Why Adco? Why Now? An Economic Exploration into the Future of Industry Structure for the "Last Mile" in Local Telecommunications Markets

Editor's Note: A version of this Article originally appeared as Phoenix Center Policy Paper No. 12. (1) I. INTRODUCTION It is now more than five years since the passage of the landmark Telecommunications Act of 1996 (1996 Act), but instead of flourishing competition, the competitive local carrier sector has experienced a financial meltdown. (2) So, what happened? Basically, the issue can be narrowed to several fundamental misconceptions about the underlying economics of the telecommunications business by all of the major stakeholders, including Wall Street, policymakers, and would-be entrepreneurs. Namely, it appeared that everybody believed that: (a) entry into the local market would be relatively inexpensive; (b) the market immediately would be capable of sustaining multiple local access networks; and (c) as a result of their desire to enter the long-distance business, incumbents would gladly embrace competitive entry. (3) As this paper will discuss, however: (a) entry into the local sector is an extremely expensive business, requiring firms to incur huge sunk costs and achieve scale economies quickly; (b) under current and foreseeable market conditions, local markets will only be able to sustain a few "last-mile" access networks (i.e., high concentration); and (c) incumbents were prepared to--and in fact did--go to great lengths in order to deter entry. (4) As such, just as it was prior to 1996, one of the key unresolved issues in telecommunications restructuring continues to be the proverbial "last mile" (5)--that is, the last segment of the network necessary to connect the customer. (6) Indeed, despite the somewhat regular deployment of state-of-the-art national and regional long-haul networks and metropolitan fiber rings by a number of carriers, the deployment of alternative networks comes to a screeching halt when it reaches into the local exchange, leaving dominant control of most switching and transport facilities, and particularly the "last mile" or "last yard" of the local exchange network, to the incumbent local exchange carrier ("ILEC"). (7) In order to bypass the economic bottleneck for local access, therefore, the competitive local exchange carrier ("CLEC") industry has been faced with the core question of transaction cost economics: is it more efficient to buy local access via unbundling, special access, and so forth from the reluctant incumbent, and conduct their transactions in the market, or build their own local access network from scratch, and bring the transaction out of the market and into the firm? (8) Unfortunately, the problem is that under current and foreseeable market conditions, neither option is particularly economically appealing. On the one hand, given the incumbents' near-complete dominance of the local access market, there really is no competitive "market" where a firm can purchase local access at just and reasonable rates that will be provisioned on a timely basis. Acquiring needed inputs (i.e., elements) from the incumbents at just and reasonable rates and provisioning intervals is no cake walk either. After all, dominant firms do not typically facilitate the demise of their dominance. This is not an irrational concept, because no firm will ever be enthusiastic about consciously going against its own self-interests by selling its rivals their key input of production (i.e., loops). (9) Indeed, while the 1996 Act requires the ILECs to provide such elements, the Act did little to fundamentally alter economic incentives. (10) So long as this inherent wholesale-supplier/retail-competitor conflict exists between an ILEC and a CLEC, then the ILECs' ability to manipulate prices for elements and to control quality leaves sufficient room for ILECs to sabotage transactions, defined as the ability to increase the cost of a rival's key input of production by nonprice behavior between itself and CLECs. …