its plans to buy Cox Cable. Under a similar “competitive” regime in cellular telephony, even AT&T and McCaw have found their merger in jeopardy.

Under rate-of-return regulations with prohibition of cross- subsidies from current cash flow, a “competitive” information superhighway simply cannot fly. An information superhighway cannot be built under a canopy of federal tariffs, price controls, mandates and allocated markets.

Highway Imperative: Cable-PC

Politicians must recognize that what is at stake is not merely games, entertainment and a few educational frills but the very future of the U.S. economy. Cable is central not only to the next generation of television technology but also to the next generation of computer technology.

Again, many companies offer bold words in business plans for interconnecting homes with new networks. Indeed, the telcos can provide some intriguing computer services through their accelerating rollout of Integrated Services Digital Networks (ISDN), as was so eloquently urged by Mitch Kapor and others. Internet will continue to expand rapidly its cornucopia of mostly narrowband offerings. Bill Gates and Craig McCaw may even enlarge the bandwidth available to homes to a level of 2.4 megabits per second through their elegant and ambitious Teledesic. Direct broadcast satellite systems and public utilities and wireless cable operators will all enrich the flow of video to the nation’s homes.

Except in the short ran, though, these systems are not remotely competitive with cable. Available ISDN, for example, offers less than one-100th the bandwidth of one digital cable channel and less than one-1,000th the bandwidth of a cable coax line. The other rivals to cable, from direct broadcast satellite to Teledesic, are similarly far too little and too late. Even the advanced 28-gigahertz wireless cable projects, for all their promise as supplementary systems, cannot ultimately compete with the potential two-way bandwidth of fiber-coax systems in the ground.

All the current plans of the telephone companies and the government leave the huge U.S. endowment of home computers — the fastest-growing and most promising segment of the computer industry — stranded in a narrowband world. Only the cable industry’s gigahertz links, passing into some 95 percent of American homes, can launch the American personal computer industry into a new level of two-way broadband digital connectivity.

For that reason the future of the American computer industry largely depends on the future of the cable industry. By linking America’s computers to broadband networks and then to telco fiber systems, cable can be the great enabler of the next phase of development in America’s digital economy.

In laying broadband systems the cable industry has already been forced to solve many of the key problems of an information superhighway. Although often depicted as an intrinsically one- way service, cable technology has, in fact, long provided two-way capabilities.

Every cable coax line, for example, offers potential bandwidth equivalent to six times the 160 megahertz of spectrum assigned by the FCC for personal communications services. Cable can accommodate as much as one gigahertz — a billion cycles per second — of communications power. This is some 250,000 times the capacity of a four-kilohertz telephone line to the home. Just one six-megahertz cable channel commands 1,500 times the bandwidth of a telephone line. In every coax connection the first four channels, between five and 30 megahertz, are reserved not for broadcast but for reverse communications to the headend. Widely used to transfer video programming among headends and satellite dishes and other programming sources, these channels alone already represent a potential information highway for home computers 2,500 times faster than a 9,600-baud modem to a phone line.

Even these possibilities, however, underestimate the potential of cable. The coax laid by the cable firms must carry analog video material without interference or distortion. This means cable equipment must track perfectly all the analog waveforms representing the shape and brightness of the image, and must detect tiny differences in the frequencies of FM signals bearing color and sound information. Because any deviation in an analog wave imparts a defect to the picture, cable TV has had to develop extremely low loss technologies. Although most current cable systems function at much lower signal-to-noise ratios, measured logarithmically, a cable TV plant can potentially function at nearly 50 decibels, or at a signal-to-noise power ratio of almost 100,000-to-one.

Necessary to transmit high-quality analog video, between 10,000- and 100,000-to-1 signal-to-noise ratios are vast overkill for the relatively crude on-off codes of digital communications, which can function at 17 decibels or less. Therefore, the one- gigahertz coax lines can carry many more than one bit per hertz. Craig Tanner, vice-president of advanced TV projects at Cablelabs, the industry’s research arm in Louisville, Colo., estimates that by wiggling every wave in readable patterns using a modulation scheme called 256 QAM (quadrature amplitude modulation), cable systems can transmit as many as seven bits per hertz. This means that the one-gigahertz bandwidth of an existing cable line might potentially carry between six and eight gigabits per second, or more than three gigabits per second each way. These potential links to homes are more capacious than the current telephone fiber lines that accommodate tens of thousands of phone calls among telco central offices.

This bandwidth represents the real potential of cable coax. For the next decade much of the cable plant will still be devoted to analog TV broadcasts or to digital renditions of pay-per-view movies. Time Warner’s Orlando project, however, envisions devoting the top 350 megahertz of its system to two-way digital communications, including 100 megahertz for the personal communications services of wireless telephony and 150 megahertz for digital two-way data flows. At a very conservative estimate of two bits per hertz, Time Warner projects a total of 300 megabits per second from these digital channels. At these levels a computer could download a full movie of two-and-a-half hours in about one minute.

Cable’s Real Potential is Not TV

Abandonment of the Malone model by Malone and the rest of the cable industry ultimately requires that cable TV magnates develop a new grasp of the dynamics of the microcosm: the exponential growth of computer power and connections. Accustomed to the role of propagating mass entertainment, cable leaders have long downplayed the potential market in computer communications.

Gradually growing throughout TCI, Time Warner, Continental Cablevision, Jones Intercable and other cable firms, however, is a recognition that the real future of cable is in computers rather than TVs. As David Fellows of Continental declared in launching his pioneering new Internet access system in Boston In late February, “The market for computer communications is huge.”

Indeed, during the next decade the cable companies are going to discover that the computer market for their services is far more important than the television market. The computer industry, hardware and software, is already some 60 percent larger than the television and movie industries put together and is growing six times as fast. On-line networked computer services, such as Prodigy, CompuServe, Delphi and America Online, are collectively growing at a pace of close to 100 percent per year. When on-line services can exchange video and audio files as readily as they transfer text today, these computer networks will be able to outperform any television system. Against all their expectations and plans, cable executives are going to find themselves a central part of the computer networking industry.

As Fellows explains, “Cable and computer network topologies go together perfectly. Both provide shared bandwidth. Ethernet over cable is a natural.” In both networks all the data flow by every terminal. The receiver tunes into the desired channel. For computers, cable offers the dumb bandwidth that is increasingly needed as terminals gain near-supercomputer powers. In the past networks had to be smart in order to provide needed services to the dumb terminals on their periphery, whether phones, computers or TVs. Dumb terminals could tolerate narrowband connections. In the future, however, all terminals will command supercomputer powers.

When terminals are smart, the intelligence in networks flows to the fringes. When terminals are smart, networks must be broad and dumb. There is no way that an intelligent switching fabric can anticipate the constantly evolving technology emerging from a computer industry in a frenzied process of change. There is no way that John Malone’s satellite farm outside Denver will be able to satisfy the demands for programming and communications of 100 million networked teleputers. While the telephone business struggles with the increasing problems of intelligent central switches with some 25 million lines of software code, the cable industry is creating dumb networks in tune with the explosive growth of supersmart machines in every home and office.

The movement of computer networks onto cable need not await the development of advanced broadband systems such as those planned by Time Warner in Orlando. Already several companies are supplying moderns that allow computers to link directly to cable systems.

Zenith provided the first system, HomeWorks, operating at a rate of 500 kilobits per second. It is being used by Cox Cable to deliver Prodigy service in San Diego at a rate 52 times faster than existing 9,600-baud phone modems. Also using HomeWorks is Jones Intercable for Internet services in Alexandria, Va., Continental Cablevision and CompuServe in Exeter, N.H., and TCI for a distance learning test in Provo, Utah.

Zenith is adding a system called ChannelMizer that can offer full Ethernet capability of 10 megabits per second over a 15-mile radius. Intel, General Instrument and Hybrid Technologies have announced an asymmetrical system that runs upstream from the home at 256 kilobits per second and downstream at 10 megabits per second, the Ethernet rate run in most office networks.

Pioneering in the field for several years has been Digital Equipment Corp. under the leadership of James Albrycht. Adapting equipment developed by LANcity, DEC’s ChannelWorks offers the functionality needed for true information highway on-ramps. Extending a two-way Ethernet transparently from the office to the home by a full 70 miles, the ChannelWorks frequency-agile modem allows the use of all 83 cable frequency channels. Cable managers can send digital information over any underused part of the coax bandwidth. Currently deployed chiefly by telecommuting Digital employees, the system is under evaluation by a variety of hospitals, libraries, schools and other institutions favored by Vice-President Gore.

Absolutely crucial to the development of the broadband superhighway, however, is not only the merger of the two networks but also access to the capital of the telephone industry. Creation of high-bandwidth cable connections to homes will be far cheaper than laying new coax. But they still will require expensive upgrades to existing cable plant.

The telcos already invest more money every year — some $ 24 billion — than the total revenues of the cable industry. But even the telcos will not be able to create information superhighways if they also have to duplicate the broadband connections to homes already offered by the cable industry. Similarly, the cable industry alone cannot attract sufficient funds to duplicate the broadband fiber networks already commanded by the telcos, while the telcos move in to skim off the best pay-per-view movie markets. Particularly in an adverse regulatory climate neither industry is capable of building broadband networks. With relatively narrowband networks, the Malone model necessarily thrives. In the name of fighting monsters the administration is in fact pursuing what amounts to a monster-protection policy.

If this policy continues, innovation once more will follow its course toward the least-regulated arenas. Cable and telco firms will install their best technologies overseas. In the U.S. the computer networking industry will build the information superhighways. To Gore’s bitter regret, only business and the wealthy will be able to afford access. Until the early decades of the next century, much of the rest of the nation will be left to the mercies of the Malone model for video entertainment and other cable programming. Interactivity will tend to take the form of games and pay-per-view TV.

Nonetheless, with the increasing movement of activity from big cities, corporate headquarters, hospitals, schools and other centralized institutions to homes and small cities, the demand for broadband computer connections is sure to soar. Most current congressional legislation that imposes mandates on businesses relating to everything from health care reform to parental leave tends to drive work away from corporations to contractual outsources. The market for “interactive TV” is likely to grow far more slowly than the market for computer connections over cable.

Both political parties are far behind the public in comprehending these developments. But the reversal of the earlier forces of conurbation and centralized industry responds to the most profound laws of new technology. It is the most important movement in America today. If the administration continues to strangle new technology with new regulation and red tape, a new coalition of liberals and conservatives alike will rise up against it and grasp the future. Al Gore may eventually wish he had never heard of broadband networks.

George Gilder

Senior Fellow and Co-Founder of Discovery Institute
George Gilder is Chairman of Gilder Publishing LLC, located in Great Barrington, Massachusetts. A co-founder of Discovery Institute, Mr. Gilder is a Senior Fellow of the Center on Wealth & Poverty, and also directs Discovery's Technology and Democracy Project. His latest book, Life After Google: The Fall of Big Data and the Rise of the Blockchain Economy (2018), Gilder waves goodbye to today's Internet.  In a rocketing journey into the very near-future, he argues that Silicon Valley, long dominated by a few giants, faces a “great unbundling,” which will disperse computer power and commerce and transform the economy and the Internet.