If there is one thing I have learned in almost 23 years of covering communications and media regulation it is this: No matter how well-intentioned, regulation often has unintended consequences that hurt the very consumers the rules are meant to protect. Case in point: “universal service” mandates that require a company to serve an entire area as a condition of offering service at all. The intention is noble: Get service out to everyone in the community, preferably at a very cheap rate. Alas, the result of mandating that result is clear: You get less competition, less investment, less innovation, and less consumer choice. And often you don’t even get everyone served.

Consider this Wall Street Journal article today, “Google Fiber Is Fast, but Is It Fair? The Company Provides Neighborhoods With Faster and Cheaper Service, but Are Some Being Left Behind?” In the story, Alistair Barr notes that:

U.S. policy long favored extending service to all. AT&T touted its “universal service” in advertisements more than a century ago. The concept was codified in a 1934 law requiring nationwide “wire and radio services” to reach everyone at “reasonable charges.” In exchange for wiring a community, telecommunications providers often gained a monopoly. Cities made similar deals with cable-TV providers beginning in the 1960s.

The problem, of course, is that while this model allowed for the slow spread of service to most communities, it came at a very steep cost: Monopoly and plain vanilla service. I documented this in a 1994 essay entitled, “Unnatural Monopoly: Critical Moments in the Development of the Bell System Monopoly.” As well-intentioned regulatory mandates started piling up, competition slowly disappeared. And a devil’s deal was eventually cut between regulators and AT&T to adopt the company’s advertising motto — “One Policy, One System, Universal Service” — as the de facto law of the land.

It took us almost a century to dig ourselves out of that mess and move towards telecommunications competition. Alas, we’re still living with the vestiges of this old regulatory mentality. Cities and counties across America still impose a wide variety of “universal service” regulatory mandates. Again, their intention is noble: They want everyone in their community served. You can’t blame them for that. But the result is still the same: Limited facilities-based competition and investment.

And so we return to today’s Wall Street Journal story about Google Fiber, which explains how local officials are finally starting to understand these realities. The story notes:

In 2011, Google struck a deal with authorities in both Kansas City, Kan., and Kansas City, Mo., to build the service based on customer demand. City officials say they didn’t push hard for universal coverage because they thought faster Internet service would boost the local economy and they were competing against so many other cities. “The main point was to win and bring that infrastructure to our city,” said Rick Usher, assistant city manager of Kansas City, Mo. As phone and cable companies slowed their own expansion plans, more cities allowed the selective approach.

Google’s ‘build-to-demand’ model is catching on because it produces results: More infrastructure investment, innovation, and competition. Traditional telecom and broadband operators are prepared to step up investment, too, when the incentives are right:

Verizon was required by cities and some state laws to build and offer its FiOS service widely across cities. It stopped expanding to new cities in 2010; to date, it has spent more than $23 billion on the FiOS rollout. Chief Financial Officer Fran Shammo said in March that the company wouldn’t expand to additional markets until FiOS had “finally returned its cost of capital.” If Verizon resumes expansion, the company would consider Google’s build-to-demand model because it has the potential to be more profitable, said Chris Levendos, a Verizon executive overseeing the FiOS build-out in Manhattan. Others are doing just that. AT&T said in April it would offer Internet speeds of up to one gigabit in as many as 100 cities. It is building to demand and working with local authorities to reduce construction costs, the company said. Tuesday, it said it would bring the high-speed service to Cupertino, Calif., close to Google’s headquarters. This approach “starts to make this business model look quite attractive,” John Stankey, AT&T’s chief strategy officer, said at an investor conference on Aug. 13.

Again, when you get the incentives right and give investors and innovators a green light, they will seize the opportunity. And that’s even true — actually, it is especially true — for high fixed-cost investments like fiber networks.

But wait, aren’t there some pockets of the population that will fall through the cracks under this alternative arrangement? In the short-term, potentially yes. But the right answer to that “digital divide” problem is never to restrict short-term investment and innovation opportunities just because you think you have a better, more “well intentioned” plan. That is the crucial mistake policymakers made in the past. Their desire to get everyone served at the exact same time with the exact same plain vanilla service meant we got sub-optimal technologies and stagnant markets with little hope of any new innovation or investment over the long-haul.

This is how “universal service” consistently fails us. Universal service sells us short. It sells human ingenuity short. The logic that motivates universal service regulation is that: ‘Well, this is about the best we can do. Let’s just get everyone some basic level of service and that will be just and good.’  Can you imagine if we would have applied this logic to other major markets and technologies?!

But what about the under-served communities? First, when you allow new innovation in networks, you never know how or where they might spread next. If you have more competitors offering unique networks architectures and services, there is a very good chance that entrepreneurial minds will figure out how to push out the boundaries of what is possible, especially in terms of how the service is delivered.

Consider this: Back in the old days, did it really make sense to try to stretch a thin copper wire way, way out into the middle of every valley, desert, farm field, and mountain? The myopic universal service mindset says: ‘Well, that’s all we had at the time.’ Perhaps for a time it really was. But how much quicker might we have seen some sort of alternative system if we hadn’t locked in those old assumptions as policy requirements? Is it impossible to believe that wireless technologies might have developed much more quickly if the incentives would have been right? Again, there was no reason for any innovators or investors to even consider the idea at a time when policymakers were mandating copper wires be stretched to every corner of the land, and as they were showering favored companies with subsidies to achieve that goal. That’s not something a new innovator could compete with, and so no one did. It would have been like policymakers saying we needed a “universal service” policy for cheap hamburgers for the masses and then showering McDonald’s with subsidies since they were the first one in many local markets who could deliver on that promise. Had we had such a universal cheap hamburger policy, do you think any other fast food places would have ever come to town and tried to compete against those subsidized burgers? Not likely.

The lesson for today’s policymakers is clear: Open up markets, relax regulatory burdens, eliminate discriminatory taxes and subsidies, and clear away other barriers to investment. Then see what happens. As the Google Fiber experience suggests, innovative minds can and will emerge to offer constructive solutions and slowly spread new networks and technologies.

OK, but won’t there still be some communities that are underserved, even with all that new innovation and investment. It’s certainly possible. And where those communities exist, some government action may be necessary to incentivize the spread of some sort of network to them, or even have the government build it for the community. I’m not opposed to that. (Have you ever driven through the hills of West Virginia or the mountains of rural Western states? Hard places to get wired networks out to!) I’m not very optimistic local governments will do a very good job of building sophisticated networks because they already have a horrible track record in this regard. But, again, I don’t oppose local action on this front if no other alternatives appear after a certain period of time.

But, again, the answer here is not crazy national and state-based universal service mandates that regulate everyone in every community as if they had the same problem. Let competition and innovation work its magic where it can and do not mess that up. Where it proves much harder for that network competition and innovation to take root, use smart incentives to get companies to build out their networks further, or offer alternative wireless infrastructure of some sort, or just have the government build the networks themselves. But we should always give competition and innovation the benefit of the doubt and see what happens first.

So, let me perfectly clear what I am saying here: GOOD INTENTIONS ARE NEVER ENOUGH! [And yes, I am using all caps because I am shouting!] The next time somebody starts mouthing something about how they have the moral high ground in these debates because their intentions are supposedly pure as the driven snow, ask them to show you results. Tell them you want evidence that their intentions have actually produced something concrete and positive for society. If their answer is, in essence, ‘Well, with our regulatory mandates we can at least get everybody some basic level of really crappy monopoly service,’ then tell them that they can take their good intentions and shove them. We can do better.

Google’s announcement this week of plans to expand to dozens of more cities got me thinking about the broadband market and some parallels to transportation markets. Taxi cab and broadband companies are seeing business plans undermined with the emergence of nimble Silicon Valley firms–Uber and Google Fiber, respectively.

The incumbent operators in both cases were subject to costly regulatory obligations in the past but in return they were given some protection from competitors. The taxi medallion system and local cable franchise requirements made new entry difficult. Uber and Google have managed to break into the market through popular innovations, the persistence to work with local regulators, and motivated supporters. Now, in both industries, localities are considering forbearing from regulations and welcoming a competitor that poses an economic threat to the existing operators.

Notably, Google Fiber will not be subject to the extensive build-out requirements imposed on cable companies who typically built their networks according to local franchise agreements in the 1970s and 1980s. Google, in contrast, generally does substantial market research to see if there is an adequate uptake rate among households in particular areas. Neighborhoods that have sufficient interest in Google Fiber become Fiberhoods.

Similarly, companies like Uber and Lyft are exempted from many of the regulations governing taxis. Taxi rates are regulated and drivers have little discretion in deciding who to transport, for instance. Uber and Lyft drivers, in contrast, are not price-regulated and can allow rates to rise and fall with demand. Further, Uber and Lyft have a two-way rating system: drivers rate passengers and passengers rate drivers via smartphone apps. This innovation lowers costs and improves safety: the rider who throws up in cars after bar-hopping, who verbally or physically abuses drivers (one Chicago cab driver told me he was held up at gunpoint several times per year), or who is constantly late will eventually have a hard time hailing an Uber or Lyft. The ratings system naturally forces out expensive riders (and ill-tempered drivers).

Interestingly, support and opposition for Uber and Google Fiber cuts across partisan lines (and across households–my wife, after hearing my argument, is not as sanguine about these upstarts). Because these companies upset long-held expectations, express or implied, strong opposition remains. Nevertheless, states and localities should welcome the rapid expansion of both Uber and Google Fiber.

The taxi registration systems and the cable franchise agreements were major regulatory mistakes. Local regulators should reduce regulations for all similarly-situated competitors and resist the temptation to remedy past errors with more distortions. Of course, there is a decades-long debate about when deregulation turns into subsidies, and this conversation applies to Uber and Google Fiber.

That debate is important, but regulators and policymakers should take every chance to roll back the rules of the past–not layer on more mandates in an ill-conceived attempt to “level the playing field.” Transportation and broadband markets are changing for the better with more competition and localities should generally stand aside.

In a recent post, Tim Lee does a good job of explaining why facilities-based competition in broadband is difficult. He writes,

As Verizon is discovering with its FiOS project, it’s much harder to turn a profit installing the second local loop; both because fewer than 50 percent of customers are likely to take the service, and because competition pushes down margins. And it’s almost impossible to turn a profit providing a third local loop, because fewer than a third of customers are likely to sign up, and even more competition means even thinner margins.

Tim thus concludes that

the kind of “facilities-based” competition we’re seeing in Kansas City, in which companies build redundant networks that will sit idle most of the time, is extremely wasteful. In a market where every household has n broadband options (each with its own fiber network), only 1/n local loops will be in use at any given time. The larger n is, the more resources are wasted on redundant infrastructure.

I don’t understand that conclusion. You would imagine that redundant infrastructure would be built only if it is profitable to its builder. Tim is right we probably should not expect more than a few competitors, but I don’t see how more than one pipe is necessarily wasteful. If laying down a second set of pipes is profitable, shouldn’t we welcome the competition? The question is whether that second pipe is profitable without government subsidy.

That brings me to a larger point: I think what Tim is missing is what makes Google Fiber so unique. Tim is assuming that all competitors in broadband will make their profits from the subscription fees they collect from subscribers. As we all know, that’s not how Google tends to operate. Google’s primary business model is advertising, and that’s likely from where they expect their return to come. One of Google Fiber’s price points is free, so we might expect greater adoption of the service. That’s disruptive innovation that could sustainably increase competition and bring down prices for consumers–without a government subsidy.

Kansas City sadly gave Google all sorts of subsidies, like free power and rackspace for its servers as Tim has pointed out, but it also cut serious red tape. For example, there is no build-out requirement for Google Fiber, a fact now bemoaned by digital divide activists. Such requirements, I would argue, are the true cause of the unused and wasteful overbuilding that Tim laments.

So what matters more? The in-kind subsidies or the freedom to build only where it’s profitable? I think that’s the empirical question we’re really arguing about. It’s not a forgone conclusion of broadband economics that there can be only one. And do we want to limit competition in part of a municipality in order to achieve equity for the whole? That’s another question over which “original recipe” and bleeding-heart libertarians may have a difference of opinion.

I somehow missed this excellent ITIF paper by Robert D. Atkinson and George Ou when it came out at this point last year, but George has just dusted it off, made a couple of updates, and re-posted it over at the Digital Society blog. Worth reading. It touches on a lot of the same case studies I have been documenting in my ongoing series, “Problems in Public Utility Paradise.”  In particular, it focuses on the UTOPIA and iProvo fiascos out in Utah. Here’s a key takeaway from those case studies:

The lessons learned in Utah is that projected uptake models and deployment plans don’t always come to fruition, and when that happens the consequence is failure.  For UTOPIA, the project was projected to reach 35% uptake rates by February 2008 but the reality was less than 17% uptake.  UTOPIA had also hoped for 17% uptake from lucrative business customers but the reality was only 2 to 3 percent.  Provo County’s iProvo was hoping for 10,000 subscribers by July 2006 with the assumption that 75% of those customers would subscribe to lucrative triple play services, but the reality was 10,000 customers in late 2007 with only 17% of those customers subscribing to triple play.  Many consumers were quite happy to subscribe to existing broadband cable or telecom providers.  The consistent theme in Utah was an overestimation of the uptake rates and the underestimation of competition from incumbent cable operator Comcast and telecom operator Qwest which led to consistent underperformance.

Ouch. For more details, see this old essay of mine about UTOPIA from 2008, and this piece from last Sept about iProvo. Not a pretty picture. As I say every time I pen a piece about the latest muni failure du jour, these case studies should serve as a cautionary tale about the dangers of grandiose, centrally planned broadband schemes. There is no such thing as a free lunch. Network-building is hard, and politicians usually aren’t that good at doing it.

FWIW…  Just upgraded — at no cost — to Verizon’s 20/5 FIOS plan. Been hitting almost 25 megs pretty consistently today. I was on Verizon’s 10/2 plan beforehand and the 5/2 plan before that. Didn’t notice as much of a difference when I moved from 5 to 10, but jump to 20 is definitely noticeable on big file downloads.

Cox Cable has also been offering nice speed boosts in my neighborhood (McLean, VA) recently, so I suspect that’s why I was offered the free upgrade yesterday when I called Verizon about adding some new HD channels to my FIOS TV package.

Ken Ferree and I just filed an amicus brief with the D.C. Circuit in what could be among the most important First Amendment cases involving economic regulation in years:  Comcast’s challenge to the FCC’s cap on the maximum size of a cable operator’s nationwide subscriber-audience.  While few may feel righteous indignation at limitations targeted at large corporations such as Comcast or Time Warner, the larger principle at stake here is deeply important: Will the First Amendment provide a meaningful check on what USC law professor Chris Yoo has called “architectural censorship” (i.e., so-called “structural” regulations that “have the unintended consequence of reducing the quantity, quality, and diversity of media content”).

In a nutshell, we argue that that:

1. The provisions of the 1992 Cable Act authorizing the FCC to impose a “cable cap” are outdated in world of media abundance and vibrant platform competition.
2. Because cable is no longer the unique “bottleneck” or “gatekeeper” that it was in 1992, these statutory provisions (not just the FCC’s 30% rule) must be subject to strict scrutiny under the First Amendment as a limitation on free speech.
3. Because there are “less restrictive means” of ensuring cable operators do not impede the flow of video programming to consumers, the court should strike down these provisions.
4. Even if the court upholds the statute, it should nonetheless strike down the cap issued by the FCC in December 2007 (30% of all Multichannel Video Programming (MVPD)  subscribers as based on an outdated model of the video marketplace.

I encourage you to read our brief (below).  I’ve provided a summary below, along with some additional commentary we just couldn’t cover under our 3500 word limit.

Strict Scrutiny.  Yoo’s article Architectural Censorship and the FCC is essential reading for anyone who believes that government regulations on the size and shape of the “soapbox” can have huge effects on speech itself.   Yoo argues that the First Amendment should check this kind of regulation–however “content-neutral” it might seem–under “strict scrutiny”, which requires that the government show that a regulation is the “least restrictive means” available for advancing a “compelling government interest.”  But Yoo ultimately concludes (pp. 713-718, PDF pp. 45-50) that, under existing precedent, most “architectural censorship will be effectively insulated from meaningful judicial review.”  Yoo explains that the Supreme Court’s 1983 decision in Minneapolis Star & Tribune Co. v. Minnesota Commissioner of Revenue, “appeared to entertain the possibility of subjecting structural restrictions to strict scrutiny even in the absence of facial content discrimination or content-based motive.”  But in its 1991 Leathers v. Medlock decision, the Court “foreclose[d] any prospect that Minneapolis Star and its progeny would serve as a check on architectural censorship” by limiting the Minneapolis Star line of precedents to cases where “a statute of general application affects a small number of speakers.”  The Court reaffirmed this position in its 1994 Turner I decision, when it applied intermediate, rather than strict, scrutiny to the Cable Act’s “must-carry provisions,” which require nearly all cable operators to carry certain television broadcast signals.  Intermediate scrutiny requires only that important governmental interests that are furthered by “substantially related means.”

Unfortunate as the Leathers/Turner I line of cases is for those concerned about architectural censorship, the cable cap is exactly the sort of regulation that falls within the reduced scope of Minneapolis Star as “affect[ing] a small number of speakers” because, unlike the Cable Act’s must-carry provisions, the cap limits the speech of only the very largest cable operators.  So the question of whether the Court should default to intermediate scrutiny as it did in its 2000 Time Warner I decision (when the cap was first challenged) should turn entirely on the question of whether cable still has the “special characteristic” of “bottleneck” or “gateekeeper” power despite all the changes in the media marketplace since 1992 and even in just the last eight years.

The Modern Media Marketplace.  The subscriber limitation provisions of the Cable Act were intended to prevent cable operators from “unfairly impeding the flow of video programming.”  Yet each of the key premises behind these provisions has been disproven:

1. Increased horizontal concentration of the cable industry has, far from reducing media choices, been accompanied by an explosive growth in the amount and diversity of video content available to consumers.
2. The rate of “vertical integration” (i.e., ownership of cable programmers by cable operators), which Congress feared would cause cable operators to discriminate against unaffiliated programmers, has plummeted.
3. Cable’s share of the MVPD market has also plummeted dramatically, with the two DBS providers now sharing 1/3 of the MVPD market and representing the second and third largest MVPDs

Two charts say it all.  First, from Adam Thierer’s excellent book Media Metrics, the number of programming services (cable channels) has grown by nearly six-fold by 1992, while the rate of vertical integration has plummeted:

(That chart stops in 2006 (based on 2005 data) because the FCC still has not released the 2007 Video Competition Report, which it approved in December 2007.  Since then, Time Warner Cable has been spun off of Time Warner’s content empire, so the actual affiliation rate today is likely less than 10%.)

Second, cable’s share of the MVPD market has fallen from 95% in 1992 to ~64% today:

In 1992, when consumers had only a single MVPD option, cable might fairly have been considered a “bottleneck” or “gatekeeper.”  But today, every American has at least three MVPD choices (their local cable franchisee + two DBS operators), and can also subscribe to a Telco video service such as Verizon’s FiOS.  (“Over-building” where two cable operators serve the same area is rare.)

Internet Video.  We also describe how the availability of TV content online provides yet another distribution channel for programmers:

The last two years have seen growing numbers of Americans increasingly substituting consumption of online video for MVPD video and the Internet driving popularity of MVPD content, rather than vice versa.  But only in the last year, since the adoption of the [FCC’s December 2007 order issuing the 30% cap], has the large-scale delivery of television  content online become a reality, as large numbers of programmers have begun distributing increasing numbers of complete episodes and entire series through their own websites and/or through a new class of rapidly-growing Internet Video Programming Distributor (IVPD) websites such as Netflix, Hulu, Amazon Video on Demand, iTunes, Vuze, Sony Playstation Store, the Microsoft Xbox 360 Marketplace, Joost and Veoh.  These IVPDs already offer a staggering, and growing, library of currently-airing and archived content—as much as 90% of broadcast shows and 20% of cable shows.  These sites are supported by a growing number of set-top devices (e.g., Netflix Player by Roku, TiVo) and wildly popular game consoles (e.g., Microsoft Xbox 360, Sony PlayStation 3) that allow users to play IVPD content from broadcast and cable programmers on demand on their television, while TiVo allows users to seamlessly switch between IVPD, MVPD and OTA content.

The FCC’s decision to exclude Internet video from its analysis is hardly surprising when one considers that the economic model behind the new 30% cap comes from a 2005 study based on cable market data from 1984-2001 and that the last official data released by the agency about the video marketplace date to June 2005.  But nine months later, the agency waxed ecstatic about the promise of IVPDs when doing so supported Kevin Martin’s attempts to enforce the FCC’s non-binding 2005 “Net Neutrality” policy statement:

In August 2008, the FCC even cited [the rapid emergence of IVPDs] in support of its claim of jurisdiction over Comcast’s broadband network management practices (because of alleged harm to an IVPD that distributes content through peer-to-peer file sharing):  “consumers with [broadband] service will have available a source of video programming (much of it free) that could rapidly become an alternative to cable television.”  But the immediate competitive impact of IVPDs comes not from the fact that some IVPD users are already canceling their MVPD subscriptions, but in the ease with which IVPDs can supplement an MVPD subscription—because most IVPDs are free, while those that charge for content do so on a per-episode/show basis.  Furthermore, IVPDs have little—if any—incentive not to offer a particular program because they are not subject to the same capacity constraints as MVPDs.  Thus, even if IVPD video consumption remains relatively small in its early years, IVPDs already offer programmers a strong alternative distribution channel capable of reaching all broadband users.

Less Restrictive Means. Of course, the fact that cable no longer has a special characteristic of gateekeeper or bottleneck power does not automatically render the Cable Act’s subscriber limits provisions unconstitutional; this merely means that the government must show that no less restrictive means are available to satisfy a compelling government interest.  We suggest a variety less restrictive means that could ensure competitive video distribution and programming markets.  These include dispute resolution assisted by the FCC, enforcement of existing antitrust laws, and crafting “special obligations on cable operators with more than 30% of the MVPD market to ensure that they do not unfairly impede the flow of video programming.”

Challenging The FCC’s Rule. Besides attacking the statute, we argue that the 30% cap imposed by the FCC last year is even more obviously unconstitutional than when the D.C. Circuit struck down the same limit seven years ago in Time Warner II. To many lay observers, this argument may seem like a “no-brainer” given how much more competitive the video marketplace is than it was in 2001.  But one must understand that when the Court struck down the 30% cap the first time, it did so on the grounds that the FCC’s own rationale justified not a 30% cap but a 60% cap.  The FCC had decided that the average video programmer (network) needed an “open field” of 40% of the MVPD market to be viable.  The FCC leapt from that conclusion to a 30% cap so that even if the two largest cable companies denied carriage, the programmer would still have the required 40% “open field.”  The court found that there was no evidence that the leading two cable operators would collude to deny carriage and that the statute did not “protect programmers against the risk of completely independent rejections by two or more companies.”  In other words, the purpose of the statute was not to guarantee carriage even if, for example, a cable operator decided (exercising the same constitutionally-protected “editorial discretion” enjoyed by all media) spend part of its limited system capacity carrying a network with questionable appeal, or to raise subscription rates to cover the marginal cost of carrying the network.

But the FCC has since come up with a new “open field” model that the court must consider anew.  This time, the model more clearly supports a 30% cap–but only if one accepts the premises underlying the model and the accuracy of the data put into the model, which we do not.  We argue that their model is “based on flawed assumptions about the nature of competition for video programming” and is thus incapable of “accurately reflect[ing] cable’s present (or future) bottleneck power.”

Click the button at the top right of Scribd’s handy iPaper display to switch to full page display of the brief–or click on the top left to download the PDF itself.

PFF Amicus Brief – Cable Ownership Cap http://documents.scribd.com/ScribdViewer.swf?document_id=8630011&access_key=key-2obr4z2ohtozi1gabbay&page=1&version=1&viewMode=

So, if Tim Wu’s thesis is correct that the broadband marketplace is “a cartel,” should we be reading headlines in today’s Wall Street Journal and CNET News.com like this: “Price War Erupts For High-Speed Internet Service” and “Broadband Price War Brews“? From the WSJ story:

The battle between cable and phone companies to sign up new customers for high-speed Internet service is heating up, creating fresh opportunities for consumers to cut their bills. […] While the most generous offers are coming from the phone companies, some analysts expect cable companies will also become more aggressive in their own promotions as they compete to retain customers.

Geez, if that’s a cartel, give me more of them!