Thursday, April 7, 2016

Municipal Broadband: Competition or Investment, Choose One

Regulation of communications services often poses a cruel and difficult choice, namely choosing between competition or investment. In fact, that is the explicit context of policymaking in the European Community and North America, for example.

In the EC, after decades of fostering policies leading to robust competition, policymakers now are focusing on methods of obtaining more of the other sort of good, namely robust investment in next generation networks.

In the U.S market, policymakers rapidly shifted to policies designed to encourage investment in next generation networks, at the expense of policies that deliberately encouraged competition.

Such trade-offs are a difficult but real constraint on all policymaking in the next generation networks arena, including that of local access and high speed access services.

The rationale for municipal broadband is that it provides social and economic good for the community, unobtainable from private providers. Occasionally, the argument is that doing so also will lead to more competition.

That is unlikely to be a stable long-term result. In the capital-intensive fixed networks business, there are huge constraints on sustainability.

Consider rural markets, where we routinely subsidize service, as there literally is no viable way for a private provider to create and sustain a business. “High cost subsidies” are precisely a recognition that, in fact, there is no private market business case for fixed network communications, in some markets.

Markets where municipal high speed access services are feasible often also are markets where existing private suppliers face the most-daunting business cases. That leads to underinvestment and also the attractiveness of municipal broadband.

One unlikely long term outcome is an increase in competition, though.

“Municipal systems regularly obtain 60 percent market share and remove a major anchor tenant (the government) from private networks, thereby weakening the economic case for private investment in upgrades, Ford notes.

In any market with two current suppliers, a third entrant grabbing 60 percent market share (installed base, actually) will drive one of the other existing competitors from the market.

In the near term, consumers might well benefit from a new entrant offering gigabit speeds in a market where none of the other providers is willing to supply more than 40 Mbps to 50 Mbps, if that. In the long term, that disparity will result in a new market share pattern that continues to support only two providers, as there is not enough profit left when two fixed network providers compete for 40 percent of the potential customer opportunity.

Generally speaking, with today’s economics, a fixed network services supplier probably requires share of about a third of potential customers to stay in business, long term.

That is ultimately unlikely, if one provider gains 60 percent share.  In the long run, the number of firms that can profitably serve a market “is what it is,” so eventually either the municipal entrant will fail or a private provider will exit or materially reduce its investments.

That is likely to be particularly true in the toughest markets, where incentives for private providers are most difficult.

Many would argue that municipalities should have the right  to create and operate their own high speed access business. But many also might argue that doing so is generally not the best use of municipal financial resources.

It is not that a municipal broadband network fails to deliver social benefits, but that it generally does so inefficiently.

One of the obvious justifications for municipal broadband is that it boosts economic development. That generally is the argument made for local government spending on sports arenas as well.

Skeptics might argue that such investments do not so much “create” economic activity as shift it from one existing area to another.

In other words, it is possible to argue both that broadband is economically important, and also that, on a net basis, such effort shift activity from one geographic area to another. For such reasons, state efforts to attract companies to move from elsewhere result in zero net gain, though helping one area at the expense of another.

As Ford argues, “most of the economic gains attributed to municipal broadband systems are based on economic migration rather than economic development.”

Municipal broadband networks should not be illegal, but most often should be deployed as a last resort, argues  Dr. George S. Ford, Phoenix Center for Advanced Legal and Public Policy Studies chief economist.

Many supporters of municipal broadband networks would agree, the difference perhaps being the evaluation of “last resort” necessity, and the inability of private actors to supply remedies.

Municipal broadband is in almost all scenarios subsidized entry, according to Dr. George S. Ford, Phoenix Center for Advanced Legal and Public Policy Studies chief economist.

“In Chattanooga-Tennessee, for example, the city’s system received a federal grant equal to about $2,000 per subscriber, while in Bristol-Virginia the subsidies received from various sources equaled about $7,000 per subscriber,” says Ford.  “Many if not most proponents of municipal broadband acknowledge that without subsidization, municipal broadband is a non-starter.”

The point is that municipal broadband provides social benefits, but at a relatively low level in most instances.

In many ways, the analysis presents the sort of “trade off” dilemmas many national telecom regulators have faced. It often, if not always, is the case that competition and investment are rival outcomes: more of one means less of the other.

As Ford argues, “the economics indicate that subsidized municipal broadband is incapable of increasing competition, if competition is measured as the number of firms offering service in a given area.”
Nor are municipal ISP operations necessarily free of the sort of predatory dynamics antitrust laws are designed to remedy.

“Subsidized municipal entry is prone to be predatory,” Ford argues. “Municipalities operating broadband networks are not, as the Supreme Court observed, acting only ‘to serve the public weal.’”

“Instead, the municipal entrant seeks to capture market share from private sector providers,” says Ford. “As such, if one discusses municipal broadband in the context of competition, the asymmetric subsidized entry of a municipal system is better characterized as anticompetitive in nature.”

“Economic theory suggests that the mere threat of municipal entry can reduce private sector investment,” Ford adds.

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