Will Net Neutrality Curtail Broadband Investment?

Nobody knows what final shape of proposed new network neutrality rules might take. What already is clear is the debate over the impact of such rules on network investment. Predictably, proponents of strong new rules say carriers are bluffing about the stifling effect new rules might have.

Just as predictably, leading industry executives say that is precisely the danger.

“We’ve invested more than $80 billion over the last five years to build these platforms for growth, and that’s Verizon alone,” says Verizon Chairman Ivan Seidenberg.

Speaking about the transformative role communication and information technologies can, and should have, Seidenberg cautioned that “while this future is imminent, it is not inevitable, and the decisions we make today – as an industry and as a country – will determine whether the benefits of these transformational networks will be felt sooner or much, much later.”

“Our industry has shown that we can work with the government as well as our partners and competitors to achieve mutually desirable goals of more competition, consumer choice and broadband expansion," Seidenberg says. "But we can’t achieve these ends if we interrupt the flow of private capital and delay the cascading productivity impacts of a more networked world."

“Rather than impose rigid rules on a rapidly changing industry, the FCC should focus on creating the conditions for growth,” he says.

Frank Gallaher, Stifel Nicolaus analyst, warned of just that outcome. At least some policy advocates are too sanguine about the impact on investment if harsh new rules are inacted. Likewise, Matt Niehaus, Battery Ventures analyst, warned that telecom investment capital has been declining over the past 10 quarters. The capital flight is caused in large part because of a perception that there is too much competition in telecoms, and therefore further investment is less likely to provide an adequate return on capital investment.

 "It's a perception in Wall Street, there's too much competition, and therefore it's difficult for entities to obtain a great return, " he says.

  "One of the things that worries me, is you can execute very well, and the problem is you may do all those things right, yet it's not clear you will be rewarded on the back end for it," Niehaus says.

But S. Derek Turner, Free Press research director, says carrier investment decisions are driven by a variety of factors, but regulation plays only a minor role.

"In general, firms’ investment decisions are driven primarily by six factors: expectations about demand;
supply costs; competition; interest rates; corporate taxes; and general economic confidence -- making
the overall decision to invest a complex process that is highly dependent on the specific facts of a given
market," says Turner. "It is simply wrong to suggest that network neutrality, or any other regulation, will
automatically deter investment."

Turner argues that "at the end of 2006, AT&T, as a condition of its acquisition of BellSouth, was required by the FCC to operate a neutral network for two years. During this period, while operating under network neutrality rules, AT&T’s overall gross investment increased by $1.8 billion, more than any other ISPs in America."

"In its wireline segment (which was specifically subject to the FCC’s fifth principle of nondiscrimination
in addition to the other four open Internet principles in the agency’s Internet policy statement, AT&T’s
gross capital investment increased by $2.3 billion," says Turner.

As a percentage of wireline revenues, AT&T’s wireline investments grew from 13.5 percent in 2006 to 20.2 percent in 2008, he also argues.

"During the years following the imposition of pro-competitive regulations on incumbent phone
companies as stipulated in the 1996 Telecom Act, investment as a percentage of revenue by these
companies rose from nearly 20 percent before the enactment of the law to a high of 28 percent in
2001," Turner argues. "In the years following the dismantling of these rules, relative investment levels declined to below 17 percent in 2008."

In fairness, the issue is fairly complex. One might argue that AT&T was willing to invest, even under temporary "neutrality" rules, precisely because those rules were temporary. One might argue that some investment was driven by competitive concerns, not necessarily because of high return on invested capital.

Indeed, the fact that investment, as a percentage of revenue, has grown is precisely because returns are lower than before precisely because the returns from broadband services are lower than for voice services.

Also, investment might have declined in 2008 because of the recession, or because such investment is powerfully affected by the general level of competition. In other words, executives might have been investing more than they believed they "should," not to gain revenue or share but simply to hold it. That, in fact, is precisely what executives say privately.

The other imponderable is that current net neutrality rules are fairly benign, and simply allow end users access to all lawful applications. Proposed new rules might go much further, and prohibit development of new services, driving new revenue, at a much more serious level.

To argue that benign rules have had benign impact is one thing. It is quite another thing to extend rules in ways that might actually choke off needed new revenue opportunities, at a time when everybody agrees the current revenues are unsustainable. Forcing wireless companies to follow the same rules that might be applied to wired networks with vastly more bandwidth is one example.