Wireless Changes the Universal Service Equation

The following is adapted from my filing last week in the FCC’s request for comments on its Connect America Fund plan and its overall Universal Broadband Service inquiry.

With its inquiry into reforming universal service funding through a new Connect America Fund (CAF), the Federal Communications Commission has a chance to craft policies that will help increase broadband penetration in rural areas, but do so in line with 21st century technologies and market realities. Yet overall success of the Connect America Fund as a replacement for the current Federal Universal Service Fund (FUSF) will hinge on the Commission’s ability to question past assumptions about universal service.

The FCC is to be commended on its goal of refocusing the objective of the fund toward broadband, and moving away from a goal of narrowband, wireline, dial-up phone service; a platform that consumers are rapidly exchanging for richer and more robust wireless choices.

Wireless, in fact, changes the entire universal service equation, both in terms of service and cost, and stands to be an important component of universal broadband scenarios going forward. It also challenges two long-standing assumptions regarding universal service—first, that there is only room for one rural service provider and, two, service is so expensive to provision in rural areas that subsidies are almost always required.

Since inception of the FUSF idea in the Communications Act of 1934 to its latest iteration in 1997, the assumption has been that universal service is achievable only through massive cross-subsidization. The reasoning has been that the cost of build-out to populations of low density would always greatly exceed the revenue that could be recovered. This was once true, but is becoming less and less the case.

For one, deployment of new technology platforms, especially wireless, can be accomplished at far less the cost than fiber and copper-based landlines. Moreover, wireless services are more popular. Again, as little as 10 years ago, landline was still considered a “gold standard” for telecommunications service. The improvement in quality, capacity and service options in the past ten years, but more acutely since the introduction of the iPhone and iPad devices, have put wireless service, including broadband services, on a par with wireline, and perhaps poised to past it.

Wireless is no longer a poor-man’s substitute for broadband. In fact, the excellent utility of numerous platforms have compared to wireline broadband is proving out. But all debate aside, on almost every broadband platform, respective service providers are upgrading constantly. So-called “3G” wireless networks are being upgraded to Long Term Evolution (LTE), which promises speeds of 5 of 12 Mb/s. WiMax has shown it can be an equally strong alternative platform to LTE, and cable modems have gone from 4 to 10 Mb/s in the past four years.

That means cable companies can have a role as well, although in rural areas, their strongest competition comes from direct broadcast satellite services, not phone companies. Satellite services, however, are at a disadvantage when it comes to Internet service. Although satellite-based broadband Internet is feasible, it is not as fast as terrestrial alternatives. This provides cable TV service providers with a critical value-add to leverage as long as rfegulations do not skew to far toward favoring legacy telcos.

In short, there are several options for broadband delivery to areas of low population density. It is quite possible for these to be delivered without subsidies. The FCC’s goal should be to encourage private investment that yields a profitable return, and, as time goes by, reduce subsidies along with the size of the CAF.

There is no reason to dismiss the role of private investment out of hand. It is more than just rural telephone companies that have an interest in expanding broadband service. Among service providers, wireless, cable, power utilities, even satellite, mentioned above, have viable platforms. Moreover, unlike conventional narrowband phone service, there exists a group of influential players that have a vested interest in greater rural penetration. Companies like Apple, Google, Netflix and Microsoft are fueled by broadband users. When they partner with service providers, or simply purchase their bandwidth in bulk, they become new sources of revenue—revenue that increases in proportion to the size of their user communities.

Applications such as movies on demand, location-based services, enhanced search and social networking are driving broadband adoption. Some 30 percent of Internet traffic is Netflix movies. It was the iPhone that pushed wireless phone service to become the broadband platform much sooner than thought.

As these applications drive demand for broadband access—and promise greater revenues to more players—they attract the necessary investment to expand the broadband infrastructure. In the process, rural broadband becomes less a policy obligation incumbent on a carrier of last resort and more of an opportunity that can fuel competition.

In the narrowband days, revenues from phone service were inelastic. Consumer price points were $30 to $40 a month. If it cost $100 a month to service the customer, FUSF paid the difference.

In today’s broadband market, revenues are far more elastic. Basic service might still be as low as $30 a month, but attractive and desirable options–additional lines, services such as unlimited text messaging, additional bandwidth, international calling packages—increase revenue streams. In addition, the demand for third-party applications, such as streaming movies, downloadable mobile applications and e-commerce create much greater incentive to service new pockets of population—no matter where there are.

On the supply side, technology improvements and innovations are driving down the cost to provision service. A rural low-density population may still require greater investment, but contemporary policy should not assume it is undesirable to serve nor that the cost difference can only be bridged through subsidies.

It also would serve taxpayers, rural constituencies and competition if the FCC were to base CAF allocation on new models, such as reverse auctions, where funds would be dispersed to service providers that can meet broadband service requirements most cost-effectively. While the FCC may chose to set parameters for broadband service, such as a minimum of 4 to 6 Mb/s per second, it should not give favor to particular platforms—such as wireline over wireless or fiber over copper—as long as the service parameters are met.

The new CAF should also eliminate the “cost-plus” provision of USF, which reimburses to telephone companies the cost of meeting universal service measures plus an additional 10 percent of that expense. All this does is incent the use of costlier materials and resources to meet a need that could be equally served for less funds.

The FCC should also make year-to-year CAF reduction a goal of the new plan. While the American Broadband Connectivity (ABC) submitted by six major U.S. service providers endorsed a cap on annual cumulative CAF distributions, a more worthy goal would be a phased reduction. Technology has a downward cost curve. Plus, if the CAF is doing its job, less and less will be needed to facilitate buildout. CAF payouts may never drop to zero, but at this point, given the current levels of penetration, plus the opportunities that broadband presents to service providers willing to make private investment, a goal to hold to the current annual FUSF high-cost fund payout–$4.5 billion–with no endpoint, is too easy.

Finally, the ABC plan also calls for a five-year phase-in of the reformed CAF structure. This is too long, especially given technology and infrastructure lifecycles. We acknowledge that most rural phone companies rely on current FUSF funding mechanisms for positive cash flow, and that an immediate shift to a reformed CAF may cause pain for investors and shareowners (For a larger discussion of the effect of USF and ICC subsidies on rural service provider financials, see my 2009 policy study on FUSF reform). At the same time, the industry knew FUSF reform was coming, and that the current method was unsustainable. Despite this, companies continued to base their business models on direct subsidies through the FUSF and indirect subsidies through intercarrier compensation. A five-year transition time unfairly penalizes potential service providers with less expensive models that are viable. Transition times for incumbent rural telephone companies to adjust to the reformed system should be short—12 to 24 months at most.

Other points:

  • CAF administrators should revisit subsidies from year to year. Recipients should be able to justify annual payouts. Do not allow service providers to develop a financial dependency of CAF distributions.
  • Do not use the CAF to fund competition, especially if an existing provider is meeting demand with private investment and without subsidies.
  • The fund should be agnostic to any current or future broadband delivery platform. Do not create carve-outs or guarantee rights of first refusal for companies in specific silos—wireline, wireless or, cable. Avoid assuming a current incumbent service provider will be most successful at delivering broadband to a given franchise area.
  • Avoid funding municipal broadband plans. The pattern over the past ten years invariably shows these schemes fail to provide ubiquitous, quality, low-cost service. No matter how much the community pours into these ventures, they rarely prove sustainable. Propping them up via CAF only prolongs their inevitable demise to the disadvantage of consumers who could see more benefits from commercial service providers.
  • The intercarrier compensation system also needs to be overhauled. The mechanism must reflect the true cost of call completion and end its use as an opaque, indirect subsidy system that, in today’s environment of VoIP’s ability to mask call origin, has become a playground for arbitrage.

Free market dynamics have changed the business of telecommunication services—and not just at the urban and suburban levels. True, rural deployment lags, but it is catching up quickly, in part because in the years since FUSF reform debate began, new technologies, especially wireless services, have demonstrated their capability to support true broadband speeds. This is not futurism: LTE wireless is being deployed now and will soon be a standard across wireless systems. When coupled with the enormous community of third-parties for whom universal broadband means greater growth and opportunities, a universal service mechanism that encourages maximum possible funding through private investment in line with market mechanisms is the soundest policy course.