The Effects of Network-Sharing Regulation in Telecommunications in the EU and

the United States

Robert W. CrandallThe Brookings Institution

PFF/CEPS ConferenceBrussels

February 22, 2007

U.S. 1996 Telecom Act Ushered in New Era of Wholesale “Unbundling” Regulation

• Required FCC to establish a regime of incumbent local phone- company network unbundling. States established the wholesale prices based on FCC guidance on the appropriate measure of cost

• U.S. unbundling regime was followed by Canada in 1997 and the EU in 1998-2001

• In most countries, unbundling was confined to the local loop, the wire from the switching center to the subscriber’s premises

• But the U.S. soon extended the policy to line sharing, allowing entrants to lease only the upper frequencies at very low rates. ( The U.S. Court of Appeals overturned line sharing in 2002). The EU followed in 2001-02

• Only the U.S. required “unbundling” of the entire network platform, thereby allowing entrants to resell incumbent services with a regulatory arbitrage margin of 50-60%. (Reversed by Court of Appeals in 2004).

The U.S. Experience with Unbundling Has Been Disastrous

• Entrants began by offering traditional voice services at about a 15 percent discount to the mass market.

• Entrants offered virtually no innovation and no output expansion in the mass market. (Everyone already had a phone, and long distance rates were being driven down by cellular services) Entry simply added marketing costs. Most entrants failed.

• The only market in which some net economic benefits may have been produced was the business market, but even the most generous estimate of this benefit is $0.8 billion/year

• Unbundling transferred wealth from incumbents to consumers and telemarketers

• Entrants reported total capital expenditures of about $60 billion; $50 billion of which likely went to traditional voice/data service competition and was largely wasted

The Focus of Telecom Unbundling Regulation Is Now on Broadband

• Most OECD countries require unbundling/line-sharing for broadband entrants. U.S. abandoned line-sharing; Canada never mandated it

• The contribution to economic welfare of unbundling/line-sharing in broadband markets depends on:

– Creation of consumer value through more rapid adoption of broadband and innovative new services

– The incremental cost of providing broadband through mandated network sharing

– The effect of the network sharing regulations on investment and innovation in the underlying networks, including the incumbents’ networks and the new entrants’ facilities

The Most Recent OECD Broadband Data Demonstrate the Importance of Cable-Modem Competition

0

5

10

15

20

25

30

Denm

ark

Nether

lands

Icel

and

Korea

Switz

erla

nd

Finla

nd

Norway

Swed

en

Canad

a

United

Kingdom

Belgiu

m

United

State

s

Japan

Luxem

bourg

Austria

France

Austra

lia

Ger

man

y

Spain

Italy

Portugal

New Z

ealan

d

Source: OECD

DSL Cable Other

OECD Broadband subscribers per 100 inhabitants, by technology, June 2006

OECD average

The Effect of Unbundling on Broadband Penetration

• Several studies, using U.S. state data or international country data, find little effect of regulated network unbundling on subscriber penetration.

• Most find that platform competition from cable television systems contributes significantly to subscriber penetration.

• No one has found that network unbundling provides entrants with a “stepping stone” from which they will build their own platforms.

• Results are based on very early experience with this policy. Exceptions may be Yahoo! BB in Japan and Iliad in France.

Capital Expenditures in Telecom Were Obviously Affected by World- Wide Stock Market Bubble

Incumbent Telephone Company Stock Prices v. S&P 500

0

50

100

150

200

250

300

350

400

450

Sept.0

6

Apr.06

Nov.05

June.

05

Jan.0

5

Aug.04

Mar

.04

Oct

.03

May

.03

Dec.0

2

Jul.0

2

Feb.0

2

Sept.0

1

Apr.01

Nov.00

Jun.0

0

Jan.0

0

Aug.99

Mar

.99

Oct

.98

May

.98

Dec.9

7

De

c. 1

99

7 =

10

0

EU USNTT S&P 500

But Some Bubbles in the U.S. Were Much Worse Than Others

U.S. Telecom Company Stock Prices,1996-2004

0

100

200

300

400

500

600

700

800

900

1000

July

.05

Feb

.05

Sep

t.0

Ap

r.04

No

v.03

Jun

.03

Jan

.03

Au

g.0

2

Mar

.02

Oct

.01

May

.01

Dec

.00

Jul.0

0

Feb

.00

Sep

t.9

Ap

r.99

No

v.98

Jun

.98

Jan

.98

Au

g.9

7

Mar

.97

Oct

.96

May

.96

Feb

.96=

100

CLECs

Long Distance Cos.

Bell Companies

U.S. Local Incumbent Carriers Have Been Investing More in Their Networks than Have the EU Carriers

Capital Expenditures/Line:U.S. v. EU Local Exchange Carriers' Fixed-Wire Networks

0.000

0.050

0.100

0.150

0.200

0.250

0.300

0.350

1998 1999 2000 2001 2002 2003 2004 2005

$000

(P

PP

)

EU-15 U.S.

Sources: Company financial reports

U.S. Local Incumbent Carriers Have Been Investing More in Their Networks than Have the EU Carriers (II)

Capital Expenditures/Revenues:U.S. v. EU Local Exchange Carriers' Fixed-Wire Networks

0.000

0.050

0.100

0.150

0.200

0.250

0.300

0.350

1998 1999 2000 2001 2002 2003 2004 2005

EU-15 U.S.

Sources: Company financial reports

The U.S.- EU Difference Is Even Greater When Cable Television Is Included

Capital Expenditures by Fixed-Wire Telecom, Wireless, and Cable TV Companies: U.S. v. EU-15

0

20,000

40,000

60,000

80,000

100,000

120,000

140,000

2001 2002 2003 2004

Mill

ion

$ (

PP

P)

EU-15 U.S.

Sources: U.S. Census Bureau; London Econ

The U.S.- EU Difference for All Fixed Wire Carriers (Including CLECs and Long Distance Companies)

Capital Expenditures by Fixed-Wire Telecom Companies: U.S. v. EU-15

0

10,000

20,000

30,000

40,000

50,000

60,000

70,000

80,000

2001 2002 2003 2004

Mill

ion

$ (

PP

P)

EU-15 U.S.

Sources: U.S. Census Bureau; London Econ

(1) (2)

Austria-0.229* -0.361*

Belgium -0.198* -0.282*

Denmark -1.344* -0.359*

France -0.852* -0.782*

Germany 0.159 -0.069

Italy -0.191* -0.136

Netherlands -0.522* -0.513*

Spain -0.189 -0.260*

Sweden -1.321* -0.437*

United Kingdom 0.120 0.111

Norway -0.995 Na

Australia -0.135 Na

NZ -0.612* -0.530*

Japan -2.225 0.731*

Regression Analysis of Incumbents’ Capital Expenditures, 2000-05Country Fixed Effects Relative to North America

*- Statistically significant at 95% confidence level(1)- Without regulatory variables (2) – With regulatory variables

Regression Analysis of Incumbents’ Capital Expenditures, 2000-05 – Regulatory Variables

• Variables reflecting existence of unbundling, line sharing, or U.S. UNE-P have limited statistical significance in regression equation

• Variable reflecting the degree of DSL competition induced by all types of regulation, including bitstream access and resale, has statistically-insignificant negative coefficients

• Variable reflecting DSL share due to unbundling has statistically significant negative coefficient

• Conclusion: network sharing regulations tend to be associated with reduced incumbent capital expenditures

Conclusion: Evidence on Effect of Mandated Network-Sharing Regulations Is Not Encouraging

• No evidence that network-sharing accelerates broadband penetration

• Preliminary evidence suggests that such regulation reduces network investment

• Network-sharing mandates will create disputes over network architecture – who decides on the technology to be deployed?

• Once regulators begin these mandates, they are induced to extend greater and greater support to failing entrants who cannot build their own facilities