Impact of Government Policies on the Telecommunications Industry

3. Case study 2: The Internet - ADSL & Cable Modem

3.1. History of the Internet

The government never imagined the ARPANET it started during the cold war has changed the way we live and work in such a profound way. US economical cycle is no longer measured by auto production or steel production, but by the growth of the information technology industry.

The history of the Internet began at the height of the cold war in the 1960's. The original motivation for its development was for US authorities to communicate with each other in the aftermath of a nuclear attack. At that time, communication networks had point-to-point connections, with each connection on the network dependent on the link before it. If one location in the network were to be blown up, the whole network would become useless. With this in mind, Paul Baran of Rand Corporation came up with a network that resembles a "fishnet" providing multiple routes from source to destination. This idea of a packet-switched network with adaptive network routes laid the foundation for the Internet.[1]

The Department of Defense's Advanced Research Projects Agency (ARPA) funded heavily on research involving communication networks. A small network, ARPANET, was established to promote the sharing of super-computers among researchers in the US. By 1969, four US universities were connected to the ARPANET. With the creation of numerous network applications, Internet popularity grew tremendously. By 1971, the ARPANET grew to 23 hosts connecting universities and government research centers around the country. However, the ARPANET was still at its infancy, it was very expensive to maintain and build new network infrastructure and equipments. But national security was more valuable, and ARPA viewed the Internet as a crucial interest to ensure national security. It allocated significant amount of money expanding and maintaining the network infrastructure, subsidizing network related research.

ARPANET gradually moved away from its military/research roots to the commercial realm. However there were still tremendous restrictions allowing the public to access the ARPANET. Finally in 1984, the National Science Foundation established an office for networking. Their first effort at a national backbone NSFNET was deployed in 1986. The NSF also subcontracted to companies to build regional networks of the NSFNET to seek commercial, non-academic customers. In the early stage of the NSFNET, NSF enforced an Acceptable Use Policy" (AUP) which prohibited backbone usage for purpose not in support of research and education. While denying access to the commercial network traffic at the national level, but encouraging it at the local and regional levels stimulated the emergence and growth of private, competitive, long-haul networks. With the booming personal computer industry, the combination of inexpensive desktop machines and powerful network-ready servers allowed many companies to join the Internet for the first time. The Internet became an essential tool for communications. As the NSF relaxed its acceptable user policy, many of the organizations operating regional networks saw the extraordinary demand of the Internet. They transitioned from not-for-profit cooperatives to profit-making commercial institutions providing Internet connections. New network start-ups were budding up everywhere at an amazing pace. New applications were created everyday making the Internet more attractive and more indispensable in our lives. NSF saw that the Internet had reached far beyond the critical mass, thus government funding in maintaining the NSFNET was no longer necessary. Too much government intervention may even slow down the rapid growth of the Internet. In April, 1995 the NSFNET was defunded and privatized. Currently there are tens of millions people connected to the net, and the is still growing at an exponential rate. The government had never imagined that it has almost single-handedly created the Internet and the entire information technology industry.

3.2. Solutions to the ever congested Internet: ADSL modem vs. Cable modem

In addition to the creation and promotion of the Internet directly involved by the government, its public policies can affect private industry indirectly yet in a significant way. The Telecommunications Act of 1996 has an enormous impact on the telecommunications industry.

The main philosophy behind the Act is to encourage competitive market forces to lower rates for consumers and to accelerate the deployment of advanced services throughout the nation further.

Traditionally, the law requires that the telephone and cable services be provided separately by their respective industries. The Act has repealed this restriction. It allows the telephone, cable and utility companies to offer broadband integrated services. It also offers additional provisions to promote the deployment of advanced technologies, such as the Advanced Telecommunications Incentives and the Telecommunications Development Fund.[2] The Act requires the FCC and each state telecommunication commission to encourage the deployment of advanced telecommunications capability to all Americans by measures that promote competition, and regulating methods that remove barriers to infrastructure investment. The Act establishes the Telecommunications Development Fund to promote access to capital for small businesses in order to enhance competition in the telecommunications industry, to stimulate new technology development, and to promote employment and training.

Only a few years ago, different networks, whether circuit-switched or packet-switched, whether phone lines or cable lines, whether privately or publicly owned, all dedicate to specific applications. This scheme is very inefficient because networks are idle between transmissions. With the explosive growth of the Internet, more and more information is published in electronic form and disseminated through the World Wide Web. Existing 51.2 Kbps modem through telephone lines can no long sustain the demand of high bandwidth transmission. There is a desperate need for alternative high speed networks. One way to increase bandwidth is by adding new fiber networks to home, which however would cost billions of dollars. The Telecommunications Act of 96 deregulated the telephone and cable industry to allow both of them to enter each other's market. The most cost efficient way is for these industry to provide integrated service over their monopolistic infrastructure. New technologies are needed to utilize these existing networks to provide efficient integrated services including data, video and voice. Dynamic new entrants have seized the opportunity by offering better innovations to improve the quality and speed of the Internet connection.

As a result of the deregulation, two emerging technologies, namely ADSL and cable modem, from two competing industries are vying for their share of the Internet. These two technologies utilize existing communication infrastructure for communication. The subsequent discussion analyzes different factors which may have impact on their success or failure.

3.2.1 Cable modem

Cable modem technology allows integrated broadband network services to be delivered to home via cable companies. Modern hybrid fiber/coax cable networks provide a high-capacity communication medium that is suitable for a wide range of communication applications. Theoretically, it is not difficult for cable modem to deliver data up at 30 Mbps downstream and 10 Mbps upstream. This is almost 1000 times the speed of ordinary telephone modem. Currently, @Home Network Corporation, a cable-based high-speed internet service provider whose original investors are Tele-communications Inc., Comcast Corp., Cox Communication, and venture capital firm Kleiner Perkins Caufield & Byers, offers unlimited Internet access for $35 per month with an initial setup fee of $150 which includes a cable modem and installation.[3] This monthly fee is very cheap in comparison with regular Internet service through phone modems which costs approximately $20 per month at a rate that is 300 times slower.

However, for a cable company to add Internet access via cable modem it must have three things: a physical system capable of two way transmission, the ability to bill and provide technical support to customers, and cable modems, routers and switches which can be configured to work on the system. The most daunting challenge is upgrading the cable infrastructure to allow two way transmissions. There are 65 million homes that have cable connection. This is more than 96 percent of the home market, but only 10 percent of current cable plants have been upgraded to handle the two-way digital connectivity, and these are only available in few cities at the present. Although it is possible to use the current cable for downstream data transmission and use a telephone line for upstream communication, this alternative does not seem too attractive to consumers since it consumes two resources. The hurdle that cable companies face in order to deliver new services over these cable networks is the substantial infrastructure investment that must be recovered by selling into competitive, uncertain markets.

Another hurdle that cable companies face is that cable lines are found mostly in residential areas, rather than in central business districts. On the other hand, telephone line has 70 percent penetration in the business world and public institutions. The business market is the one usually willing and is able to afford advanced technologies and services in the early stage of a new technology. Without adequate infrastructure in these locations, cable industry stands at a lesser ground in breaking into corporate market. For now, cable companies can only provide services to telecommuters, and aggressively invest in laying down infrastructure to companies.

3.2.2 ADSL modem

Asymmetric Digital Subscriber Line (ADSL), a new modem technology, converts existing copper twisted-pair telephone lines into access path for multimedia and high speed data communications. Current versions of ADSL delivers information at 1.5 Mbps downstream and 64 Kbps upstream. Subsequent versions of ADSL will push the delivery rate to 6, 8, and even 52 Mbps.[4] With such a speed, ADSL can literally transform the existing public information network from one limited to voice, text and low resolution graphics to a powerful, ubiquitous system capable of bringing multimedia, including full motion video, to everyone's home. Although ADSL does not require a carrier to upgrade its central office switch to support, it requires ADSL modems at the customer site and at the central office integrated with an access device. The existing copper infrastructure has three underlying problems: ADSL can't be provisioned on copper circuits equipped with load coils or bridge taps. The phone companies need to manage other functions of the public switched telephone network; ADSL's high frequencies pose considerable interference potential to other copper lines in the same cable sheath; there's length limitation on how far ADSL signal can travel before too much distortion to the signal. Current technology allows a maximum of 18000 ft. for ADSL modem that transmits at 1.5Mbps. About 60 percent of Southwestern Bell's local loops are under the maximum distance. This length limitation on existing local loops means that 40 percent of users and carriers who live in rural areas will need to adjust their local loops.

These technical challenges and high cost of ADSL modems, about $1500 per ADSL modem compare to $300 per cable modem, prevent wide deployment of ADSL. PacBell is rolling out ADSL service by the end of 1997 to local customers with a price comparable to an ISDN line, which is about $100 per month with an initial equipment and set up cost of $500. This is much more expensive than what cable modem offers. As time progresses, new technologies will improve the quality of ADSL modems, therefore driving down the initial equipment and installation cost at customer sites. Then the subsequent cost of accessing the Internet at high bandwidth will be the same as today's low band price.

3.2.3 Impact of government policies

The Telecommunications Act of '96 lifted the long distance restrictions on the RBOCs in exchange for the breakup of local service monopoly. Companies like MCI who has provided internet circuits for many years and has strong Internet expertise is very well-positioned to offer high-speed residential internet access to local customers. Increased competition will further stimulate new technology development and drive down cost.

Another government imposed rule that has encouraged competition in the telephone industry is the open access rule (or Open Network Architecture) which allows any approved, subscriber-owned equipment to be plugged in the network.[5] The open access rule has expanded the concepts of service alternatives and network fragmentation into the very core of the networks, and lowered barriers to entry for rival and varied communications services. With increased competition within existing telephone companies, and competition from many new entrants, ADSL technology is likely to improve quickly, and its cost will likely decrease significantly in the near future.

Unlike the telephone industry, open access rules are not applied to the cable companies. This hinders the development of the "internet over cable" innovation. Open access on the subscriber side would accelerate the technological development of cable modems and lower the providers' risks by distributing among subscribers the cost of a large portion of the necessary equipment. On providers' side, open access would strengthen the Internet provider's position relative to the cable firm, so that more Internet providers would be willing to make investment. If the government requires the cable industry to allow open access to the cable infrastructure, more competition will likely occur, thus improves the service and lower the cost of cable modems.

In the early 90's, the Integrated Broadband Network (IBN) technology started to be widely deployed. Rate-base regulation and depreciation accounting rules favored telephone utilities. The rules allowed local telephone companies to increase their depreciation rates for existing copper plant, the increased depreciation being recovered from subscriber rates. Cash flow from depreciation was then used to support digital fiber construction, which is also charged to the subscriber base. With the Telecommunications Act, the uniform rate structure requirements no longer apply to the provision of cable service, including integrated broadband services over cable, in a geographic area in which the cable operator is subject to effective competition. This gives more flexibility and incentive for the industry to roll out new services and technology. However a cable operator will still bear the burden of demonstrating that its rates are not predatory. It is difficult to determine how much, if any at all, infrastructure upgrading cost should be passed down to rate payers who may not need the added feature. Cable companies and government agencies have disagreement over pricing, thus cable companies are very slow in pushing cable-based integrated services technology. If policy makers believe that cable-based integrated services technology can bring about more benefit to the public, they can encourage the deployment of this technology by proposing high depreciation rates to existing cable systems, or providing tax-break like incentives.

As a result of the Telecommunications Act, states no longer may regulate in the areas of technical standards, customer equipment and transmission technologies. All these provisions offer an open system environment for facilitating technological innovations. System specifications are publicly available, anyone can build the software needed to communicate across an internet. More importantly, the entire technology has been designed to foster communication between machines with diverse hardware architectures, to use almost any packet switched network hardware, and to accommodate multiple computer operating systems. But without standardization, there is the potential danger of having incompatible products, thus causing consumers not be able to gain from the economies of scale and the economies of scope. Government policies should not interfere with standardization but they should encourage cooperation among business sectors to reach a standard for each technology. Most of times, when there is no one dominant player who controls the entire market, it is beneficial to all players to have compatibility among products.

In the late 1995, cable service providers and cable modem manufacturers formed the Data Over Cable System Interface Specification (DOCSIS) working group to a set of specifications for interoperable high-speed cable modems. By the end of 1996, DOCSIS working group defined eight interface specifications for cable modems. Modems compliant with the specification will be able to deliver data to users at a minimum rate of 27 Mbps.

The primary problem beyond the loop limitation in ADSL deployment involves the challenge of understanding, testing and implementing a technology that is continuing to evolve. There are two incompatible modulation standards: Carrierless Amplitude and Phase modulation (CAP) and Discrete Multitone (DMT). Both technologies have adherent, and it remains to be seen which one will emerge as the sole survivor, or if they will share the spoils.

Cost efficiencies depend on private innovation and the struggle for competitive advantage. New market development would eventually drive much of the innovation. This is one of the major reasons that the Telecommunications Act of '96 deregulated telephone, cable and utility industry to compete in various markets. But history has shown that putting business sector in the driver seat fails to benefit the society as a whole. Specifically, income and education gaps continue to grow under such policies and the risk is that the information rich will get richer while the poor will get poorer. The government believes that access to various information by everyone is critical to the well-being of the society. The definition of Universal Service has been broadened to include access to advanced telecommunications technologies and services. Particularly, the Act identifies schools, libraries and health care providers as important institutions in extending the benefits of telecommunication services to all. The Act targets these institutions for preferential rates for basic service and mandates a plan for deploying advanced services at these sites.

Further government policies to promote the Universal service can dramatically influence the success or failure of cable modem and ADSL modem technology. Since telephone lines have more penetration to schools than cable lines, if the government wants to encourage schools and libraries to be connected as soon as possible, ADSL technology is likely to be the best choice in most areas. Government may provide subsidy to connect schools to high-speed internet access through ADSL. This would offer great incentives to telephone companies to provide ADSL service, and modem companies to develop better cheaper modems quickly. This would help the successful deployment of ADSL technology. On the other hand, cable-based technology can provide higher bandwidth at a much lower cost. If the government believes that in the long run, it is more economically efficient for schools and libraries to use cable modems, it may provide incentives to speed up cable infrastructure upgrade and expansion to schools and libraries.

3.2.4 Our prediction

We believe that although government policies may have great impact on the success and failure of cable modem and ADSL technologies, their success depends more heavily on how fast these services can be deployed, and how much market share each industry is able to grab first.

Once slow and reluctant cable companies have started aggressively pursuing upgrade infrastructure and providing net access recently. @Home Network Corp. sold $48 million of preferred stock - representing 4.5 percent of the company's equity - to investors such as Bay Networks, Motorola Inc., Sun Microsystems, and Canada's two leading cable operators. At this price, 100 percent of the company's stock would be worth $1.07 billion.[6] With this large sum of publicly raised money, cable companies can use it to upgrade and expand cable infrastructure. Tele-Communications Inc. (TCI) has recently announced that it will commit an investment of $1.7 billion to $2.5 billion over the next 30 to 35 months to make advanced two-way telecommunications services, available wherever TCI has a franchise by the end of 2001 at the latest. Many other cable companies are making similar plans. The goal is to have about 200,000 people subscribing to high-speed cable Internet services by early next year, and 3.2 million people by 2002.[7]

On the other side, telephone companies have the luxury of having appropriate infrastructure in most areas. However, if ADSL technology is to succeed, phone companies and ADSL modem companies can not afford to slow down, they need to aggressively to deploy ADSL services before cable industry catches on.

At the current moment, it is still too close to call which technology will succeed. Our view is that both will have about equal market share with ADSL more in the business world and cable modem in the residential market.


[1] Net History - An overview of the history of the Internet

[2] Telecommunications Development Fund - A summary by the Benton Foudation

[3] Doug Fine, "It's a two-way digital cable road ahead Telecommunications companies prepare for rival technologies", Electric Results, Vol. 18, Issue 44, October 28, 1996.

[4] Jeff Caruso and John Rendleman, "Special Report: ADSL's Copper Pipe Dream", Communications Week, October 21, 1996.

[5] Robert F. Corazzini and Howard J. Barr, "Telecommunications Act of 1996 Impact on Cable."

[6] Jonathan Marshall, "Stock Sale Values @Home at $1 billion Plus", San Francisco Chronicle, April, 1997.

[7] Mike Antonucii, "TCI vows to push ahead hard with upgraded cable, Net access", San Francisco Chronicle, May 1, 1997.