I’m disturbed by the EU’s rejection of a local muni network as unfair competition to commercial incumbents.
You won’t find a more droolingly rabid supporter of free markets than me as a means of co-ordinating demand and supply. Competitive markets are noted as being the most efficient possible information clearing mechanisms between thousands or millions of participants. As the (aprocryphal?) story goes, the Mayor of communist Moscow comes to London, sees the wealth of goods on offer, and asks “But who is in charge of bread supply to this city?”. He doesn’t understand the Hayeckian process of spontaneous order and emergence. So there is some reason to be suspicious when someone pops up and asks “Who is responsible for the supply of bit pipes to this city?”.
Nonetheless, free markets don’t work well in networked goods with high fixed costs and low marginal costs. One such case, which I won’t explore further, is in information goods themselves (songs, movies, etc.), where copyright law, for better or worse, steps in to alter the incentives. It restricts short-term supply, and raises prices, with the anticipated benefit of increased long-term innovation.
The other is in local access and distribution networks for utility services. We don’t have competing pipes for water, gas and electricity to domestic premises. (For large industrial sites the cost of access becomes proportionately small compared to the cost of the “product” like gas or Internet backhaul, so access competition can work.) The problem with competing infrastructure is that in competitive markets prices will converge on marginal cost, plus a small amount of profit to keep entrepreneurial capital out of your savings account.
Unfortunately for owners of fixed distribution networks, those marginal costs may effectively be zero. So Supplier A competes against Supplier B, goes bust, Supplier X comes in and buys up the assets at pennies on the dollar. (Supplier B is excluded from the auction because of “competition” concerns, irony notwithstanding.) Supplier B can’t service it’s debt at the prices that Supplier X now offers goes bust, and Supplier Y buys them up.
Eventually we get a “third owner” effect where the capital costs are washed away into the ocean, and competition is based on marginal efficiency of operational and marketing costs. I don’t think I need to dwell too long on the obvious fact that this isn’t a pretty process for shareholders or customers. It also takes a long time to play out, and emphasises extraction of value from legacy infrastructure rather than investment in new pipes. The competition also erodes eficiency because of the reduced take-up rate of each network. Imagine if you could only install one IM client on your PC, and not several; ICQ would be the only IM network by now, and you can bet they’d have found a way to make us pay for the trivial directory/rendezvous service.
Traditionally vertical integration of services and networks has allowed duopoly infrastructure around “voice” and “video”. This is breaking down, and the shareholder capital erosion is about to begin again. For example, in the UK BSkyB has just announced it’s going to join the unbundlers and offer “free” DSL service to pay-TV subscribers. This is good news for BT, who will be wholesaling the DSL service, but terrible news for NTL, who operate the competing cable access infrastructure. Unless something dramatic changes, or NTL pull off a strategic coup against some BT missteps, NTL will go bust in about 3-4 years. At that point, sell your BT shares, because the twisted pair copper network will come under economic attack from recycled NTL assets.
I’ve recently read about how in the US you can easily play the cableco and telco off against each other by repeatedly getting the 6-month introductory “free” offer and then switching. Once the capital’s gone, any cash flow counts as a positive. (In the case of Verizon’s FIOS, it is possible that they may have a capacity advantage that the cableco can’t match. Sadly for them, they’re deploying a fairly obsolete PON fibre architecture that won’t let them drive home this advantage.)
There are some problems with a “pure muni” approach. Any type of government is a coalition of different opinions and factions under one or more party umbrellas. You elect them to manage the police force, schools, roads, etc. So there’s only a weak mandate to do any one radical action, including getting into the wholesale broadband business. As a means of users expressing demand, it’s defective.
That’s not to say that local government isn’t a participant in the process. They’re a catalyst, but not the fuel. The internal connectivity needs of public services, plus the social needs of vulnerable users, are legitimate public concerns. Economic development is too — you need to co-ordinate a whole bunch of public services before you build a large business park, for instance. If the population arrives but there are no roads, or the local reservoir can’t cope with demand, you’ve got a problem that may not have a price mechanism solution.
What private network operators perform is a collection of functions that can be unbundled. They do market research to develop a hunch that a critical mass of homes will subscribe to the service. They then co-ordinate a supply chain of trucks, expensive boxes of photoelectronics, reels of cable and some linemen to go deploy the network. In the meantime, someone at head office is developing “services” like phone, TV, etc. that will help bring in the cash. They’re also building alliances with other forms of connectivity to be sold in the same bundle.
The high level of uncertainty as to take-up rates means that only the most profitable users and geographies make economic sense. This cramps scale efficiencies, creating a vicious circle. Franchising rules that try to get around this by outlawing “red lining” by offering a local monopoly are a pact with the devil. It made sense when technology forced vertical integration in the cable industy. It’s madness in a horizontal economic model of connectivity separate from service.
Today, the public are over-paying for that up-front co-ordination cost.
Imagine for a moment that you have a litter problem in town. The mayor issues a challenge to its citizens: let’s have a clean-up Sunday where we all go out with a black bag and some rubber gloves, and make the place tidy. Public-spirited citizens respond to the call, and the town is cleaned up. Is this unfair to commercial environmental services companies? No, because there’s no obligation for people to tender for services in a market when they can (individually or collaboratively) self-supply them. Nobody gets paid to tie my shoelaces in the morning.
In this case, the mayor offered the co-ordination function, and the public supplied the service. Thus it is less extreme to see the mayor offering a co-ordination function for comissioning other public goods, whilst private entities do the actual supply. We do this all the time; indeed, the streets get swept because if there wasn’t an institution to co-ordinate and commission supply, we’d have to invent one.
The secret sauce is in the design of that institution.
We need to acknowledge that fixed networks in urban areas are a rare case of natural monopoly. You just have to choose whether all the surplus rent will be kept with the network owner, or re-distributed to other players or end users. That still leaves enormous scope for varying the size of the entity, from single city blocks, to districts and whole cities. There is also scope to vary the ownership constitution: general public, direct government, indirect governement (e.g. housing trusts), private equity, banks, vendors, operaotrs, content owners, and downstream retailers. We also see scope of varying the asset base and timescales over which it is contracted to work.
In other words, there’s a huge amount of scope for innovation in how networks are brought into being. It isn’t about technology, and “business model” is too narrow an idea because we’re talking about more than just profit-for-investment.
My hope is that the EU and US government allow mistakes to be made. “Unfair competition” should be allowed to happen, and the long-term consequences make clear. There’s a difference between unfair competition and state aid. If the tender process is open, and applicants have incentives to ask for the least resources, there’s no transfer payment. If the public hire someone to tie their shoelaces, so be it. But as a shoe-boy, don’t complain if they simply bend over and do it for themselves.
Posted by Martin Geddes at 10:02 AMTrackBack URL for this entry:
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Thanks Martin,
a useful analysis and I agree that this space currently benefits from as wide a scope of deployments/models as possible.
Posted by: at July 25, 2006 09:54 PM