High-Capacity Services: Abundant, Affordable, and Evolving

High-Capacity Services: Abundant, Affordable, and Evolving Patrick Brogan USTelecom Evan Leo Kellogg, Huber, Hansen, Todd, Evans & Figel, P.L.L.C. July 2009 Introduction The United States government has established as a national priority the ubiquitous deployment of broadband facilities and services to all Americans. Broadband investment is critical to economic growth and recovery, not only through the creation and preservation of jobs in the communications sector, but through improvements in efficiency and productivity across the economy, as well as through development of innovative consumer products and services. Recognizing the significant policy interest in ubiquitous broadband deployment, some parties have sought to tie to the broadband policy engine their demands for government mandated price reductions in special access, a type of dedicated high-capacity service used by enterprises and communications providers. Given the importance of getting broadband policies right, policy makers evaluating action concerning high- capacity services and potential implications for broadband deployment should have an up-to-date factual record concerning competition, investment, and innovation in high-capacity services. Report Purpose and Methodology Because of the significance of this issue, USTelecom has undertaken this report to compile and update factual evidence concerning competition for high-capacity services. This report brings further concrete data to the current debate over the state of competition in this area. The current debate is too often conducted over outdated concepts and unsupported accusations. This report combs through High-capacity services the publicly available data from companies and analysts on competition, investment, and innovation to produce a snapshot of what companies are actually doing today to build, expand and operate high- are characterized capacity wired and wireless networks and how they are competing and innovating to meet rapidly by growing demand, growing market needs for higher and higher capacity services to support broadband services. In addition, the report provides information on high-capacity service pricing trends based on data from expanding competition, USTelecom members. While the publicly available data confirm that the market for high-capacity declining prices, services is vibrantly competitive, the data necessarily are incomplete because alternative providers continued investment, of such services generally have withheld from public scrutiny data regarding their competitive networks and services. Consequently, a thorough and complete assessment of the competitive and ongoing innovation. dynamics of high-capacity services depends on privately held data on the reach and strength of competitive networks, which likely will become available only through governmental process. The report reveals that high-capacity services are characterized by growing demand, expanding competition, declining prices, continued investment, and ongoing innovation. This is due, at least in part, to the current regulatory regime set in place by the Federal Communications Commission (FCC) in 1999. Under that regime, while all special access services remain subject to “just and reasonable” pricing requirements and the vast majority of areas remain under strict price controls, the FCC has lifted direct price controls only in certain areas that meet certain triggers establishing that competitors have made irreversible, sunk investments in the facilities needed to provide high- capacity services. USTelecom | High-Capacity Services: Abundant, Affordable, and Evolving | July 2009 i Despite this evidence, some users of high-capacity communications services are calling for new price controls that mandate unjustified price reductions on one component of the broader high- capacity service market known as “special access.” But, for years, most of the competitive providers have refused to supply regulators the data necessary to accurately evaluate the competitiveness of high-capacity services, particularly the location of their high-capacity facilities. The information compiled in this report, while extensive, is merely the tip of the iceberg. The evidence indicates that competition for high-capacity services is strong and growing, and we are confident that the marketplace is even more competitive than the publicly-available data suggest. For example, traditional analyses do not capture intermodal competition from cable operators and fixed wireless providers. Nonetheless, this report is not a substitute for a comprehensive FCC data collection since a full accounting of competitive facilities and services is not publicly available. It is therefore essential for the FCC to undertake a comprehensive data collection and analysis that captures all sources of competitive supply, including self-supply, before contemplating new price controls. In a market characterized by growth and competition, as the initial evidence in this report suggests, the drastic price controls being proposed would put the brakes on, rather than accelerate, the investment so important to upgrading our nation’s broadband networks and creating jobs and economic growth. Context: Sorting the Rhetoric from the Facts Since any change in policy must be based on a complete and accurate assessment of the facts, it is first necessary to address several misconceptions that have been perpetrated about special access and high-capacity services. In particular, certain parties contend that new and expanded price Special access is but controls on special access are necessary based on several claims that simply are unsupported by the facts. one component of a broader high-capacity First, claims that there is a market failure or that the market is broken are inconsistent with the facts laid out in this report. As an initial matter, special access is but one component of a broader high- services market. capacity services market. The high-capacity services market is characterized by growing demand driven by next-generation broadband network upgrades. Growing demand represents a multi-billion dollar opportunity and a wide range of competitors are pursuing this opportunity. Competition has not been decimated. Rather competitors continue to invest and innovate and prices for special access services continue to fall. These are indicators of a dynamic, functioning market, not a failed or broken market. Furthermore, competitors include not only traditional fiber-based competitors, but also cable operators and fixed wireless providers. These new entrants are successfully providing alternatives to special access and are projecting growth; they are not merely fringe competitors. Therefore, static concentration analyses are poor indicators of competitiveness in this dynamic market. Such analyses have focused predominantly on wholesale special access services, under-representing retail competition and self-supply, and they do not account for ongoing technological substitution or the impact of potential competition. ii USTelecom | High-Capacity Services: Abundant, Affordable, and Evolving | July 2009 Second, regulators have not eliminated protections for consumers and competitors. Interstate special access remains subject to FCC regulatory oversight under Title II of the Communications Act. Rates, terms, and conditions are subject to FCC enforcement action if found to be unjust or unreasonable. Within that framework, typically rates for special access in rural areas are subject to stringent price controls. For the largest carriers serving the great majority of the country, the FCC abandoned the rate-of-return regulatory regime for special access nearly twenty years ago and adopted the current price-cap model as the best way to spur competition. During the Clinton Administration, while under The drastic price the leadership of Chairman William Kennard, the FCC in 1999 determined that, for price-cap-regulated controls being proposed carriers, price caps for special access could be lifted in certain competitive areas. Under Phase I would put the brakes on (partial) pricing flexibility, rates remain under price-cap regulation but discounting is permitted. Under Phase II (full) pricing flexibility, price caps are lifted. Where flexibility is granted, it may be granted rather than accelerate to some, but not all, incumbent local exchange carriers (ILECs) that provide special access in the investment. metropolitan statistical area (MSA). The FCC has granted full Phase II pricing flexibility to the largest price-cap carriers in approximately one-third of the MSAs in the United States, Phase I partial pricing flexibility in approximately one-third of the MSAs, and no pricing flexibility in the remaining one-third of MSAs. So, in almost two-thirds of the MSAs special access prices continue to be capped, and in nearly all non-MSAs prices continue to be subject either to price cap or to rate-of-return regulation. Even where the FCC has granted full Phase II pricing flexibility, providers are subject to enforcement action if the FCC finds their rates to be unreasonable, and there has not been even a single instance of such an action during the decade following implementation of pricing flexibility. Third, special access is not generating 100 percent-plus profit margins, as many proponents of increased regulation claim. Such claims are distortions, based on outdated allocations as reported in the FCC’s Automated Reporting Management Information System (ARMIS). ARMIS category allocations between special

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