Weathering the telecom storm

Deregulating US telephone services has been the holy grail of free marketers for decades. In the wake of a stock market bust that has hit telecommunications stocks particularly hard, The McKinsey Quarterly talked to Reed Hundt, a McKinsey adviser and recent chairman of the US Federal Communications Commission, about the future of the telecommunications industry and how to make deregulation work.

Hundt took over the FCC chairmanship in 1993, under President Bill Clinton, after a career practicing law. The biggest event of his four-year tenure was the passage of the 1996 Telecommunications Act, the first major legislative reform of the industry since the 1934 Communications Act, which made AT&T a regulated monopoly and established the principle of universal coverage. Hundt and the FCC designed the regulations to implement this reform and to translate its procompetition goals into reality.

Q: What do you think about the telecommunications industry today and about the progress of deregulation?
A: Looking at the industry right now reminds me of Snoopy, when he writes the first line of his novel in the cartoon strip Peanuts: "It was and dark stormy night." The big companies are burdened by debt; the new competitors are starved for capital; the equipment providers are on thin ice; and the component providers are seeing their revenue expectations unmet. It?s a brand new experience for communications companies, which have been protected from downside risk as well as denied the upside of growing markets and rewards for innovation. But that?s our brave new world: Now the old communications companies are supposed to face more competitive pressure and to become more innovative and efficient as a result.

The Clinton administration, Congress and the FCC supported the 1996 act in order to increase competition and to promote investment in the most important activity of the country: the information sector. This part of the economy was then about 7 percent of the whole, and five lanes of the information highway ran toward the future: broadcast, cable, wire, wireless and satellite. Since the passage of the 1934 Communications Act, these had been legally separate industries; for the most part, none was permitted to compete with any of the others. Each was regulated so as to work well and to earn steady but unspectacular profits. FCC rules drew the dividing lines and kept the monopolies intact. The 1996 act busted this old world apart.

That increased competition has made for some rough sledding. ICG Communications, Iridium, NorthPoint Communications and Winstar Communications, for example, are in bankruptcy and others might follow. If the whole industry goes bust, it?s not good for anyone.
I?m not sure that?s true. For the most part, the boom in building data networks will benefit the entire economy for years to come, but maybe not all shareholders. This sort of evolution has happened many times before. And the whole industry is far from bust, although I do think we need to see capital providers stepping up to the plate for new companies that are innovating and developing new technologies. The Bells? share of business customers has dropped. The new competition is forcing the Bells to respond.

Technologically, we have made vast improvements and discoveries. Some companies may have managed their investments poorly, but now there are countless miles of fiber that have been laid, and tower sites on hills, and satellites up in the sky that will be useful assets for decades. That?s what competition was supposed to do.

If you were to do things again, would you have tried to insist on another factor to get the former Bell companies to open their local markets, in addition to the "carrot" of entry into the long-distance market?
If you want competition in a hurry, you should minimize litigation. The 1996 legislation was written vaguely because Congress wanted to please everybody. As it was, instead of giving the national regulatory agency the power to set interconnection prices, the statute was ambiguous, so the authority of the FCC to determine the prices for new competitors to interconnect with the Bell local loops was challenged. This cost methodology is the same policy the United States has argued for in trade negotiations globally. In fact, it?s easier to convince France than Mississippi, easier to get 69 countries to agree to a WTO treaty than to get 50 states to accept FCC rulemaking.

In any case, the market is getting more competitive. Long distance is the best example. Deregulation was started in the early 1980s, when AT&T had the entire market. By the mid-1990s, AT&T?s market share was down to less than 50 percent in the enterprise market but still 70 percent in the consumer market. That?s what we are seeing in the local communications market: competitors are now making inroads in the enterprise space.

The only real question is whether government procompetition policies will remain consistent.

What do you mean?
The appellate court ruled that NextWave still owns the spectrum it bought in auction from the federal government but hasn?t paid for. I don?t want to debate the merits of that decision. But the fact is that the spectrum has been slow to be put into use and to offer customers more choices, such as different types of wireless communications devices, because the companies involved are mired in litigation. Auctions are currently on hold. The federal government has to make the rules very clear and then enforce them.

I am also concerned about the growth and development of the Internet. One of our primary policy goals when I was in government was to have the Internet become a mass-market phenomenon. That has happened with narrowband connections, but I?m not sure the current policy makers have the same commitment to making broadband universal. I think it would be a major mistake and a cause of great regret if we didn?t make the commitment to low-cost, high-speed Internet access that is always on, for everyone and everywhere in this country.

Some might call that more of a luxury than a right.
A right to information is essential. It is not unusual for a new medium to be embraced by government so that the medium will become universal. Bell Labs was funded partly to develop new low-cost methods to extend telephone access. Transistors were developed to replace vacuum tubes as part of the research seeking an electronic switch to replace manual or mechanical switching in telephone systems. It is ironic that the transistor, which grew out of research into improved telephone switching, eventually spawned the Internet, which will overturn the Bell companies? local monopoly. But the point is that a government policy ensuring universal coverage forced innovation that was of benefit to everyone, including the many businesses that sprung up as a result of the policy.

Although the 1996 act didn?t mandate universal Internet access.
Reed Hundt: It wasn?t mandated, but we tried to make the Internet universal in two ways. Number one, let?s put it in every classroom where the next generation will be trained on it, using government money. The country went from 3 percent of classrooms with an Internet connection in 1994 to 77 percent today. It?s been the fastest-growing innovation in education since chalk. Second, we wanted competition to rule the Internet. By promoting competitive ISPs, we kept the price of Internet access low. Today everyone thinks it?s a God-given right to be on the Internet. In my view, that?s great. I?d like everyone to have the same view of broadband--because that would spur massive investment, job creation, productivity gains, and, I hope and believe, advances in health care and education.

We have 55 percent household Internet penetration--twice that of Europe and three times that of Asia. Yet this version of the Internet is like black-and-white TV compared with color TV. This is narrowband; broadband is next.