Misguided regulatory policy is “among the most important inhibitors of capital investment in telecommunications,” conclude Debra J. Aron and Robert W. Crandall in a recent paper.
The authors observe that
Business firms do not make investments for altruistic reasons but rather make investments in order to earn a return on the invested capital. For any company to make any investment, it must determine, and convince the capital market, that the investment is reasonably likely to produce a positive return in net present value (NPV) terms sufficient to compensate for the risk incurred. When companies seek funding to execute a project, they compete for those funds with all other potential projects in the economy, not just with other investment opportunities available to the company itself and not just with investment opportunities in the same industry or geographic area.
Regulators cannot set optmal prices — as a practical matter — only prices which either are too high or too low. Prices which are too low discourage investment.
The risk that regulatory prices would not be compensatory is magnified by the fact that any investment in new fixed-wire networks is largely sunk. That is, the company making the investment cannot remove the assets and deploy them in alternative pursuits if they prove to be non-remunerative in the telecom sector. Thus, a decision to invest today in a given technology is irrevocable and potentially very costly. In contrast, if a competitor were to be granted access to these assets, once they are in place, at regulated rates, the competitor’s decision would not be irrevocable. If it is allowed to lease these facilities on a short-term basis, it could simply walk away if a new technology were to appear. For this reason, economists refer to the competitor as having a “real option” which should be priced into the regulated rate. Alternatively, the competitor could be required to share the incumbent’s investment risk by leasing the asset for its entire life. In this way, if the competitor remained solvent, it would be faced with its proportionate share of the risk of early obsolescence. (footnotes omitted.)
But that is not what regulators do. Regulators require incumbents to share the rewards of successful investments, not the losses arising from investment failures. The competitor gets to walk away while the incumbent is forced to write off huge amounts of fixed investment.
Next, the authors confirm that Wall Street is skeptical of Verizon’s and AT&T’s massive broadband investments.
A recent report by Bernstein Research, for example, concludes that “Even with aggressive assumptions about incremental adoption and retention, we believe the FiOS [Verizon’s fiber-to-the-home initiative] project, in aggregate, falls well short of earning its cost of capital.” An earlier report by industry analysts Pike & Fisher was also pessimistic, stating that its “report suggests Verizon is spending so much on FiOS that it could take a decade or more for the company to pay back its investment should it fall considerably short of its market-penetration goals.” In contrast, Stifel Nicolaus analysts Christopher King and Billie Warrick were fairly optimistic about Verizon’s FiOS product, predicting that “Verizon will still be able to offer a superior product to cable (and AT&T) due to its FTTH [fiber-to-the-home] architecture, and will still be able to generate a positive ROI [return on investment], given its superior product offering to its cable competitors, in our view.” (footnotes omitted.)
The authors caution that regulation harms some consumers more than others.
The effects of the depressed investment incentives would be most immediately and directly felt in areas where the economics of investment are at the edge of profitability even without unbundling burdens. This is likely to be in already disadvantaged geographic areas. Hence, consumers in the least attractive areas for investment in advanced broadband networks would be the ones who would likely be disproportionately deprived of the new investment.
The authors point out that
The vigor and speed with which ILECs make investments in
broadband infrastructure will affect the vigor and speed with which cable and wireless broadband companies will continue to invest in response, and the ferocity of intermodal competition.
Finally, we are reminded that that the Federal Communication’s Commission policy of deregulating broadband investment by incumbent telephone companies has in fact unleashed a virtuous cycle of multi-billion dollar investment by the phone companies and their competitors in the cable industry.
In this deregulatory environment, broadband subscriptions in the U.S. have soared, more than trebling in the three years ended June 2007. Clearly, the FCC’s forbearance policy has borne substantial fruit for U.S. citizens.
Verizon and AT&T are not alone among communications companies in the U.S. in substantially increasing their investments since the TRO decision. Consistent with the mutually-reinforcing dynamic of responsive competitive investments we discussed earlier, cable companies have made massive investments in their broadband infrastructures as well. While the combined annual capital expenditures of AT&T and Verizon have increased from $17.1 to $24.6 billion since 2004, the aggregate annual capital expenditures of the three largest publicly held cable providers, Comcast, Cablevision, and Time Warner Cable, have nearly doubled, from $5.6 billion to $10.1 billion. (footnotes omitted.)
The paper is entitled “Investment in Next Generation Networks and Wholesale Telecommunications Regulation.”