Telecommunications: Network Strategies for Network Industries?

21 Pages·0.245 MB·English

by  Werbach, Kevin

(Chapter 24)
Telecommunications:
Network Strategies for
Network Industries?
Kevin Werbach
Kevin Werbach, Assistant Professor of Legal Studies and Business Ethics,
The Wharton School, University of Pennsylvania
©
2009 by Pearson Education, Inc.
Publishing as Wharton School Publishing
Upper Saddle River, New Jersey 07458
Company and product names mentioned herein are the trademarks or registered
trademarks of their respective owners.
All rights reserved. No part of this product may be reproduced, in any form or by
any means, without permission in writing from the publisher.
ISBN-10: 0137024509
ISBN-13: 9780137024506
Telecommunications is a networked business, yet it traditionally has resisted a
network-based view in its strategies and business models. In this chapter, Kevin Wer-
bach explores this paradox, contrasting the worldview of Monists such as AT&T, who
see the infrastructure as inseparable from the network, and Dualists such as Google,
who see the network and its applications as distinct from the underlying infrastruc-
ture. Not surprisingly, AT&T is a proponent of “tiered access” whereas Google argues
for “network neutrality.” Finally, Werbach examines how a more modular future
might bridge the gap between those who seek to own and capitalize on the network
and those who seek to expand it through more neutral offerings.
Contents
Abstract
A Network-Based View of Telecom
Network Monists and Dualists: AT&T and Google
The Modular Future
Conclusion: A Network View of Networks
References
24
Telecommunications: Network Strategies for
Network Industries?
Kevin Werbach
Abstract
Telecommunicationsis a networked business, yet it traditionally has resisted a network-
based view in its strategies and business models. In this chapter, Kevin Werbachexplores
this paradox, contrasting the worldview of Monists such as AT&T, who see the infra-
structure as inseparable from the network, and Dualists such as Google, who see the
network and its applications as distinct from the underlying infrastructure. Not surpris-
ingly, AT&T is a proponent of “tiered access” whereas Google argues for “network neu-
trality.” Finally, Werbach examines how a more modular future might bridge the gap
between those who seek to own and capitalize on the network and those who seek to
expand it through more neutral offerings.
If there is a sector of the economy that should embrace network-based thinking, it is
telecommunications. Surprisingly, the opposite is the case. The leading firms building
telecommunications and Internet infrastructure increasingly emphasize consolidation,
hierarchy, and exclusive control, rather than collaboration and decentralization. Regula-
tors are dismantling legal frameworks that once promoted openness and interconnec-
tion, in favor of misguided efforts to create incentives for proprietary investment. And
many scholars, even those challenging the current drift of policy and business models,
embrace a static worldview that is a relic of earlier eras. Network-based strategies are
thus hard to find today in the so-called “network industries,” even as such ideas flourish
3
4 THENETWORKCHALLENGE
in adjacent digital information markets. This chapter explores the origins of this paradox,
describes its manifestations in the legal and business environment, and traces a more
hopeful future.
Telecommunications industry participants and scholars may be divided into two
camps: Monists and Dualists. The Monists see physical network infrastructure as the
linchpin of the telecommunications and Internet ecosystem. Any activity using that
infrastructure must first ensure adequate cost recovery for the massive investments
involved in building it. The Dualists, on the other hand, see a division between the net-
work infrastructure, which is an enabling utility, and the activities on top, which are the
locus of innovation and value. They urge regulation of the network to free the applica-
tions, communication, and content, whereas the Monists believe the network should be
permitted to impose greater controls. Both sides recognize that their industries are
undergoing dramatic transformation, with the potential to both create and destroy mon-
umental amounts of value. The Monists have been in the ascendancy in recent years, at
least in the United States. However, the victories they achieve are pyrrhic. Innovation on
top of the network is being stifled, and the forces undermining the Monists’ cost-
recovery business models are merely being slowed, not stopped.
A Network-Based View of Telecom
Communications systems are nothing more or less than information pathways con-
necting human and machine nodes.1 They are, in other words, networks by definition.
The telegraph, telephone, radio, television, mobile phones, and online information serv-
ices are perfectly modeled as network graphs. Engineers use network-based techniques
to build and manage telecommunications networks, in areas such as traffic modeling and
system architecture. And those in the telecommunications industry invariably describe
and represent the infrastructure with the terminology of networks.2 Nonetheless, truly
network-based business strategies are hard to find in today’s telecommunications infra-
structure sector.
1 This chapter focuses primarily on the networks of telecommunications carriers such as AT&T and Ver-
izon, and to a lesser extent on cable television providers such as Comcast and Time Warner and mobile
phone operators such as AT&T and Verizon Wireless. The examples given generally involve the United
States, unless otherwise specified.
2 On the other hand, as noted in Mitchell 2006, at least one U.S. Senator describes the Internet as “a
series of tubes.”
CHAPTER24 • TELECOMMUNICATIONS 5
There is a great deal of network-oriented analyses to draw on. Peter Huber’s influen-
tial analyses of the modern telephone system as a “geodesic network” more than 20 years
ago (Huber 1987) explained in detail how network properties influence cost structures,
competition, and innovation. More recently, network scientists have engaged in exten-
sive study of the properties of the Internet and its physical infrastructure(Pastor-Sator-
ras and Vespignani 2004). For example, researchers showed that sites on the World
Wide Web (Albert, Jeong, and Barabasi 1999) and Internet routers (Faloutsos, Falout-
sos, and Faloutsos 1999) follow a power-law distribution in degree of connectivity. There
have also been a few academic efforts to apply network-theoretic techniques to telecom-
munications policy (Spulber and Yoo 2005; Werbach 2008b). However, such findings
have not so far connected with the business models of network operators or those who
use their infrastructure.
Most telecommunications infrastructure owners view their assets as nodes—even
though those assets are networks. Each network operator’s node connects horizontally to
other network infrastructure nodes, and vertically to application/content providers or
customers, but the value arises in the nodes, not their interconnection. This is not as odd
as it might seem. All Coasian firms are networks, but they are subject to central and hier-
archical control to minimize transaction costs (Coase 1937). In telecommunications,
fixed investments for network deployment are generally more significant than recurring
transaction costs. The mainstream view of the industry, therefore, emphasizes backward-
looking cost recovery over the forward-looking catalytic potential of distributed activity
on the interconnected network.
The one area of network theory that has made its way into the business and policy
discussion around telecommunications infrastructure is network effects (Rohlfs 1974).
“Network effects” refers to the positive externalities of networked activity, which, among
other things, cause networks to enjoy increasing returns to scale. A bigger network gives
users access to more users, and to more content or services that can be delivered
through the network. As analyzed by Katz and Shapiro (1985), network effects have
complex impacts in telecommunications-based markets. They allow new services, such
as Google, Facebook, or Skype, to grow extremely rapidly, because their value proposi-
tion improves with more users. On the other hand, network effects mean that, even with
absent anticompetitive behavior, network industries may tend toward concentration, as
AT&T demonstrated in its early days by exploiting its larger network and strategically
refusing to interconnect with others.
Recent developments in the telecommunications industry, such as the growth of the
Internet, have only enhanced its network-centric characteristics (Shapiro and Varian
6 THENETWORKCHALLENGE
1998). Since the 1970s, the telecommunications sector has evolved from a collection of
vertically integrated, often government-owned, monopoly telephone companies to a
diverse mesh of interconnected wired, wireless, and data networks (Nuechterlein and
Weiser 2005). Barriers between geographies, transmission modalities, legal structures,
formats, services, and devices are collapsing dramatically. Where once AT&T and its
brethren dominated as vertically integrated colossi, today the world’s largest telecommu-
nications company in subscribers is China Mobile (Xinhua Financial News 2008), and in
capacity is, by some reckonings, Google.3 Prices have plummeted as service offerings
have exploded.
Today’s telecommunications industry is, on some levels, radically interdependent.
Even behemoths such as AT&T cannot always serve customers without handing off traf-
fic to other carriers. A telephone call from an AT&T customer to a Comcast or Sprint
customer is a collective effort of competitors, because both law and customer expecta-
tions dictate cooperation (Werbach 2008a). The rise of the Internet, a “network of net-
works” that significantly decentralizes intelligence and control, has accentuated this
tendency (Werbach 1997; Werbach 2008b). A simple search query to Google, in a frac-
tion of a second, can incorporate handoffs among multiple data network operators and
swarms of distributed servers around the globe. As Benkler (2006) and Lessig (2001)
elucidate in detail, the Internet is an open infrastructure platform, which allows for
many different uses. Those uses are defined not by the network owner, but by network
users. The network owner may offer specific services, but usage of the network is not
limited to those services (Frischmann 2005).
The emergence of a diffuse, interconnected infosphere has so far failed to elevate
network-based thinking in either the telecommunications boardroom or the academy.
As we enter the broadband era, leading telecommunications carriers proclaim the need
for “managed” networks (Yoo 2006). They lock out potential rivals, throttle peer-to-peer
applications, lock mobile phones to particular networks, hatch plans to charge content
and application providers for the privilege of reaching users, and develop standards to
control rather than encourage usage (Wu 2003). It is no accident that the nation where
this proprietary approach is most prominent, the United States, has gone from the dom-
inant adopter of narrowband Internet access to a laggard in broadband penetration, near
the bottom of Organization for Economic Cooperation and Development (OECD) and
other rankings (OECD 2007).
3 Google does not publicly disclose details about its network capacity. However, it operates a massive dis-
tributed network of hundreds of thousands of computers in data centers around the globe, which
requires tremendous communications capacity. Both internal and external sources have anecdotally
suggested that it now distributes more bandwidth than any telephone company.
CHAPTER24 • TELECOMMUNICATIONS 7
The carriers are aided in their efforts by regulatorsand scholars, who either promote
a return to centralized, proprietary control or advocate artificial barriers that ignore the
essential fluidity of the networked information economy. On one side, “free market”
thinkers ignore the voluminous evidence that network topologies are important in ways
that simple rational-actor models do not capture, as explained in Crawford (2007) and
Benkler (2006). On the other side, opponents of the incumbent carriers’ vision of a man-
aged network rally around “network neutrality” rules that would prohibit operators from
blocking or degrading unaffiliated content and applications (Wu 2003). Neither camp is
happy with the current situation. Incumbent telecommunications carriers fear their
businesses will be hollowed out, and application providers fear that their growth and
innovation will be constrained. As discussed later, there is some cause for optimism
about the future.
Network Monists and Dualists: AT&T and Google
The strategies of two major players in thetelecommunications and Internet market-
place—AT&T and Google—offer insights into two competing views of telecommunica-
tions networks. On the one hand, Monists, such as AT&T, see the physical infrastructure
as the only “real” network, with applications, services, and content as subsidiary phe-
nomena. In contrast, Dualists, such as Google, see additional layers of functionality on
top of that infrastructure as the source of value for users, with the physical connections
as merely a means to that end.
Although Google is not considered a telecom company, it resembles a traditional
network operator such as AT&T in many ways.4Both invest billions of dollars annually in
fiber-optic transmission links, and in geographically distributed data centers filled with
computers that route and deliver services to the millions of users of their networks. Both
generate billions of dollars of annual revenue from customers who value the services
those networks provide. Both must interconnect their networks with others, because no
single provider can control access to every user worldwide. Both think of themselves as
their customers’ trusted gateway to the richness of the Internet. Both are expanding
aggressively into video, and both see wireless data services as an increasingly important
growth area.
4 Gilder (2006) and Carr (2008) discuss the development of “cloud computing” infrastructures by Google
and others, which deliver information services through networked data centers.
8 THENETWORKCHALLENGE
Yet the two companies’ business models are dramatically different. AT&T charges
connection and usage fees for access to its network, by both customers and other opera-
tors. Google gives away its dominant service, search, for free, and also provides free
access to application programming interfaces for third parties to “mash up” its services
into their own offerings. AT&T charges well-defined prices that are carefully differenti-
ated to maximize revenue based on its customers’ willingness to pay. Google makes vir-
tually all its money from advertisers participating in a continuous real-time auction for
placement in its search results, with no payments until Google delivers a concrete result.
AT&T defines specifications and purchases its software and hardware from a variety of
providers, such as switch vendors, billing system providers, and mobile handset manu-
facturers. Google ties together commodity computers and open-source software with its
own internally developed “cloud computing” software platform (Carr 2008; Gilder
2006). AT&T’s new offerings emerge after multiyear development cycles and typically
involve incremental fees. Google tweaks its search algorithms constantly, and constantly
introduces new services with no business model other than driving usage of the core
search/advertising platform.
AT&T and Google diverge in other ways as well. The company that today bears the
name AT&T was formed through the consolidation of four of the seven regional “Baby
Bells” and the long-distance operator that retained the AT&T name after the 1984 gov-
ernment-mandated divestiture. Google was founded in 1998 by two Stanford graduate
students, and its acquisitions have been either small or, as with YouTube and Dou-
bleClick, expansions into new markets. AT&T is a leading proponent of “tiered access,”
under which content and applications providers (including Google) would pay network
operators for enhanced connections to AT&T’s broadband customers (Werbach 2008a).
Google is a leading advocate of “network neutrality” regulations to preclude such
approaches, to the extent that they block or discriminate against unaffiliated providers.
Many of these differences are rooted in history. AT&T built its infrastructure as a regu-
lated utility, with competition prohibited and profits guaranteed under a rate-of-return
system. Google could take the global network infrastructure as a given, allowing it to
invest only in less-costly and more localized data centers, computers, and software.
These differences reflect a fundamental tension. There are two possible views of
communications infrastructure, which I will call the Monist and the Dualist perspective.
AT&T typifies the Monist viewpoint, whereas Google represents the Dualist approach.
A successful vision for telecommunications in a network-centric world must take both
views into account.
CHAPTER24 • TELECOMMUNICATIONS 9
Monists and Dualists differ in critical ways. Monists emphasize the supply side, and
control of physical networks of wires and switches. Dualists emphasize the demand side,
facilitating applications such as telephone service, video distribution, or searching the
Internet. Monists live in a world in which fixed costs are high, variable costs are negligi-
ble, and congestion is a negative externality to solve through pricing. Monists, therefore,
seek managed hierarchical networks, metered pricing, value capture through proprietary
advantage, and clear lines of service differentiation. Dualists draw more from network
economics and complexity theory, stressing the positive externalities of network effects.
They support radical openness and connectivity, and seek to drive the price of admission
to zero, so as to more easily grow a community that can be monetized in other ways.
As shown in Figure 24-1, Monists and Dualists perceive the same world, but they
understand the relationship of users and the network differently.5Monists see the infra-
structure as the business, while Dualists see the infrastructure as a platform for experi-
ences. Generally speaking, Monists include those who operate communications
networks, and those who sell equipment to those operators. Dualists include most of the
companies that deliver content and services through the Internet, such as Yahoo!, Ama-
zon.com, Google, and Microsoft.6 These two camps are largely on opposite sides of
debates over network neutrality, wholesale access requirements for networks and wire-
less spectrum, unlicensed wireless access, and imposition of regulatory obligations on
Internet-based services.
Figure 24-1 Monist and Dualist perspectives on the network
5 The diagram is quite stylized for clarity. In the real world, the dividing lines are not always so clear.
Many services “on top of” the network incorporate devices at the customer premises or within the net-
work switching fabric, for example.
6 Academics are split between the two camps. Anecdotally, the majority of economists seem to adhere to
the Monist view, while the majority of legal scholars appear to favor the Dualist perspective. Engineers
are divided, often based on whether their roots are in studying telecommunications or data networking.