Why Even Bells Need Net Neutrality

By Daniel Berninger
Definition: Net Neutrality – Internet access without discrimination by use or user except as required for network management purposes.

The FCC’s decision to relieve AT&T and Verizon of net neutrality requirements in August 2005 definitively broke the chain of events the companies use to assert right-of-way privileges. The Bells claim privileges based on over 100 years of practice that may or may not coincide with the intent and limits of the original deals, but the resulting laws explicitly require a public purpose in exchange for the right-of-way concessions.

The obligations established on a state by state basis sometimes include build-out requirements or other compensation, but they all specify that access to state right-of-way at largely no cost or limit requires common carrier status (aka net neutrality.) The loss of common carrier status invalidates the contracts. The Bell companies have no access to state right-of-way for deployment of private, closed, non-neutral, non-common carrier network deployments.

There may exist many unfulfilled obligations in the century old details of these arrangements, but there exists no doubt right-of-way access requires common carrier status. Maryland represents a typical case. The terms of right-of-way obtained by the Chesapeake and Potomac Telephone Company (now a unit of Verizon) after its founding in 1883 persist in the Maryland Code section covering public utility companies. Title 1-101 defines a telephone company as “a public service company that owns telephone lines to receive or transmit telephone communications.”

The same section defines a public service company as a “common carrier” company. Title 8-103 “Construction of lines and fixtures” defines the right-of-way available to the public service telephone company. The authority of Maryland to regulate telephone companies shows up in the Maryland Constitution Article 12 titled “Public Works” noting among other things that “the Directors of all said Public Works guard the public interest, and prevent the establishment of tolls which shall discriminate against the interest of the citizens or products of this State.”

Another interpretation to the plain language requiring a public purpose for right-of-way concessions does not exist. Does anyone believe government should grant public assets to private entities for private purposes? The loss of net neutrality changes the terms under which the Bells enjoy access to right-of-way. The non-neutral private network deployments associated with the Bell company broadband offers look like the non-common carrier networks of the cable companies.

Cable companies do not enjoy the same no cost access to right-of-way and pay franchise fees that typically equal 5% of gross revenues or $30 billion over the last ten years. The assertion that property rights convey an ability to leverage any business model regarding the Internet seems ironic given the telephone companies own less than 2% of the property where they deploy infrastructure. The real estate Verizon owns directly represents less than 3% of the value claimed for equipment and infrastructure.

The exposure to litigation for private use of public right-of-ways already exists. Verizon deployed FiOS as a entirely non-common carrier private network. Scrutiny of right-of-way arrangements could change the balance of power in the battle between the Bells and municipal wireless projects. Ed Whitacre and Ivan Seidenberg might regret their push to remove government oversight.

The regulatory sphere offers cozy warmth compared the to risks that await their plans to extract increasing private returns from public assets and government granted monopoly. Regulation has proven a potent defense from antitrust litigation while still allowing price increases, industry consolidation, and the use of the risk free returns from local telephone monopoly to subsidize expansion in new markets like wireless and broadband. The tariffed rate doctrine has long protected the Bells from pricing litigation. Verizon does not report R&D as a separate expense on income statements like Intel, Microsoft, or Google, because lobbying and litigation rather than technology dominates spending.

The Bells want Congress to believe ignoring net neutrality requirements will incent investment in broadband networks, but their idea of return on investment means monopoly rents. The Bells only invest in more monoply which usually means buying each other. The track record shows steadily lower spending on networks to increase free cash flow for acquisitions. The $140 billion SBC spent acquiring Ameritech, PacBell, SNET, AT&T Wireless, and AT&T lifted the company’s market cap by only $40 billion. The fact that $100 billion disappeared might suggest the need for a different strategy, but the new AT&T seeks government approval to spend $67 billion to acquire BellSouth. SBC missed an opportunity as $140 billion happens to be about what it would cost to run fiber to every home in America.

The Bells fund think tanks to explain why private organizations need to privatize a public asset, but the decision process in Congress should consider the public’s return on investment from the previous 100 years of access to right-of-way. It hardly qualifies as a public good that the Bells trimmed the number of people they employ by 40% and doubled the price of local service since 1984. The $200 billion in profit generated by Bells over the period did not even benefit investors as their chosen investments left equity values relatively unchanged.

Ed Whitacre might want to pay fair value for the public and private property utilized by the telephone network, before asking “…why should they be allowed to use my pipes…” when explaining to a Business Week reporter why Google, Yahoo, and Vonage should pay new usage based fees. There will be arguments Internet access represents an “incidental use” allowed by state laws, but these arguments will succeed only at the cost of the Bell’s much promised transformation plans. The desire to extinguish net neutrality does not arise from worries about incidental use.

The Bell companies need to stop the neutral Internet from erasing the legacy telephone network’s voice revenues. Price discrimination enables metering of Internet access by keeping per bit price of low bandwidth voice relatively high while offering relatively lower per bit prices to initiate a video revenue stream. Net neutrality stands in the way of their becoming digital economy toll collectors.

Daniel Berninger is a senior analyst at at Tier1 Research.