The innovation dilemma

Former FCC Chief of Staff Blair Levin asks whether policy-makers deciding new rules for telecom and media companies could blow it if they make the wrong choice.

Tech Industry
February marked the sixth anniversary of the Telecommunications Act of 1996. It also marked the fifth consecutive year that many parties who warmly greeted the bill's passage condemned it as a failure, albeit with contradictory rationales.

Leave it to history to determine the Act's merits. We still don't fully understand its meaning today. One small example: The Act gave the Federal Communications Commission six months to determine how the word "cost" should be interpreted. The FCC complied but the legal appeals are still pending.

What we do know is that the telecom revolution of the last decade is an extraordinary success.

The growth of wireless services and data networks were the single biggest factor in the economic growth of the 1990s, contributing hundreds of billions of dollars to the growth of the economy through hundreds of thousands of new jobs, driving productivity gains and improving the lives of consumers everywhere.

Although fortunes initially made in these markets have fallen--a phenomenon common to every new market--the long-run importance of these markets is certain.

As we contemplate policy directions in the post-Telecommunications Act environment, it is worth considering what made it possible for those markets to emerge as powerfully as they did. As an FCC veteran from the 1990s, I'd like to think that our actions then were key. But the most important action occurred long before: It was the breakup of AT&T in 1984.

Simply put, the dynamic growth would not have occurred had AT&T continued its monopoly over the telecom network. Before the breakup, AT&T suppressed the growth of wireless.

An infamous AT&T-sponsored study projected the number of wireless users by the end of the century would be 1 million, which proved wrong by about 100 million. Whether the estimate was lowered deliberately or accurately reflected its best guess,

As an FCC veteran from the 1990s, I'd like to think our actions then were key. But the single most important action occurred long before; it was the breakup of AT&T in 1984.
allowing AT&T continued dominance of that market would have meant the actual figure would have been much closer to its estimate. And innovators such as Craig McCaw, who drove the mass market for wireless, would not have had an opening to attack.

The history of data networks is similar. AT&T's control of the network would have made the network of networks--now thought of as the Internet--much less of a dynamic market. For example, in the 1970's, Corning tried to convince AT&T to use fiber-optic cables to create a far more efficient transmission network. AT&T said no on the grounds that it still had many more years to depreciate its existing copper network.

It was only after the breakup that Sprint and MCI were able to finance the construction of fiber networks, forcing AT&T to do the same and, in the process, build the backbone for today's Internet.

The breakup itself was not the only government policy that mattered. Without the government's decisions to create at least five wireless competitors and to keep the Internet free from telephone minutes-of-use charges, neither market would have grown with the speed it did. But the breakup was the most important step.

From this history, policymakers should discern some critical lessons. The most important benefit of the breakup was not the incremental price reductions in long-distance calling; it was network innovations that drove new ways of communicating, massive economic growth, and improved consumer welfare. But, too often, regulators, particularly at the state level, focus on retail price constraints that stifle the market's willingness to invest in innovation.

Innovation is rarely the product of the powerful incumbents. As Harvard Business School Professor Clayton Christensen illustrates in "The Innovator's Dilemma," large companies find it difficult to invest in innovations that could cannibalize their own markets. And while their problems in innovating eventually reduce their dominance, there is a huge cost to the economy resulting in delays in innovation, particularly when they control an essential network.

This creates a dilemma for the government. AT&T's post-breakup history demonstrates that innovation is a function of market structure. Making sure market

Making sure market structures are open to innovation may require, as it did with AT&T, significant government intervention in the market. But the government has to make sure the intervention does not suppress investment.
structures are open to innovation may require, as it did with AT&T, significant government intervention in the market--but the government has to make sure the intervention does not suppress investment.

The coming collision
This dilemma is about to hit center stage for the telecom and media industries.

Traditionally, their market structures were determined by prophylactic rules limiting the size or scope of telecom and media companies. Now, the courts and the FCC are in the process of relaxing many of those rules, leaving the merger review process as a central protector of open markets.

The government's response to deals already announced, such as the proposed merger of the two satellite television providers EchoStar Communications and DirecTV, and deals often speculated about, such as between cable and broadcast behemoths like AOL and NBC, or the reintegration of local and long-distance carriers, such as SBC Communications and AT&T, will determine whether we are able to rekindle the economic growth the Telecommunications Act catalyzed in the last decade.

The answer is not that big is always bad. Nor can the answer be determined by merely looking at a deal's impact on consumer prices. Rather, the government needs to focus on whether the merger would seriously impair market forces that would make it rational to invest in entities or technologies challenging the dominance of the incumbent.

Two decades ago, our government had the wisdom--and courage--to break up AT&T, while simultaneously having the wisdom to step away from similar action against IBM. The best hope for stimulating economic growth is that the government has the wisdom and courage to know when it needs to act to protect innovation and assure open markets again.

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