Number 00-7 September 2000 IIE International Economics INSTITUTE FOR INTERNATIONAL ECONOMICS Policy Briefs No to Foreign tition between privately-owned US telecom firms and publicly-owned foreign firms. To Telecoms Equals No put the debate in a sound bite, “How can a private firm compete with a government to the New Economy! wallet?” But even at the sound bite level, it’s Gary C. Hufbauer and Edward M. Graham wrong to characterize Deutsche Telecom as Institute for International Economics an extension of the German government’s wallet. Deutsche Telecom is now 42 percent Gary C. Hufbauer is Reginald Jones Senior Fel- privately owned (US investors own approxi- low and Edward M. Graham is a senior fellow at mately 20 percent of all privately held the Institute for International Economics. Graham Deutsche Telecom shares). Acquisition of is the author of Fighting the Wrong Enemy: VoiceStream by Deutsche Telecom, Antiglobal Activists and Multinational Enter- through a share exchange, will increase prises. Hufbauer is coeditor of Unfinished Busi- the private ownership of Deutsche Telecom ness: Telecommunications after the Uruguay Round. to 55 percent. The German Federal Govern- © Institute for International Economics. ment is already a largely passive investor, All rights reserved. holding no “golden share” in Deutsche Telecom and only one of 20 board seats; in Within a few weeks, the United States fact, the German government plans to sell will make a pivotal decision—whether to off the rest of Deutsche Telecom as fast as prohibit foreign telecommunications firms market conditions permit. Deutsche that are partly owned by foreign govern- Telecom enjoys no special tax breaks. Nor ments from competing in the US market. The decisive case is Deutsche Telecom’s If Hollings prevails in his bid to acquire the US mobile telephone op- campaign to block Deutsche erator VoiceStream (and VoiceStream’s own new acquisition, PowerTel). Telecom, two groups of Senator Ernest Hollings (D-SC) is doing Americans will be certain losers everything he can to stop the German telecom giant. Along with 29 Senate co- all US consumers and most US sponsors, Hollings has introduced a bill (S. telecom companies. 2793) that would block Deutsche Telecom, or any other telecom owned more than 25 can it borrow from the German Finance percent by a foreign government, from ac- Ministry. Indicative of the arm’s length re- quiring a US telecom firm. S. 2793 may not lation between Deutsche Telecom and the pass, but to reinforce their objections, German government is that the Standard Senator Hollings and the 29 other senators & Poor’s credit rating for Deutsche Telecom wrote a stern letter to William Kennard, is AA- (the same as AT&T, SBC, and Chairman of the Federal Communications BellSouth), while the German sovereign Commission (FCC), urging the FCC to block rating is AAA. the acquisition. Hollings worries about what If Hollings prevails in his campaign to he sees as the unfair character of compe- block Deutsche Telecom, two groups of 11 Dupont Circle, NW * Washington, DC 20036-1207 Tel: (202) 328-9000 * Fax: (202) 328-5432 http://www.iie.com September 2000 2 00-7 Americans will be certain losers—all US consumers nentially with the size of the network. Thus, for ex- and most US telecom companies. Potential corporate ample, both modern e-mail and traditional voice te- winners may be lurking in the background, but so lephony are of great value to the user because both far they have kept out of sight. can be used to reach millions of other users. If the To understand why the Hollings initiative can in- number of persons connected to the network were flict so much damage, and finds so little support among small, the value of being connected would also be US telecom firms, let alone US consumers, it’s useful small. (For this reason, telecom firms interconnect to start with a short background on telecom econom- their networks, so a customer of one network can ics. reach customers on other networks.) Thus, the larger a network, the more valuable it Telecom Economics becomes to its business and household users, be- The telecommunications industry—once a staid cause they enjoy a seamless reach to more firms, investment for widows and orphans—is simulta- people and places. And this value is increasing as neously going through two revolutions. These are al- the result of new technology: For example, technol- most the industrial equivalent of the American and ogy has enabled households to add broadband com- French Revolutions happening simultaneously. On puter connections at low cost to their basic telecom- the one hand, the industry is being rocked by an ex- munications service. With this connection, they can plosion of new technology and applications of this access foreign Web sites and even order merchan- technology—digital, mobile/PCS, broadband trans- dise from abroad. Business firms can link their re- mission, internet, e-commerce and more. On the mote offices and factories using customized voice, other hand, there’s the dramatic introduction of com- video, sound and data facilities. petition into what was once a near-monopoly indus- try, not only in the United States but everywhere else . the larger a network, the more as well. Working together, technology and competi- tion have made telecommunications the main en- valuable it becomes to its business and gine driving the information technology revolution. household users, because they enjoy a Once telecommunications was largely about calling seamless reach to more firms, mother on Sunday night. But now telecommunica- tion networks have become the muscles that drive people and places. the “new economy”. When these muscles work well, we see the economic equivalent of an Olympic The Urge to Merge marathoner; when they work poorly, we see the once- Network economics are a supercharged variant a-month jogger. of economies of scale. Every student who passes Eco- nomics 101 can predict the outcome in an industry Network Economics that is characterized by powerful economies of scale. But there’s another dimension to the story—net- Firms will merge in order to reduce costs. If carried work economics. A telecom network becomes expo- too far, of course, these combinations could lead to nentially more valuable when more companies, one firm that monopolizes the industry. But that out- people, and services are connected to that network. come seems remote in telecommunications. Rather, Thus, a network with 50 million customers is twice firms are entering what once used to be another the size but many more times the value of a net- firm’s exclusive market simply to remain competi- work with 25 million customers. tive. This is happening on a world scale. US firms The value of a network to a telecom firm in- are the most aggressive players in this global game: creases faster than its size because the marginal Five of the world’s top ten telecom firms are based cost of adding additional subscribers and services is in the United States—and they are growing like a fraction of the fixed cost of building the backbone kudzu in every corner of the globe. Four foreign firms, of the network. This is why Deutsche Telecom can with substantial government ownership, are also in bid roughly $51 billion for VoiceStream, more than the top ten—NTT (Japan), Deutsche Telecom, France $15,000 per customer. Voice Stream (in combina- Telecom, and Telecom Italia. Telefonica (Spain) is tion with PowerTel) is only the sixth largest telecom close behind. nationwide, with around 3 million existing custom- The Deutsche Telecom acquisition of ers. Potentially, however, it could serve nearly 250 VoiceStream (and Powertel) exemplifies the sort of million Americans. As it expands in the rapidly grow- horizontal expansion that adds to competition in the ing US wireless market, with finance and technol- U.S. market. Deutsche Telecom, like most other for- ogy from Deutsche Telecom, the cost of serving addi- eign carriers (Mannesmann/Vodaphone is an ex- tional customers will fall dramatically. ception), has no significant presence in the US mar- Importantly, the value of the service provided by ket. If Deutsche Telecom makes an entry, it will the network to the customer also increases expo- add to competition. VoiceStream can potentially 00-7 3 September 2000 serve nearly all American households. But petitive manner to ensure that incumbents don’t VoiceStream is now the sixth largest player in the block innovation and new entrants. The free-for-all US market. Unless it combines with another player, of the market then drives down prices. That was it won’t have the capital and technology to expand Judge Harold Greene’s strategy when he broke up and compete. And with Verizon, SBC, BellSouth, AT&T in 1982, and it has since become the guiding AT&T and Sprint already nationwide carriers, un- star of FCC policy. The pro-competitive strategy has less VoiceStream combines with a carrier not already in fact delivered a more abundant economic cornu- in the US market, a VoiceStream merger is likely to copia than anyone twenty years ago could have ex- subtract competition. pected. The newer reconciliation has delivered powerful Pro-competitive Regulation benefits to US consumers. A great example is mo- While the Deutsche Telecom acquisition poten- bile telephony—VoiceStream’s business. Until 1995, tially adds to competition in the US market, that isn’t every regional market had only two mobile telephone necessarily true of all telecom mergers and acquisi- operators—the regional bell operating company and tions. Indeed, there’s an obvious tension between the the winner of the FCC’s cellular license lottery. New network cost reduction enabled by consolidation and competitors began to enter the market in 1995.