Tuesday, May 30, 2006

Net Neutrality and the Value-Chain

A concept that seems to be hard for the carrier execs and Richard Bennett to grok is that of commoditization. Throughout history, lower-value functions have become commoditized. Those organizations that can successfully move up the value-chain survive. Those that can't... don't.

Billions in Lost Opportunities

The giant railroad companies didn't realize they were in the transportation business - not the railroad business. They subsequently ignored the nascent airline industry altogether.

Likewise, the telcos never figured out that they were in the communications business. They weren't in the phone business -- they never were. They provided infrastructure to allow people to communicate with other people. That's it. Moving bits around. Even when their network was pure PSTN, that was their business. They just hadn't realized it: AT&T thought of itself as "the phone company". They weren't. They were in the business of transporting bits from one device to another in the form of a switched, analog phone call.

Because they didn't realize that their business was really moving information around for customers, they ignored -- and, for the most part, continue to ignore -- the real value-creation opportunities represented by the Internet.

Consider all of the billion-dollar business opportunities that the telcos ignored. The opportunities jumped up, waved their arms, shot off signal flares, did everything but bite them on the butt. Ask yourself: did the telcos meaningfully innovate and/or partner in any of the following areas to the tune of billions of dollars?

Domain registrars like Network Solutions? Nope. Certificate authorities like Verisign? Nope. Search engines like Yahoo or Google? No. E-commerce solutions like PayPal? No. Online auctions like eBay? Nada. VoIP offerings like Vonage? No. Open-source communications projects such as Open H323? No. Video distribution tools like BitTorrent? No. Telephony solutions like Skype? No. Online retail? No.

The carriers studiously ignored the multitude of value-creation opportunities that were popping out of the ground like moles in a slow-motion whack-a-mole game.

The Telco's Alternative Strategy

Instead, the telcos seemed to expend energy on lobbying Congress, suppressing last-mile competitors such as municipal wireless, and building out plumbing: the layers 1-3 infrastructure that makes up the backbones and last-mile loops of U.S. communications infrastructure.

Their plan was to gain control of all last-mile infrastructure. And, once that was accomplished, to erect tollbooths on the Internet to extract every drop of revenue from the application providers that had built fortunes on their networks.

Remember H.R. 2726, the "Preserving Innovation in Telecom Act of 2005," introduced by Rep. Pete Sessions (R-TX)? If enacted, the bill would have prohibited any municipal government from offering a telecom facility "in any geographic area" that might intersect with a telco's footprint.

How about H.B. 699, a cable franchise bill that "takes local control... [from municipalities] and transfers it to the state level because it would be more convenient (that is, more profitable) to a single large corporation if local governments could be neutered." Easier to lobby a single state government than thousands of cities and towns, I suppose.

The list goes on. In short, the telcos spent (and continue to spend) a lot of time, energy, and money on inhibiting last-mile competition.

Even the network buildout was questionable. Some sources assert that the telcos gamed taxpayers and never built the high-speed networks they had promised. Of Bruce Kushnick's book, "The $200 Billion Broadband Scandal," attorney Harold Feld wrote:

...[it] meticulously documents how the incumbent telcos have used the promise of broadband to win subsidies and regulatory goodies. The pattern Bruce describes is a fairly straightforward one. Bell companies go to [name state] legislature and promise to provide fiber networks (which will bring high-speed internet access, video services, jobs, education etc. to [name state]. All the telco asks in exchange is deregulation of prices, deregulation of competitive obligations (such as opening the network to rivals), and subsidies or tax incentives to reach the areas where it is not profitable to deploy. Then take the goodies, make some high profile efforts to deploy, then quietly forget about it while enjoying deregulated monopoly and tax subsidies. Don't worry, state legislators and the public will forget about it as well, and will accept the current state of the universe as the best possible world that can be achieved.

While apparently lifted from today's headlines, Kushnick traces this kind of behavior back to the early 1990s. His book asserts that this behavior has cost the U.S. tax payers over $200 Billion, at a minimum over the last ten years. Lest one ask “how could the Bells ever get away with such a thing?!?!” I will observe that what Kushnick documents are no secrets. Rather, like the purlioned letter, each broken promise, terminated project, absorbed tax incentive, and regulatory bonus happened in plain sight...

In short, the telco strategy appears to have been suppression of last-mile alternatives, strengthening lobbying ties to appropriate governmental officials, and investing in low-value-added (and very, very high profit-margin) plumbing.

Last-mile plumbing

As it stands today, last-mile infrastructure is a natural monopoly. How many water lines would you want running into your house? Sewer lines? Power lines? Network fiber lines? In fact, it makes little economic sense to build more than one high-speed fiber loop in a given geographic area.

Think about the germination of the power or water utilities. They were heavily regulated because, in fact, they were natural monopolies.

Susan Crawford believes that the carriers must be forced to unbundle their last-mile infrastructure:

The only standard that will keep the architecture of the internet optimized on innovation (instead of billing) is to ensure that all broadband pipe providers (cable as well as telco) are required to unbundle their facilities so as to promote competition...

While this will almost certainly result in a litigious, regulatory morass -- consider the nightmarish stream of local- and long-distance cases ignited by the Telecommunications Act of 1996 -- it is a far preferable scenario than the alternative.

Of the seven Baby Bells formed after the breakup of Ma Bell in 1984, only four remain. The old AT&T, Southwestern Bell, Ameritech, SNET, Pacific Bell, and BellSouth are now collectively “AT&T.” Similarly, GTE, Nynex, Bell Atlantic, and MCI have joined together to form Verizon. Two Baby Bells, the new AT&T and Verizon, control telco access around the country. The vast majority of Americans have at most two choices of broadband provider wherever they are, and competition between these providers is not intense. Prices have stayed high and speeds have stayed low. In effect, the industry is re-monopolizing.

If the carriers' track record is any indication, re-monopolization bodes poorly for the Internet.

Moving up the value chain

In the auto industry, imagine if GM hadn't decided to manufacture and integrate radios, air-conditioners, small motors for power-windows, and the like. In other words, the "applications" that make automotive infrastructure more usable. Had they ignored those innovations, they'd have been swept into the dustbin of history decades ago.

In the software industry, plumbing layers invariably became commoditized. The Trumpet TCP/IP Stack used to be an add-on to early versions of Windows. Microsoft began incorporating its own TCP/IP stack (OSI layers 3 and 4) and Trumpet was no more.

In recent years, open-source software (OSS) commoditized lower levels of the software stack. If you're a web-hosting provider, you can choose to license Microsoft operating systems as your defult offering or you can use Linux, Apache, MySQL, and PHP (otherwise known as the LAMP stack) for free. Most hosting providers use LAMP as a default stack.

EAI products, application servers, email clients, browsers, security software, and many other types of offerings represent lower layers on a value stack. The lower layers invariably become commoditized. Vendors must relentlessly move up the stack. Or they die.

Microsoft recognizes this. They've branched out from the core OS and language business in a major way: they acquired Great Plains Software in order to move up the software stack. They branched out into gaming, telephony, cable distribution, and other areas.

In order to compete, successful businesses must find ways to move up the value chain to differentiate themselves and to find profitable niches.

For whatever reason, the carriers haven't bothered to play at higher levels of the network stack: layers 5-7. They haven't moved up the value-chain. Instead, they remain in their comfort-zone, primarily layers 1 through 3. In order to bring more money in, they've proposed killing off network neutrality and -- essentially -- erecting tollbooths all over the Internet. The tollbooths are ostensibly there for video and other streaming, "real-time" content. But, in effect, if you listen to AT&T chieftan Ed Whitacre, anyone might have to pony up to get prioritized treatment. Search engines, auction sites, booksellers, you name it.

Given the telcos' history of lobbying, suppression of competition, and questionable build-out of fiber infrastructure, the risks of "trusting them on this one" are far too high.

America's technological leadership position (and, by extension, its national security) hang in the balance. The value-creation machine that has been the net-neutral, democratic Internet also sits on a precipice. Go to Save the Internet today. And take action.

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