Reforming Telecommunications Regulation in Indiana

Proposed bill would bring more competition and market freedom to state

Mr. Chairman and Honorable Committee Members:

I respectfully submit this testimony as Senior Fellow for Information Technology and Telecom for the Heartland Institute, Chicago, IL, and Telecom Policy Analyst with The Reason Foundation, Los Angeles. CA.

Sen. Hershman’s bill to reform telecommunications policy and regulation in Indiana is necessary and welcome. It is in line with state initiatives undertaken in Illinois, Florida, Texas and South Dakota, just to name four. It follows the policy agenda of the FCC toward more competition, less regulation and more market freedom throughout the sector. Passage of this bill would demonstrate the state of Indiana correctly recognizes that an environment of intermodal competition has taken hold in the provision of telecommunications, Internet and video services and that individual, narrowly defined, former monopoly services have been replaced by multiple, competitive broadband platforms that can deliver integrated voice, data, video and interactive services.

Rather than attempt to shoehorn or refashion regulations from a monopoly era into a new environment, the bill understands that Indiana consumers will see the greatest benefits from broadband if the barriers to entry and investment embodied in obsolete regulation are eliminated and services and prices are largely deregulated. New and existing providers must have the freedom to experiment and succeed with delivery of a value proposition that leverages their individual strengths and assets. Only then will Indiana truly see the potential of the broadband economy unleashed within its borders.

That’s why the committee and the Indiana legislature should give strong and serious consideration toward passage of this bill. As it moves forward through the legislative process, the Heartland Institute and the Reason Foundation look forward to contributing to the debate.

In keeping with the spirit and intent of the bill, which seeks to move away from defining and regulating service providers based on their legacy past – i.e., telephone, cable, wireless, ISP-I would like to suggest that the bill do its best to avoid even casual classification of voice, data and video services.

At heart, the bill recognizes that applications have become separate from the network that delivers them.

For this reason, lawmakers must be careful about creating distinctions between “basic” and “non-basic” telecommunications (Section 7) because consumers themselves are abandoning such distinctions. For at the end of the day, what is “basic” telecommunications service but the ability to easily and reliably place a phone call? This can now be done with a variety of technologies, each with its own advantages and disadvantages. With that in mind, we should be careful about legislating value judgments. Is classic dial tone superior to VoIP? Certainly dial-tone offers the best quality in terms if sound reproduction, but it falls short of VoIP in terms what it can offer in terms of caller ID, voicemail and integration with Web applications. Again, for users, the value proposition enters the picture. While there is justification for consumer protection and notification rules when it comes to the limits of different technologies, lawmakers must be wary of fashioning legislation that awards a special, even protected status, to dial tone such that it either discourages investment, use or adoption of other less expensive or more robust alternatives.

Another section where definition of services is important concerns video services. We applaud and endorse the Indiana bill’s intent to create a process of statewide video franchising. This will speed competition for multichannel video services to all communities in the state because it will eliminate the need for new entrants to negotiate franchise agreements with every municipality.

We also urge that the bill clarify the process whereby all competitors can transition to a statewide franchising regime, preferably within 12 months of date of passage. Ideally, state franchise requirements would pre-empt all requirements at the local level with a uniform set of terms and obligations applicable to all state franchise holders. Chapter 34, Sub-section 21 of the bill appears to endorse this approach, although Subsection 22 appears to hold existing local franchise holders to all pre-existing terms and conditions, despite their decision to elect to pursue a statewide franchise. We fear this could create an unlevel playing field for existing franchisees.

However, given the developments in terms of video content delivery to consumers, it is our position that franchise fees in general create a barrier to broadband deployment by selectively penalizing carriers who use multichannel video delivery platforms. We believe that both local governments and their citizens would be better served if video franchise fees were eliminated and we urge legislators to give serious consideration to this move.

Video franchise fees were born of the original monopoly nature of cable TV. In most communities, franchise fees exist largely independent of right-of-way fees, which are levied as compensation for use of public streets and underground conduit and other such physical plant. In addition, Sen. Hershman’s bill specifically addresses right-of-way fees elsewhere in its text.

The reasoning for franchise fees was that, in return for the right to a captive market for a popular service-TV-the cable provider would return a portion of its revenues to the community and be required to meet certain obligations, such as running cable past all homes in the community, providing free or discounted service to government buildings, schools and libraries, and setting aside a channel for local public access. The Indiana bill, as drafted, calls for a franchise fee of five percent tax on all revenue derived from video service delivery.

But the captive market that justified this assessment is gone. The bill’s own rationale for broad deregulation recognizes this. If we were to look at the video segment, however, we find the premise supported. In growing numbers, consumers are exercising other options to receive video entertainment: from direct broadcast satellite; from phone companies offering video over DSL or fiber, from content aggregators on the Internet who now provide downloadable video on demand in MPEG, PSP and iPod formats within a legal digital rights management framework. Cities, or states for that matter, cannot guarantee the right to market exclusivity inherently promised with the payment of a franchise fee.

The Television Advertising Bureau, a trade group that represents advertising buyers, not cable companies, estimates that cable companies lost 1.4 million subscribers in the 12 months ended November 2005. Further, the group, using data from Nielsen Media Research, says that alternative methods of video distribution reach more than 30 per cent of the market.

Video on-demand allows the viewer to select, download, pay for and view a program, from an interactive menu. Technology is available that allows video files downloaded to a PC or cell phone to play on a standard television. Cable companies and phone companies offer on-demand video with their programming packages. However, services like Vongo, owned by Starz, the premium cable network, now offer unlimited movie downloads via the Internet servers for a monthly fee of $1.99. ESPN, MTV, NBC Universal and CBS plan to follow suit. Within 12 to 24 months, Internet video downloads will be a common way of renting and viewing entertainment.

Video content is just another application; like voice, email and music, that can be delivered to users over the Internet independent of the underlying infrastructure. In this situation, it is difficult to justify singling out two local providers – telephone and cable-for a special five percent assessment on the revenues accrued from video content delivery.

This is where the assessment of franchise fees becomes discriminatory against common carriers. In fact, they may be counterproductive to the common goal of increasing broadband availability, because video franchise fees are levied on infrastructure builders-the companies we depend on to get broadband facilities to the home.

It also isn’t simply a matter of extending the franchise regime to third party providers like Vongo or even independent ISPs. Part and parcel of the franchise fee regime are state laws that require phone and cable companies to report revenues derived from the sale of video services. Third-party, out-of-state content and service providers are under no such obligation.

In practical terms, however, the downside for municipalities, of course, is that elimination of franchise fees takes control of a captive revenue source out of their hands. However, as video options proliferate, consumers will be able to avoid the payment of franchise fees simply by downloading video from someone other than their cable company. In addition to directing revenue away from infrastructure, it creates the opportunity for regulatory arbitrage that we already see in VoIP.

For the cable companies and their telephone company competitors, video services are no longer a captive market, but part of a value proposition critical to the success of their local broadband investment. Given this shift, does the state want to provide a sound business climate for the growth of broadband? Or does it want to levy a special tax on infrastructure providers? We would argue that the former course is the more constructive over the long term. Further, we would say the Indiana bill as a whole reflects this progressive line of thought. That’s why we recommend that the Indiana bill be clear on the terms of migration from local to state franchising and, further, set up a process for the eventual phase-out of franchise fees.

Respectfully submitted,

Steven Titch
The Heartland Institute
The Reason Foundation