Lessons learned from the U.S. unbundling experience.

• Author: Ford, George S.

TABLE OF CONTENTS I. INTRODUCTION II. REVIEW OF THE 1996 ACT'S UNBUNDLING REQUIREMENTS A. What Gets Unbundled? B. Pricing of Unbundled Elements C. The Quid Pro Quo of Section 271 D. Summary III. ECONOMIC FUNDAMENTALS OF NETWORK COMPETITION IV. REGULATED ACCESS TO THE NETWORK AND SABOTAGE V. THE RISE OF ALTERNATIVE DISTRIBUTION PLATFORMS VI. CONCLUSION AND POLICY RECOMMENDATIONS APPENDIX A: RELEVANT FCC ORDERS AND COURT CASES A. Local Competition Order B. Iowa Utilities Board v. FCC C. AT & T v. Iowa Utilities Board D. The Commission's UNE Remand Order E. Availability of Enhanced Extended Links ("EELs") F. Line Sharing Order G. Iowa Utilities Board v. FCC (Remand Decision) H. Verizon v. FCC I. United States Telecom Association v. FCC (USTA I) J. Competitive Telecommunications Association v. FCC K. Triennial Review Order L. United States Telecom Association v. FCC (USTA II) M. Triennial Review Remand Order I. INTRODUCTION

Prior to 1996, one of the key unresolved issues in telecommunications restructuring was competition over the "last mile"--i.e., that last segment of the network necessary to connect the customer. (1) Although the Federal Communications Commission ("FCC") had opened some monopoly telecommunications markets to entry by the late 1980s (e.g., Customer Premise Equipment ("CPE") and "long distance" services), (2) the Communications Act of 1934 (3) still reflected a presumption that local telecommunications markets were natural monopolies subject to regulation by both the FCC and state public utility commissions. (4) Indeed, despite the somewhat regular deployment of state-of-the-art national and regional long-haul networks and metropolitan fiber rings by a number of carriers, the deployment of alternative wireline networks ended when they reached into the local exchange, leaving dominant control of most switching and transport facilities, and particularly the "last mile" of the local exchange network, to the Incumbent Local Exchange Providers or "ILECs." (5)

Frustrated by the lack of local competition, Congress passed the landmark Telecommunications Act of 1996. (6) At the centerpiece of the 1996 Act was the most ambitious regulatory intervention ever attempted: i.e., to stimulate local competition by forcing the ILECs to make unbundled network elements available to competitors at regulated rates. (7) The notion of stimulating facilities-based competition via a mandatory wholesale model was not without precedent, however. In large part, Congress's plan was to replicate the experience of competitive development in the U.S. long-distance market a decade before, where early entrants were permitted to resell the capacity of the then-monopoly long distance carrier AT&T, thereby allowing the new firms to offer services ubiquitously. (8) Over time, as the business of the new entrants grew, these new competitors would construct their own networks and move away from resale. (9) Following this "stepping stone" theme, the 1996 Act required, among other things, the ILECs to unbundle various components of their local networks and make them available to potential competitors, thus "sharing" with their competitors the inherent economies of scale built into their ubiquitous local networks. (10)

As a result of the 1996 Act, financial resources poured into the communications industry at a frenzied pace. (11) In the fifteen years preceding the 1996 Act, the capital stock of telecommunications firms grew on average at an annual rate of 3.0%. In the few years after the 1996 Act, the annual average increase in telecommunications capital stock was 7.9%. (12) In the five years following the passage of the Act, the U.S. capital stock in telecommunications plant was $194 billion above trend, or about 36% above the forecast level. (13) The increase in capital expenditures in the communications industry actually began in 1994, at which time a sizeable equity bubble began to inflate in the U.S. economy. (14) Part of the rise in capital investment can be attributed this bubble, which burst in the Spring of 2001, and a vigorous decline in industry investment immediately followed. (15) Nevertheless, by 2004, Competitive Local Exchange Carriers ("CLECS") would be serving about 20 million of their 33 million access lines (about 20% of the total market) using unbundled elements made available by the rules implementing the 1996 Act. (16)

Despite this initial success, via a series of orders by the FCC and court decisions, the scale and scope of the 1996 Act's unbundling regime was increasingly narrowed, culminating in the FCC's Triennial Review Order (17) in 2005 that effectively rendered most business plans based on unbundled network elements financially unviable. After that, the effort to stimulate local telecommunications competition via unbundled elements came to a screeching halt. Indeed, from 2004 to 2010, the number of lines serviced using unbundled elements would fall nearly 90% from a peak of about 21 million to only 3 million lines, largely due to the elimination of the unbundled switching element which serviced most of the competitive lines. (18) The decline continues: over the last three years for which data is available (2001-2010), the number of access lines served using unbundled elements has declined at a rate of 22% annually. (19) By the end of 2010, unbundled switching was all but gone, with competitive lines served using the switching element falling from about 11 million in 2004 to only 53,000 lines at the end 2010. (20) With mixed success, the ILECs have requested grants of forbearance from their unbundling obligations, drawing ever nearer the official end of the unbundling experiment in the United States. (21) As to be expected, most of the competitive carriers who relied on the unbundling regime--including the long-distance telecommunications behemoths AT&T and MCI--are now gone, some dying quickly, some slowly, and some eventually acquired by the ILECs. (22)

Yet, despite the failure of the unbundling paradigm mandated by the 1996 Act, the world did not end. Quite to the contrary, competition in the United States is nonetheless thriving due to new technologies totally unforeseen in 1996. As lines served by unbundled elements declined, the total number of lines served by competitors would soon begin to grow again and eventually skyrocket to over 50 million landlines (by recent measure), with the growth coming mostly from the commercial emergence of Voiceover-Internet-Protocol technology ("VoIP"), which permitted voice services to be provided over broadband Internet connections. (23) Local competition in the United States, it turns out, was not the result of new entrants constructing new plant, but from the repurposing of the embedded cable television plant and the migration of many households to the exclusive use of mobile wireless services. Today, between VoIP providers and wireless substitution, the once-dominant ILECs serve fewer than half of all access lines, a decline in market share that few industry analysts thought possible. (24)

Today, the United States' experiment with unbundling is all but over, (25) with only a few clinging to the possibility of an unbundling renaissance. (26) Much modern day support for unbundling networks suffers from a lack of direct experience with its implementation in this country (or else are the residual users of network elements). In this Article, we present a brief summary of the rise and ultimate demise of the United States' experiment with unbundling. With the benefit of hindsight and extensive experience, we contend that three fundamental defects underlying the United States' unbundling paradigm gave it little prospect for success over the long-term--dooming unbundling nearly from its conception. In so doing, we hope that this Article will provide some guidance to policymakers as they contemplate regulatory interventions across a range of settings.

The formulation and dismantling of unbundling policy in the United States spanned an intense eight years, so our review is by no means exhaustive. We apologize for excluding the discussion of an issue, order, or court decision that the reader may find far more relevant than those we discuss, and we suspect there are many. For those readers with battle scars, we hope this review brings back fond memories of what has to be one of the most exciting periods in the recent history of telecommunications policy.

While it is tempting to place blame on particular regulatory or legal decisions, and even the personalities associated with these decisions, the demise of the unbundling regime in the U.S. was driven (in our view) by three underlying economic causes which policymakers failed to fully comprehend: (a) the expectations of policymakers for competitive "green field" facilities-based entry into the local market were, at the time of the enactment of the 1996 Telecommunications Act, unrealistic; (b) the unbundling regime was incentive incompatible in that the incumbent local phone companies were required to surrender market shares to entrants at regulated prices without any permanent offsetting benefit; and (c) the rise of new alternative distribution technologies such as cable, wireless and over-the-top services that expanded the availability and quality of competing voice services.

Importantly, we make no consumer welfare claims about the desirability of unbundling or its failure. In fact, we pass no judgments on the unbundling regime at all, but merely present what we believe to be the underlying and fundamental economic forces that led to its now trivial role in the development of competition in the United States local telephone market. We do so because we believe these same factors are relevant in a variety of settings, both domestically in the United States and abroad. (27)

To explore these important topics in greater detail, this paper is organized as follows: In Part II, we begin with an overview of the...