Lessons from the Meltdown of U.S. Telephone Industry - Giving Top Priority to the Internet

Shumpei KUMON (Executive Director and Professor, GLOCOM)

Beginning of a Telecom Meltdown

The telephone industry in the U.S. is in a state of "utter crisis" (Michael Powell, Chairman, U.S. Federal Communications Commission) and the collapse of the industry would be "probably the largest single meltdown in a defined industry" (L. William Seidman, former chairman, U.S. Federal Deposit Insurance Corporation). The telephone industry became a major topic of conversation when The New York Times reported that 24 out of 29 existing telephone companies might fall and seek protection under the bankruptcy act within a few months.

At the time, however, it was believed that the Baby Bell telephone companies, which provide local exchange networks and which were considered healthy, would extend their resources to save the industry. But as it has become clear that the Baby Bells are also facing significant revenue decreases due to losing support for fixed-line telephones and surmounting interest expenses on debts derived from huge capital investments. Critics such as Eli Noam, professor of Columbia University, have begun to point out that recently introduced policies such as inducing competition, reducing interconnection charges, and unbundling network elements were based on a wrong premise, and that it has become necessary to allow cartels to be established in order to maintain a healthy price level on their services during a recessionary period.

Bob Frankston, who is now at the forefront of promoting Weblogs as a new type of journalism on the Internet, opposes that approach and presents his views using an interesting metaphor. In the nineteenth century, the task of delivering ice formed in a nearby lake to houses was big business. But ice delivery became extinct upon the arrival of electric refrigerators, which enabled each household to produce ice on their own.

Telephony is the same, says Mr. Frankston. When it becomes possible for people to communicate with one another bypassing the switches sitting in telephone companies, the services provided by those companies will become unnecessary. He says the basic cause of the recent fall of telephone companies lies in this structural shift.

Not Much Hope for "Content" Services

To be in business by providing only a simple Internet connection service is not an easy task. There is no guarantee that offering convenient services such as network infrastructure to the public can sustain a viable business. This is what David Isenberg calls "The Paradox of the Best Network." If this premise stands, it would mean that fiber and wireless IT infrastructure must initially be built by users themselves through collaboration among local communities, local industries, and local residents, perhaps employing the services of telephone or electric companies. Then these local networks could be mutually connected for the whole network to grow.

The same could be said about the so-called content services on the network, where movies, music, and software are provided online. As the Internet becomes an infrastructure in a true sense, most of the contents, such as video streams of conferences that flow through the system will be created and shared by users themselves. Present e-mail and websites can be considered primitive forms of this trend. Accordingly, there are few prospects for telephone companies venturing into this form of service, while broadcasting business also will become a depressed industry in the same context.

Still a Chance for Japan's Telephone Companies

It is widely acknowledged that the IT network system in the Internet age will have three layers; physical, code, and content. As it is evident from what we have seen that the physical layer at the bottom and the content layer at the top both will become unpromising as businesses, the IT industry in the future should look to the middle code layer to perform as a provider of applications and services in supporting the lives and works of individuals, businesses and various groups. The code layer is indeed the most promising area in which these companies should seek new businesses.

Regulations on Japan's telecommunications exercised by the then Ministry of Post and Telecommunications was for a long time governed by the supreme doctrine of "managed competition" which resulted in postponing of major policy issues and the beauty-contest model adopted in spectrum allocation. It is an irony that because of this controversial policy telephone companies in Japan have not experienced the hardships of their American counterparts. One might also point out that, in stark contrast to its American counterparts NTT has been quite collaborative with the MPT and the U.S. government in reducing interconnection charges, opening up their networks, and laying fiber to the home.

But now is the time to take a new course of action in Japan. The Japanese government should adopt the following set of telecom policies. One is to refrain from policy measures that may discourage further growth of the Internet, especially in the physical and content layers where new forms of businesses are currently emerging, while restricting the closed and exclusive operation of the existing network. A very cautious approach is necessary in assessing policies that would strengthen intellectual property rights, as are being promoted by the U.S. Congress and content providers in the U.S. It would in fact be beneficial for Japan as well as other countries to be critical toward the stance the U.S. is forming in this field.

The other is to transform the business styles of telephone and broadcasting companies smoothly, during which a certain level of government intervention might be warranted. Measures like the precautionary nationalization of telephone and analog broadcasting operations, which are presently in the process of decaying into non-performing assets, should not be left out of consideration.

(English translation of the original Japanese article that appeared in the "Seiron" section in Sankei Newspaper on August 22, 2002)