U.S. telecommunications today

Business Economics, April, 1998 by Nicholas Economides

PRESENTLY, the U.S. telecommunications industry is going through a revolutionary change. There are three reasons for this.

The first reason is the rapid technological change in key inputs of telecommunications services and in complementary goods, which have reduced dramatically the costs of traditional services and have made many new services available at reasonable prices. Cost reductions have made feasible the world wide web (WWW) and the various multimedia applications that "live" on it.

The second reason for the revolutionary change has been the sweeping digitization of the telecommunications and the related sectors. The underlying telecommunications technology has become digital. Moreover, the consumer and business telecommunications interfaces have become more versatile and closer to multifunction computers than to traditional telephones. Digitization and integration of telecommunications services with computers create significant business opportunities and impose significant pressure on traditional pricing structures, especially in voice telephony.

The third reason for the current upheaval in the telecommunications sector was the passage of a major new law to govern telecommunications in the United States, the Telecommunications Act of 1996 (1996 Act). Telecommunications has been traditionally subject to a complicated federal and state regulatory structure. The 1996 Act attempted to adapt the regulatory structure to technological reality, but various legal challenges by the incumbents have so far delayed, if not nullified, its impact.

Before going into a detailed analysis, it is important to point out the major driving forces in U.S. telecommunications today:

1. Dramatic reductions in the costs of transmission and switching;

2. Digitization;

3. Restructuring of the regulatory environment through the implementation of the 1996 Telecommunications Act coming twelve years after the breakup of AT&T;

4. Move of value from underlying services (such as transmission and switching) to the interface and content;

5. Move toward multifunction programmable devices with programmable interfaces, such as computers, and away from single-function, nonprogrammable consumer devices, such as traditional telephone appliances;

6. Reallocation of electromagnetic spectrum, allowing for new types of wireless competition;

7. Interconnection and interoperability of interconnected networks; standardization of communications protocols;

8. Network externalities and critical mass.

These forces have a number of consequences:

1. Increasing pressure for cost-based pricing of telecommunications services;

2. Price arbitrage between services of the same time immediacy requirement;

3. Increasing competition in long-distance services;

4. The possibility of competition in local services;

5. The emergence of Internet telephony as a major new telecommunications technology.

TECHNOLOGICAL CHANGE

The past two decades have witnessed dramatic reductions in costs of transmission through the use of technology, reductions in costs of switching and information processing because of big reductions of costs of integrated circuits and computers, and very significant improvements in software interfaces. Cost reductions and better interfaces have made feasible many data- and transmission-intensive services. These include many applications on the world wide web, which were dreamed of many years ago but only now became economically feasible.

The general trend in cost reductions has allowed for entry of more competitors in many components of the telecommunications network and an intensification of competition. Mandatory interconnection of public telecommunications networks and the use of common standards for interconnection and interoperability created a "network of networks," i.e., a web of interconnected networks. The open architecture of the network of networks allowed for entry of new competitors in markets for particular components, as well as in markets for integrated end-to-end services. Competition intensified in many, but not all, markets.

Digital Convergence and "Bit Arbitrage"

Entry and competition were particularly helped by the open architecture of the network and its increasing digitization. Currently, all voice messages are digitized close to their origination and are carried in digital form over most of the network. Thus, the data and voice networks are one, with voice treated as data with specific time requirements. This has important implications on pricing and market structure.

Digital bits (zeros or ones) traveling on the information highway can be parts of voice, still pictures, video, or of a database or other computer application, and they appear identical, "a bit is a bit is a bit." However, because some demands are for real-time services while others are not, the saying that "a bit is a bit is a bit" is correct only among services that have the same index of time immediacy. Digitization implies arbitrage on the price of bit transmission among services that have the same time immediacy requirements.