I’ve discussed at some length how critical it is that the physical infrastructure be built out to provide broadband connections to homes. I described the competition in the United States, and the strategies of the telephone and cable industries, the major players. The cable companies are younger and smaller than the big telephone companies and tend to be more entrepreneurial. Cable television networks provide customers with one-way broadband video through a web of coaxial, and sometimes fiber-optic, cable. Although the penetration rate worldwide is quite low—189 million subscribers—cable systems run past nearly 70 percent of all American homes, and into 63 million of them. Already, cable systems are gradually being converted to carry a digital signal, and a number of cable companies are working to provide PC users with connections to the Internet and on-line services. They’re gambling that many PC users accustomed to downloading information on a telephone line at 28,800 bits per second will be willing to pay more to download information through their television cable at 3 million bits per second.
As for the phone companies, they are much stronger financially. The American telephone system is the world’s largest switched-distributed network providing point-to-point connections. The combined local telephone exchange market, with annual revenues of about $100 billion, is far more profitable than the $20 billion U.S. cable business. The seven regional Bell operating companies (RBOCs) will compete with their former parent, AT&T, to provide long-distance, cellular, and new services. But, like phone companies around the world, the RBOCs are new to the competitive world, just emerging from their heritage as heavily regulated utilities.
The local phone companies will be motivated by increased competition. They are in a defensive position. Other phone companies and cable companies are going to want to offer telephone as well as other communications services in their areas. New regulations will unleash this competition and, as I’ve already noted, the cost of long-distance voice-telephone service will drop dramatically. If that happens, phone companies will be deprived of much of their current profitable revenue.
The companies providing local service have slowly been introducing advanced digital transmission capabilities into their networks. They haven’t felt pressure to hurry, because until now it seemed they were protected from competition by the large financial barriers to market entry. They knew a potential rival would have to make a duplicate investment of, say, $100 million in equipment in order to compete in a given community. But the costs of switching equipment and fiber are coming down every year.
This means the companies are faced with the sort of decision that has confronted almost everyone who has contemplated buying a PC. Do you wait for prices to come down and performance to improve, or do you bite the bullet and start getting use out of the equipment sooner? The dilemma will be acute for some network companies. They will have to move very fast and upgrade constantly. A company will get bargain prices if it waits long enough before making investments in cabling and switches, but it may never recover the market share it will have lost to less cautious competitors.
Phone companies, despite their enviable revenues, could be strapped for the cash required to fund the expensive upgrade of the new network, because regulatory rate commissions may not permit them to raise telephone rates or even to use profits from current service to cross-subsidize this new kind of business. Shareholders, accustomed to attractive dividends from the RBOCs, might balk at a diversion of profits to build the information highway. For more than a hundred years telephony has been quietly making its profits as a regulated monopoly. Suddenly the RBOCs must become growth companies, which is about as radical as turning a tractor into a sports car. It can be done (just ask the folks at the Lamborghini Company, which makes both), but it’s hard to do.
The opportunity to provide ISDN to PC users will provide new revenues to phone companies that want to bring the price levels down to establish a mass market. I expect ISDN adoption to get off to a faster start than PC cable modes. Phone companies are doing some clever work to find out how to use their twisted-pair connections for at least the last few hundred feet to the home and still deliver broadband data rates. Phone and cable companies can both succeed as demand for new services increases their revenue opportunities.
The ambitions of cable and phone companies go well beyond simply providing a pipe for bits. Imagine you are running a bit-delivery company. Once you own a network in a given area and have hooked up most of the homes, how can you make more money? By getting customers to consume more bits, but there are only twenty-four hours in a day for people to watch TV or sit at their PCs. If you can’t ship more bits, an alternative is to have a financial interest in the bits being shipped. Many see the highway as a sort of economic food chain, with the delivery and distribution of bits at the bottom, and various types of applications, services, and content layered on top. Companies in the bit-distribution business are attracted to the idea of moving themselves up the food chain—profiting from owning the bits rather than from just delivering them. This is why cable companies, regional telephone companies, and consumer-electronics manufacturers are rushing to work with Hollywood studios, television and cable broadcasters, and other content businesses.
Some companies are investing because they are afraid not to. For a long time distribution has been pretty lucrative, largely because of the monopolies granted by the government. As these monopolies disappear and competition begins, bit distribution might become less profitable. Companies that hope to participate in the creation of the applications and services and enter the content business through investment and/or influence want to move now, while the opportunities are open. Some of these companies may choose to give away or subsidize the set-top box that connects up the television set. Part of their strategy could be to offer, for a single monthly fee, the connectivity to the highway, the set-top box, and a package of programming, applications, and services to go with it. Cable TV systems work this way, and telephone companies in the United States used to, before deregulation.
Network operators that include the set-top box as part of the standard service fee will attract customers who might hesitate to spend several hundred dollars to buy one. As I explained, in the early years there is a real danger that the box will quickly become obsolete, so why buy one? Although supplying the boxes will increase the up-front capital required by the network operator, the outlay will be worth it if it helps create a critical mass of users. But government regulators worry that allowing the network operators to have control of the boxes will put them in a position to capitalize on their privileged position. A network operator that owns the boxes could also seek to exert control over what software, applications, and services run on those boxes. There could be limited choices for studios that wanted to sell their movies. Whether or not to allow various services equal access to the wires and boxes is one of the tough issues deregulation is going to have to address. One argument for equal access is that if multiple services can use the same wire, the government can avoid setting standards for those services and their interoperability.
Retailers would like the opportunity to sell you the set-top boxes. After all, they already sell the TV sets and PCs, so why not the set-top box too? Consumer-electronics companies want to compete to manufacture