The end of the local phone and cable monopolies

In his presentation at this year’s Digital World (see Vol. 3, No. 3, p. 19), Alfred Sikes, former chairman of the FCC and now head of the new media and technology group within the Hearst Corp., predicted that an on-rush of technical and business developments in telecommunications in the United States would soon overwhelm the ability of federal regulators and lawmakers to keep up. In short, events, not policy-makers, will be in the saddle.

Less than two months later, it is clear that his prediction is coming true. A series of events in the month of August makes it all but certain that local monopolies in telephone and cable service in the U.S. will be broken, and only slightly less certain that from here on out communications policy will rely a lot more on competition and a lot less on service and price regulation.

Radical changes, such as those proposed by Ameritech and Rochester Telephone to open up local phone service to competition (which most people considered unlikely a month or two ago), now appear to be both rational and very likely to happen. (For more on the Ameritech proposal, see Vol. 3, No. 2, p. 9.)

THE MONTH CABLE OPERATORS, TELCOS WILL NEVER FORGET

Even though it was August, a month when typically work slows down, people take vacations without their cellular phones and the Friday workday tends to end between 2 and 3 PM, it seems that the people who control the telecommunication industry were working as if they were preparing for a long, cold winter. Similar to last December, when Bell Atlantic, Viacom, Tele-Communications, Inc., and PBS all made major announcements within weeks of each other (see Vol. 2, No. 7, p. 19), there was so much activity during the month of August that people were getting whiplash just reading the morning papers.

Fractiousness aside, some very basic assumptions in the business of telecommunications began to crumble as the technology — and the courts — surpassed the law once again. The truly amazing part is that this is becoming commonplace; the advances in telecommunications technology are stripping down the legal and regulatory structures that were designed to keep individual industries in line.

The sanctioned monopolies of the cable industry and the local phone companies have come into question; the turf wars between local and long-distance phone carriers have heated up; television and computer networks are now interconnecting. (Indeed, this phenomenon is not even endemic to this country: European telecommunications policies and practices are also up for grabs, as new competitors enter the fray without the baggage of established behemoths.)

THE WHOLE IS GREATER THAN THE SUM OF ITS PARTS

To understand better where we are heading, it is important that we look at the events of the past month, not as singular announcements but as part of a whole.

AT&T/McCaw. Last fall, AT&T and McCaw Cellular had agreed in principle to a complex deal in which AT&T would acquire a minority interest in McCaw and the two companies would develop joint products and services. Speaking at Digital World in June, McCaw chairman Craig McCaw indicated that the deal was still a long way from completion. In August, McCaw and AT&T chairman Robert Allen decided that trying to work out the ins and outs of a cooperative venture was too complex. The only sensible way to complete the deal was to have AT&T buy all of McCaw.

Under the terms of the acquisition, AT&T would swap $12.6 billion of AT&T stock for the stock in McCaw and would assume McCaw’s $4.9 billion debt. This makes the total value of the transaction roughly $17.5 billion — about 10 times McCaw’s annual sales of $1.74 billion! Craig McCaw himself will get 16.7 million shares of AT&T stock (worth just over $1 billion at current prices), and the four McCaw brothers as a group become the largest shareholder in AT&T, with a total of more than 45 million shares.

What AT&T gets. Why would AT&T pay so much? Because, if approved, this deal will make AT&T the largest cellular operator in the U.S., give it a base to expand into additional cellular markets, digital cellular CDPD (cellular digital packet data) services and celluar PCS (personal communication services). Equally important, it will also give AT&T the expertise to offer cellular services to new markets outside the U.S., where it will probably prove less expensive to install wireless phone networks than to string all the cable required for wired systems.

What particularly galls the regional phone companies is that this move puts AT&T back into the local phone business, able to connect its cellular customers directly to its long-distance services without the need to pay 45 cents of every dollar in local access charges — and without the “universal service” obligation to serve money-losing, low-volume customers.

Naturally the regional phone companies are crying foul. If AT&T is allowed back into the local phone market, they argue, they should be allowed to compete in the lucrative long-distance market.

Getting approval. This is not a done deal. James Quello, the interim FCC chairman has already mused that the deal could be anti-competitive or even monopolistic. Things could come unglued if the Justice Department or the FCC (or both) decided to oppose it.

You can bet that there is going to be some serious lobbying on the part of everyone who might be affected. You can also bet that this deal will give the regional Bell operating companies (RBOCs) — which have been devoting increasing amounts of attention to competing with each other — incentive to cooperate in order to compete with their erstwhile parent. Shortly after the initial AT&T/McCaw announcement last fall, GTE announced formation of a nationwide “MobilLink” cellular consortium. All of the RBOCs except for Southwestern Bell have since joined the group.

CABLEVISION CONNECTS SUBSCRIBERS TO THE INTERNET

On August 24, Continental Cablevision, the third largest cable operator in the U.S., announced that it will be offering cable access to high-speed data networks, including the Internet. (For more on the state of the Internet, see p. 18.)

The service, which is expected to start in January in selected Massachusetts communities, will include high-speed access to the Internet, access to local services that provide such information as bus schedules and school lunch schedules, and some interactive services (such as program listings). It will be expensive ($70 to $100 per month), so it is likely to appeal to people and organizations that want to move large amounts of data rather than casual users.

If Continental expands this service to other cities, it could open up some interesting possibilities for people who would like to be able to send large amounts of data from one point to another. Since there is no charge for sending data over the Internet, a $70-per-month coax connection to the Internet could end up being a hell of a deal.

The arrangement could also raise the status of the Internet as the existing de facto high-speed digital highway for distribution of increasing amounts of commercial information and entertainment products. (For more on commercial services on the Internet, see News Corp. buys Delphi, p. 27.)

BELL ATLANTIC WINS RIGHT TO ENTER CABLE BUSINESS

On the same day of the Continental Cablevision announcement, federal district judge T.S. Ellis ruled that the legal provision that prevents local phone companies from offering cable service in their home service areas is unconstitutional on the grounds that it abridges the First Amendment right to free speech.

Until now, forays by RBOCs into cable and video services have been outside their own territories, as required by the 1984 Cable Act, which prohibits phone companies from running cable TV operations in the areas where they offer phone service. So most of the RBOCs, in an effort to learn the cable business, invested in other systems: US West bought 25 percent of Time Warner Entertainment, and is one of the largest cable operators in the United Kingdom. Southwestern Bell bought two cable systems in suburban Washington, DC, which is Bell Atlantic territory (see Vol. 2, No. 10/11, p. 32), and Bell Atlantic plans to roll out CellularVision service in New York, which is Nynex territory.

The suit was filed by Bell Atlantic Video Services and Chesapeake and Potomac Telephone Companies of Virginia (both Bell Atlantic subsidiaries) to win the right to start cable service in Alexandria, VA. If the ruling is upheld, Bell Atlantic can operate both cable and phone service in the same service area. If it chooses to do so by acquiring an existing franchise (rather than starting a new competitive one), the effect of this ruling could be to nip in the bud local competition between cable and phone companies.

If the ruling stands, it would enable telephone companies to compete with cable companies for local monopolies. The telcos, however, would be able to offer both video and voice services (as US West already does in the UK) over parallel systems or, eventually, over a single, integrated network.

There are some significant anti-trust issues here as well: Can the phone companies be trusted not to use the information they have about customer calling habits (including shopping, 800 and 900 number usage, etc.) to engage in unfair marketing practices, as has already happened.

On the upside, the threat of telco entry into the cable market, especially after the RBOCs were able to demonstrate video dial tone, has spurred the cable television industry to move extremely rapidly to develop digital technologies and new services. The threat of competition from outside the industry has also added to the sense of urgency for cable reform, especially in the area of customer service (more on this later).

Judge Ellis’s decision will undoubtedly be appealed, but it may prove difficult to overturn. While the decision applies only to Bell Atlantic, it provides a precedent for the other Bell operating companies, and opens up the question about whether the cable companies should be able to offer telephone services. (The cable industry is still far from this level of sophistication.) The ruling throws a big wrench into the works of separate regulatory policies for the cable and telephony businesses — a policy environment that the federal government is going to have to address soon.

Bell Atlantic and CellularVision. Bell Atlantic is not about to wait on this decision, however, before it gets into the video-on-demand game. In fact, it has been one of the most aggressive of the RBOCs in looking for new technologies and market opportunities to provide video services.

On August 4, three weeks before Judge Ellis’s decision, Bell Atlantic and CellularVision of New York announced a partnership for a New York area rollout of “wireless cable” using CellularVision’s patented technology.

The CellularVision system uses a very high radio frequency (27.5 to 29.5 GHz) previously reserved for point-to-point commercial communication, and now being opened up by the FCC for other uses. As with a cellular telephone system, the service area is divided into multiple cells, each is serviced by its own transmitter. Each transmitter covers an area approximately six miles in diameter.

The receiving antenna is a flat five-inch plate that can be attached to a window. It feeds a coax cable that runs to the settop decoder box.

Initially, the system will be essentially a 49-channel, wireless cable system. Each cell uses 1 GHz of the available bandwidth, divided into 49 20-MHz video channels. CellularVision says that it expects to double this to 98 channels by broadcasting two signals with reverse polarity over the same channel. Reverse polarity is a process by which two signal waves are sent with opposite electrical impulses, allowing both signals to travel down a single channel. These are analog signals.

CellularVision claims that its system delivers higher-quality signals than wired cable, and at lower cost. It claims that broadcasting FM signals in a relatively interference-free part of the radio spectrum produces distinctly better pictures than does analog cable. And, since you do not need to run wire down every street to every subscriber’s home, the system is significantly cheaper to build.

By using phone lines or the reverse-polarity channels for “back-links” from the home to the service provider, CellularVision can be extended to provide interactive services. Although neither Bell Atlantic nor CellularVision is saying so, we presume that, like a wired cable system, the system could also be used to send compressed digital video — which would significantly increase the number of channels available and make the system a more direct competitor to the next generation of fiber/coax digital cable systems.

An end-run around cable. In 1991, CellularVision received an FCC license to install the system in the New York area. Bell Atlantic, which has now taken a minority interest in CellularVision, will deploy and operate the CellularVision system in the five boroughs of New York City, plus the adjacent Westchester, Rockland and Putnam counties — a service area with a population of 8.5 million.

If this initial rollout is successful — and if they can obtain rights to the necessary radio frequencies — the partners will install the system in additional cities and/or license the technology to other operators for use in other areas.

In some ways, the wireless cable initiative is an end-run around the traditional cable operators. In the same way that satellite operators can provide services in an area covered by a local cable company, the wireless system can become another option for the consumer, and another form of competition for consumer home entertainment dollars and loyalty. All they have to do is stop calling it “wireless cable,” a ridiculous term if we’ve ever heard one!

Expertise in video dial tone. In addition to its proposed trial with CellularVision, Bell Atlantic has also teamed up with Future Vision of America Corp. and Sammons Communications — in two separate trials in the New Jersey area — to test the feasibility of delivering both telephone and video services into the home using a combination of optical fibers and coaxial cables.

If the CellularVision, Future Vision or Sammons tests are any indication, Bell Atlantic will be trying to move into the cable market in its home turf as soon as possible. The company is bringing expertise in a number of areas that the cable television people are just beginning to learn about. So whether Bell Atlantic buys an existing cable system, or implements its own technology for the delivery of video, the local cable operators in this particular RBOC’s region have reason to panic.

THE CABLE ACT AND RE-REGULATION BLUES

In the absence of an open competitive environment, Congress last year passed a bill re-regulating the cable industry. On September 1, cable customers got their first taste of what it will mean for them. We doubt that they were impressed.

The FCC decided that the changes in cable pricing and services should be “revenue neutral.” That is, even though it was complaints about high rates (and poor service) that brought about re-regulation, rates are not being rolled back. Instead, rates are being reconfigured. What most consumers saw was a confusing shuffling of channels and a monthly bill that is probably little changed. (The local operator in Malibu, CA, moved a third of the channels around with no prior notification and raised basic rates to compensate for the fact that it can no longer over-charge for settop boxes and remote controls.)

We doubt that this experience is going to increase consumer trust in either cable operators or government regulators. Our guess is that it will make increased competition, such as those we’ve mentioned, a better alternative than regulation.

CAN WE KEEP COMPETITION ALIVE AS TELECOM INDUSTRIES MERGE?

What a glorious mess! It is difficult to see how any of this ever gets put back in the box. It is clear that the legislators (most of whom clearly do not understand this stuff) and regulators (some of whom understand it) are going to have to play catch-up to lay out the new playing fields.

What should we do? The Ameritech proposal (as well as a similar proposal made by Rochester Telephone) to open up local phone service probably has a lot more appeal than it did a month ago. In simplest terms, Ameritech is offering to give up its monopoly in local phone service in exchange for permission to enter markets it was kept out of by Judge Greene: long-distance service, video and telecom equipment manufacturing, in competition with AT&T, MCI et al. Following the AT&T/McCaw deal, we would imagine that other regional phone carriers are beginning to think that this would be a pretty good idea.

But the Ameritech/Rochester Tel proposal does not go far enough. We have been saying for several years that it is imperative that we begin treating telecommunications as a single market rather than as separate markets. The Bell Atlantic decision pretty well mixes telco and cable together. (If phone companies have a constitutional right to carry video, then don’t cable companies have an equal right to provide phone services?) The trick now is going to be insuring that we really do get competition by ensuring that there are multiple service providers for the full spectrum of telecommunication services in all service areas.

There is a lot of good news out of what happened this past month, but there is also some troubling news. On the positive side, virtually every one of these developments should increase competition for both telephone and cable services. On the negative side, Judge Ellis’s ruling in the Bell Atlantic case could lead to a situation in which a single company is providing wired telephone, cable and even wireless service in the same service area. This would be a terrible outcome!

The lesson is simple: Competition works, whether for local or long-distance phone service or the delivery of video and other entertainment to the home. The primary focus of public policy should be ensuring that we do, indeed, get open competition on a level playing field. While all sides will posture about when such a situation can be realized, the pace of change — in the month of August alone — shows that all of the parties are up to the challenge.

Jonathan Seybold

IF YOU TOOK A VACATION IN AUGUST

August was a busy month for the cable operators and telcos. In chronological order, here’s a quick snapshot of some of the highlights of the month:

• August 4: Bell Atlantic shattered the conventional wisdom that wires will be used for video and wireless communications for voice with the announcement of a joint venture to deliver wireless cellular television services that will compete directly with coax cable services.

• August 16: AT&T and McCaw Cellular announced that, rather than buying a minority interest in McCaw as previously announced, AT&T intends to acquire the entire company. If approved, the $17 billion deal will be the second largest corporate acquisition in history and will transform the telephone business in the U.S. and around the world.

• August 24: As a result of a lawsuit filed by Bell Atlantic, a federal judge ruled that the prohibition that prevents the phone companies from offering video services is unconstitutional. If this ruling stands (and we believe that it will), it opens up the floodgates for telephone companies to compete directly with cable companies.

• August 24: Continental Cablevision announced that it will offer its subscribers (expensive) connection to the Internet.

• Also in late August: More and more information about AT&T’s ambitious plans began to filter out including:

– Extraordinarily high-speed lasers (that will dramatically increase the data rates over fiber-optic trunks).
– Ties to the Viacom and Time Warner interactive cable test sites.
– A series of initiatives in the cellular, PCS (wireless personal communication services) and CDPD (cellular transmission of digital data) arenas that will help to leverage the McCaw deal.
– New investments in the hand-held wireless digital assistant and interactive game markets.

• September 1: The first implementation of re-regulation of cable TV rates and services took effect Sept. 1. The net effect of a law inspired by consumer revolt over rising cable rates: rates did not go down. For most users, the great push for re-regulation of cable rates and services yielded no tangible benefit.

The combined effect of these events is almost certainly fatal to the established division of “turf” between phone companies, cable companies and cellular providers, and between local and long-distance services.

Jonathan Seybold