Michael Powell and the FCC
Michael Powell's announcement that he is leaving his position as head of the FCC allows me to wax philosophical about something I know fairly little about: telecom policy. I just can't resist.
I worked for a DSL startup a few years ago which has since sunk beneath the waves. There were a huge number of these in 2000. The Telecommunications Act of 1996 was the culprit---it was designed to open up the territory settled by the Baby Bells to outside companies and in so doing created a weird distortion of the marketplace that made lots of lawyers rich and lots of stockholders poorer.
Given that I had the opportunity to ride a dotcom down, I have a unique and limited perspective on the matter others might find useful to some degree.
Basically, here's what happened:
Once the Act passed in 1996, droves of executives at the Baby Bells left to start their own companies, fueled by venture capitalists who thought DSL would be an easy payday. There was good reason for their confidence---broadband looked like the wave of the future, and DSL (digital subscriber lines) seemed to be a proven and stable technology for its delivery.
DSL had some weaknesses. First, upload and download speeds were dependent upon how close you were to the phone company's CO (central office). The further away you were, the slower the connection was. Not an insurmountable problem, and even at slower speeds, you'd still be a lot faster through DSL than through a dialup connection.
The second weakness was where a lot of the cost entered the picture. The Last Mile. In order for DSL to work, a line had to be run from the CO to the home or business where it was to be installed. While one didn't have to buidl out a nationwide network of COs, you essentially had to build a nationwide network one level down from the CO. A study we did found the typical cost to be somewhere around $120 per link to install. That means the DSL startups needed cash---lots of cash---to build out their network.
The third weakness came from the FCC not quite getting how markets work. The Act basically forced Baby Bells to rent space in their CO to their competitors. The Bells were working on their own DSL offerings, yet were compelled by law to treat their competitors as customers. Needless to say, the Bells found ingenious ways not to do a very good job at this. Phone companies have a spotty record of customer service to begin with; imagine what the service was like when they didn't even like you. This made installations tougher and more expensive for DSL startups. This essentially drove up the cost of the link.
The fourth weakness was apparent chiefly from inside the industry. Too many people were chasing the broadband dream. In addition to the glut of DSL companies essentially racing to build out their network first to seize market share, competing technologies swiftly emerged. Not close to a CO, use the Internet during off-peak times, and have a cable line installed---the cable companies had a deal for you. Live off the beaten path but have satellite---DirecTV's in the house. Large company hungry for broadband---T1 lines just got a lot cheaper. So imagine a situation where a large number of DSL companies are chasing an emerging customer base and trying to lock it up. The price pressure on each DSL link was enormous---basically anyone charging more than $19.95 per link per month would be laughed at. At that rate, recovering installation cost alone could take nearly a year.
In addition, the suppliers of DSL-related equipment were having a field day. Cisco and the like were cranking out servers, routers, and other network equipment like nobody's business. As DSL startups often didn't have lots of cash on hand (see the installation cost issue above), Cisco and others operated in some cases as venture capitalists themselves---we'll give you the equipment for a stake in the company. This looked like a good deal to them. Whoever won the DSL race would then be both customer and investment for the network equipment companies, which could make huge money off of them.
Finally, as is often the case when government manipulates markets, the lawyers got involved. What do you do when you're a small DSL and the Baby Bell impedes the network buildout you've promised Wall Street? You sue them, of course. Lawsuit after lawsuit after lawsuit. And the DSL companies won most of them.
It didn't matter, of course.
Lawsuits are expensive. DSL companies didn't have enough cash to sustain their buildout. Once the broadband bubble burst in 2001, the bankruptcies piled up, as did the slightly-used network equipment. Money became a lot harder to come by, and more DSLs defaulted on loans gained during what our erstwhile CEO termed "The Summer of Free Money" in 2000. The whole house of cards collapsed.
There were some pretty heavy casualties. The city of Denver, Colorado, invested heavily in telecom, which was to be the region's savior following the collapse of the oil industry in the 80s. A beautiful Tech Center was built out on the south side of town and expats from Silicon Valley began pouring into it. I visited Denver again last year and most of those buildings were still vacant.
The DSL and telecom companies weren't the only ones to fall. Equipment manufacturers like Cisco and Sun found themselves having to eat their lost investments, settle for pennies on the dollar in bankruptcy claims, and buy their own equipment back to try to prop up their margins when the glut of servers and other network equipment hit.
Related tech sector industries also took a pounding as all that juicy DSL business dried up. The IT bubble of the 90s burst as a result.
And lest anyone think these evils befell only the technologists, bear in mind that my old DSL company's money woes led an energy company to hedge its investment in DSL by creating the first off-balance sheet "partnership" that would later cause so much trouble in the economy. That company was Enron.
In the end, it remains unclear what Michael Powell or the FCC could have done to avoid all this turmoil. I would suggest that what happened in telecom as a result of the Act designed to save it was far more disastrous than what would have happened had the market been allowed to work. By underpricing links and creating lots of nonproductive legal overhead, Congress and the FCC managed to nearly destroy the telecom and technology sectors by meddling where they oughtn't to have meddled.
Let me sum up the problems with the DSL startups with a revealing little anecdote that I think will demonstrate that the root cause of the tech bust didn't have much at all to do with the Baby Bells acting like big, bad monopolists.
There was a meeting with some sales representatives for our DSL company. As was common in the industry, their bonuses were tied to the number of links they sold. The colleague who had researched exactly how much a link cost us (and who sat next to me and relayed the story after the meeting) shared his findings, and basically stated that we couldn't charge $19.95 per link per month when it cost us $29.95 per link per month. One sales guru responded, "Sure, we'll take a bath on the individual link, but we'll make it up in volume."
If you want to nurture an industry, understanding how markets work might be the best place to start.
I worked for a DSL startup a few years ago which has since sunk beneath the waves. There were a huge number of these in 2000. The Telecommunications Act of 1996 was the culprit---it was designed to open up the territory settled by the Baby Bells to outside companies and in so doing created a weird distortion of the marketplace that made lots of lawyers rich and lots of stockholders poorer.
Given that I had the opportunity to ride a dotcom down, I have a unique and limited perspective on the matter others might find useful to some degree.
Basically, here's what happened:
Once the Act passed in 1996, droves of executives at the Baby Bells left to start their own companies, fueled by venture capitalists who thought DSL would be an easy payday. There was good reason for their confidence---broadband looked like the wave of the future, and DSL (digital subscriber lines) seemed to be a proven and stable technology for its delivery.
DSL had some weaknesses. First, upload and download speeds were dependent upon how close you were to the phone company's CO (central office). The further away you were, the slower the connection was. Not an insurmountable problem, and even at slower speeds, you'd still be a lot faster through DSL than through a dialup connection.
The second weakness was where a lot of the cost entered the picture. The Last Mile. In order for DSL to work, a line had to be run from the CO to the home or business where it was to be installed. While one didn't have to buidl out a nationwide network of COs, you essentially had to build a nationwide network one level down from the CO. A study we did found the typical cost to be somewhere around $120 per link to install. That means the DSL startups needed cash---lots of cash---to build out their network.
The third weakness came from the FCC not quite getting how markets work. The Act basically forced Baby Bells to rent space in their CO to their competitors. The Bells were working on their own DSL offerings, yet were compelled by law to treat their competitors as customers. Needless to say, the Bells found ingenious ways not to do a very good job at this. Phone companies have a spotty record of customer service to begin with; imagine what the service was like when they didn't even like you. This made installations tougher and more expensive for DSL startups. This essentially drove up the cost of the link.
The fourth weakness was apparent chiefly from inside the industry. Too many people were chasing the broadband dream. In addition to the glut of DSL companies essentially racing to build out their network first to seize market share, competing technologies swiftly emerged. Not close to a CO, use the Internet during off-peak times, and have a cable line installed---the cable companies had a deal for you. Live off the beaten path but have satellite---DirecTV's in the house. Large company hungry for broadband---T1 lines just got a lot cheaper. So imagine a situation where a large number of DSL companies are chasing an emerging customer base and trying to lock it up. The price pressure on each DSL link was enormous---basically anyone charging more than $19.95 per link per month would be laughed at. At that rate, recovering installation cost alone could take nearly a year.
In addition, the suppliers of DSL-related equipment were having a field day. Cisco and the like were cranking out servers, routers, and other network equipment like nobody's business. As DSL startups often didn't have lots of cash on hand (see the installation cost issue above), Cisco and others operated in some cases as venture capitalists themselves---we'll give you the equipment for a stake in the company. This looked like a good deal to them. Whoever won the DSL race would then be both customer and investment for the network equipment companies, which could make huge money off of them.
Finally, as is often the case when government manipulates markets, the lawyers got involved. What do you do when you're a small DSL and the Baby Bell impedes the network buildout you've promised Wall Street? You sue them, of course. Lawsuit after lawsuit after lawsuit. And the DSL companies won most of them.
It didn't matter, of course.
Lawsuits are expensive. DSL companies didn't have enough cash to sustain their buildout. Once the broadband bubble burst in 2001, the bankruptcies piled up, as did the slightly-used network equipment. Money became a lot harder to come by, and more DSLs defaulted on loans gained during what our erstwhile CEO termed "The Summer of Free Money" in 2000. The whole house of cards collapsed.
There were some pretty heavy casualties. The city of Denver, Colorado, invested heavily in telecom, which was to be the region's savior following the collapse of the oil industry in the 80s. A beautiful Tech Center was built out on the south side of town and expats from Silicon Valley began pouring into it. I visited Denver again last year and most of those buildings were still vacant.
The DSL and telecom companies weren't the only ones to fall. Equipment manufacturers like Cisco and Sun found themselves having to eat their lost investments, settle for pennies on the dollar in bankruptcy claims, and buy their own equipment back to try to prop up their margins when the glut of servers and other network equipment hit.
Related tech sector industries also took a pounding as all that juicy DSL business dried up. The IT bubble of the 90s burst as a result.
And lest anyone think these evils befell only the technologists, bear in mind that my old DSL company's money woes led an energy company to hedge its investment in DSL by creating the first off-balance sheet "partnership" that would later cause so much trouble in the economy. That company was Enron.
In the end, it remains unclear what Michael Powell or the FCC could have done to avoid all this turmoil. I would suggest that what happened in telecom as a result of the Act designed to save it was far more disastrous than what would have happened had the market been allowed to work. By underpricing links and creating lots of nonproductive legal overhead, Congress and the FCC managed to nearly destroy the telecom and technology sectors by meddling where they oughtn't to have meddled.
Let me sum up the problems with the DSL startups with a revealing little anecdote that I think will demonstrate that the root cause of the tech bust didn't have much at all to do with the Baby Bells acting like big, bad monopolists.
There was a meeting with some sales representatives for our DSL company. As was common in the industry, their bonuses were tied to the number of links they sold. The colleague who had researched exactly how much a link cost us (and who sat next to me and relayed the story after the meeting) shared his findings, and basically stated that we couldn't charge $19.95 per link per month when it cost us $29.95 per link per month. One sales guru responded, "Sure, we'll take a bath on the individual link, but we'll make it up in volume."
If you want to nurture an industry, understanding how markets work might be the best place to start.
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