The End of the Line, But Which Line?

By Fred Goldstein December 19, 2012

December 21, 2012 marks the end the 13th baktun of the Maya calendar, a curiosity that has sometimes been misinterpreted as portending the end of the world. Apocalyptic forecasts are nothing new. Not long ago, preacher Harold Camping worked his followers up to a frenzy about his own forecasts. But instead, Camping’s own Family Radio broadcast network ended up liquidating many of its holdings. And so it fits the American character to predict that the end is near for familiar aspects of telecommunications.

Probably the most common apocalyptic claim is that the Public Switched Telephone Network (PSTN) itself is near its end. We have the incumbent local exchange carriers, led by AT&T, petitioning the FCC to end pretty much all regulation of the telephone network, on grounds that the PSTN is obsolete as it will be replaced by all-IP “broadband.” And somehow rules about consumer protection, cooperating with competitors, and providing universal service to unprofitable rural areas (an obligation called “carrier of last resort” and already waived in several states) are obsolete. Why? Because instead of using time slots to identify which telephone call is which on a shared transmission medium (TDM), we will instead use packet headers (IP).   Doesn’t that make a lot of sense? This is sometimes called the Magic Pixie Dust theory of regulation, where the presence of IP blinds regulators and consumers alike and makes them instantly foolish. The FCC’s own Technical Advisory Council, with close ties to the incumbents, is helping the Commission advance this foolish agenda.

Of course the transition from TDM to IP is just another technical tweak in a long succession of tweaks. Telephone switching mostly went from analog to digital between 1980 and 1995.  Digital fiber optic transmission replaced an analog carrier systems beginning even sooner. Computer-controlled switching replaced relay-controlled logic beginning in 1965. Direct distance dialing replaced most operator-handled long distance calling between 1950 and 1965, and dial replaced most operator-handled local calling in the first half of the 20th century. Each of these stages was evolutionary, and while they eventually impacted rates and rules, the fundamental PSTN regulatory framework stayed intact.

IP should be treated the same way, especially given the fact that it is singularly unsuited to voice communications. It is nonetheless the new fashion, and supported by all of the new equipment, and it is already supporting a large share of traffic. But that isn’t the magic. Rather, IP also just happens to be the multiplexing header also used on that packet-switching prototype we call the Internet. And the Internet is definitely not just the telephone network, packetized. It is not even telecommunications; internetworking takes place as the content of telecommunications, a higher layer. That’s why the public Internet could happen in the first place! The telephone companies certainly didn’t like it and didn’t welcome it, but they had no choice; carriers didn’t own the content that their customers sent over their networks.

But confusing content with carriage is a very popular activity, especially among the big vertically-integrated service providers. This almost came back to bite them at the recent International Telecommunications Union conference in Dubai, where a group of mostly (shall we say) less democratic countries voted to regulate the Internet, and its content, even more rigidly than telephone calls. The United States and most industrialized democratic countries simply walked out, rendering the century-and-a-half-old ITU largely irrelevant. But this outcome might have been avoidable if people understood that IP was simply a multi-purpose tool that does not define the services that use it.

Here in the United States, then, we have confusion between the largely-unregulated Internet and the still-more-regulated PSTN when the latter adopts the former’s multiplexing header (IP). This is a flagrant mistake. For one thing, the Internet doesn’t carry much telephone traffic – “over the top” (or parasitic) Internet VoIP providers such as Vonage represent a tiny fraction of total VoIP traffic or telephone traffic in general. Most VoIP, be it PacketCable or enterprise IP Centrex, is “managed”, kept separate from the Internet’s insecure, chaotic traffic flow. Another protocol below the IP layer, such as Carrier Ethernet or MPLS, does much of the heavy lifting. No wonder the FCC can’t decide if VoIP is “information service” (content) or “telecommunications service” (carriage). It can be used in both types of activity.

Maybe it’s just the end of the line for POTS?

Plain Old Telephone Service, or POTS, is the name usually given to standalone analog telephone lines. It is used by business and residential customers alike. There’s no firm definition of what POTS is and what isn’t, but the old way of delivering telephone service is clearly in decline. The Bells have lost a substantial share of lines to cable, and many people, perhaps even a majority of the under-30 crowd, have abandoned POTS entirely in favor of just using cellular phones. While the Bells succeeded in killing off Basic Rate ISDN, meant to be the 1990s’ all-digital replacement for POTS, they haven’t really got much new up their own sleeves, unless perhaps they can leverage the VoIP evolution for regulatory purposes. AT&T and Verizon have focused their efforts on wireless. CenturyLink has focused on bulking up by acquiring distressed wireline properties, hoping that they’ll somehow pay off.

It is quite reasonable to suggest that old-fashioned POTS is going to fade out. Verizon has essentially written it off, as it tries to migrate its subscribers to FiOS where that’s available, and to wireless elsewhere. They even have a non-aggression pact with the cable industry to essentially abandon wireline to the cable companies in areas where they still depend on old copper. They just don’t see it as worth investing in any more. (Why support even a duopoly when you can divvy up markets for a true monopoly?)

But POTS as we know it can be upgraded transparently, even to a managed VoIP-based service, without throwing the PSTN baby out with the copper-colored bathwater. It may even be practical to replace the PSTN’s core Signaling System 7 network with SIP over IP. Maybe – SIP was not designed for this and it is not that well defined. But there are serious efforts under way to manage that migration. So perhaps POTS will fade away. We can still have telephone service, as well as wireless, Internet and other means of communications. It’s hardly apocalyptic.

But maybe something else is.

Too many next quarters are catching up with the Bells

American businesses often seek to maximize their quarterly returns to the detriment of the long term. Investors discount the future, so managers follow their lead. Thus many companies that were powerful in past decades have gone belly-up, been acquired, or just faded away.

One class of companies that has usually been exempt from that is the utilities. These companies provide a vital service and are allowed to charge regulated rates to let them earn fixed rates of return. Electric and gas delivery (though usually not generation) utilities still, for the most part, work that way. And for most of their lifespans, telephone companies were regulated as utilities. 

Until the early 1990s, the Bells were under rate-of-return utility regulation. This meant that their profits were set as a percentage return on their rate base, which was the value of their undercoated capital plant. Individual rates had no specific connection with cost – they were rife with cross-subsidies – but the total profit was fixed. The companies, then, had a positive incentive to invest, as more investment meant a bigger rate base, higher rates, and thus more profits. It was up to regulators to prevent them from padding the rate base. And in every state that was the norm.

But that’s when a new fad took over. The FCC allowed the companies’ interstate share of investment to be moved off of rate of return and on to price caps. This system set their prices for all services at current (usually based as of 1992) levels, adjusted upwards for inflation and downwards by an “x-factor” representing assumed productivity gains. If they could lower their costs, they could make more profit. Most states followed suit and adopted similar “alternative form of regulation” (AFOR) plans to cover their intrastate rates.  In most cases, basic local telephone rates were capped, though prices for many other services were deregulated. (Rate of return regulation remains in place for small rural telephone companies that depend on subsidies from the Federal Universal Service Fund. They have continued to gold-plate their networks, but that’s a different story.)

The results were predictable. The Bells laid off huge numbers of workers. They cut back investment, choosing instead to milk the existing plant as much as possible. Modernization plans largely froze, except as required to continue to provide basic service. When the Internet boom came, demand for second lines for dial-up users forced some new investment. A little bit was also spent rolling out DSL, although, being newer than the price caps, it was always at unregulated rates. When the boom ended in 2001, investment fell off the cliff. Other than wireless, most “investment” was in buying up each other, as Bell Atlantic morphed into Verizon and Southwestern Bell became the faux “AT&T”.

Since then, the Bells have put next to nothing into their regulated wireline networks, which are often over 80% depreciated. Sure, Verizon spent some billions on FiOS, but that was a fraction of the money they were originally going to spend on fiber to the home. Indeed their AFOR plans were actually predicated on promises of wiring their territories for fiber. Not for closed FiOS, either, but regulated common carrier fiber, open to competitive video, voice and data services. That was never built. AT&T’s U-Verse is a late-life kicker for the ancient copper plant, putting DSLAMs closer to subscribers in order to bump the speed up to something capable of carrying switched digital video. But it’s chump change compared to the extra profits, above and beyond what rate of return would have allowed, that they all made from AFOR. The original title of Bruce Kushnick’s book, The $200 Billion Broadband Scandal, is now out of date – it’s now up to $340 billion.

But while AFOR led to higher quarterly profits in the short term, the lack of investment is now catching up with them. The switching systems that deliver telephone service are mostly over 20 years old, ancient for computerized gear. Several racks consuming many kilowatts of power are required for this old gear to do what fits today into a small server enclosure that only needs a few hundred watts. 

The copper plant is largely 50+ years old; some is still buried in century-old wooden conduits or hung on rotting poles. Pulling fiber through deteriorated conduit is extremely difficult; that may be why Verizon avoided putting FiOS in some older cities. Given the limited maintenance performed in the past 20 years, the network is deteriorating rapidly. No wonder Verizon is willing to surrender wireline to cable – after two decades of minimal maintenance, it’s just too far gone.

That’s why it may really be the end of the line for the Bells. The lack of investment since price caps replaced rate of return may finally be catching up with them. Technical transitions like VoIP are relatively minor. They’re a distraction, basically business as usual. But when the physical plant is in decay, customers are leaving, and the only answer they can come up with is even more deregulation, they’re facing real trouble. 

Not that their public financial disclosures make any of this obvious, or that the end has arrive yet. AT&T and Verizon are still making money on “wireline” overall, while just their regulated state subsidiaries claim to be losing money. Some of this is accounting sleight of hand, as expenses may stay in the state subsidiary while revenues go to unregulated ones. FiOS revenues, for instance, are largely kept off of the state books. This lack of transparency makes rational regulation even more difficult.

This would be a smaller issue if there were more alternatives. But “facilities-based competition” for wireline service was never really possible outside of a few core business districts; the economics are just too dismal. The Bells and the cable companies are really the only ones who have any chance of reaching the vast majority of homes and workplaces with any kind of reasonable broadband service. Wireless is great for rural areas and mobility but it has very limited capacity, and cell sites themselves usually depend on some kind of wireline connection (nowadays usually fiber optic). The Bells were, after all, utilities –businesses vital to the economy. They just don’t want to be any more.

Deregulating them to become profit-maximizers has backfired. Something will need to be done. The last decade’s telecom policy in the United States has failed. Wireline competition has degenerated into a cozy duopoly, and that is now at risk of becoming a true monopoly once again, only this time minus the regulation. The last thing we need is more deregulation, more magic pixie dust, more short-term thinking. Policy needs to set the incentives straight, allow competition where possible, regulate what’s not competitive, and get investment going where it’s needed. It should be the end of the line for antiquated networks and failed policies, not for good service at reasonable rates.

Edited by Brooke Neuman

ionary Consulting

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