Order Code RL33034
CRS Report for Congress
Received through the CRS Web
Telecommunications Act: Competition,
Innovation, and Reform
August 12, 2005
Charles B. Goldfarb
Specialist in Industrial Organization and Telecommunications Policy
Resources, Science, and Industry Division
Congressional Research Service ˜ The Library of Congress

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Telecommunications Act:
Competition, Innovation, and Reform
Summary
In 1996, Congress enacted comprehensive reform of the nation’s statutory and
regulatory framework for telecommunications by passing the Telecommunications
Act, which substantially amended the 1934 Communications Act. The general
objective of the 1996 Act was to open up markets to competition by removing
unnecessary regulatory barriers to entry. At that time, the industry was characterized
by service-specific networks that did not compete with one another: circuit-switched
networks provided telephone service and coaxial cable networks provided cable
service. The act created distinct regulatory regimes for these service-specific
telephone networks and cable networks that included provisions intended to foster
competition from new entrants that used network architectures and technologies
similar to those of the incumbents. This “intramodal” competition has proved very
limited. But the deployment of digital technologies in these previously distinct
networks has led to market convergence and “intermodal” competition, as telephone,
cable, and even wireless networks increasingly are able to offer voice, data, and video
services over a single broadband platform. However, because of the distinct
regulatory regimes in the act, services that are provided by different network
technologies, but compete with one another, often receive different regulatory
treatment. Also, the act created a classification, “information services,” that was not
subject to either telephone or cable regulation. Today, voice and video services that
are provided using Internet protocol technology may be classified as information
services and therefore not subject to traditional voice or video regulation.
There is consensus that the current statutory framework is not effective in the
current market environment, but not on how to modify it. The debate focuses on how
to foster investment, innovation, and competition in both the physical broadband
network and in the applications that ride over that network while also meeting the
many non-economic objectives of U.S. telecommunications policy: universal
service, homeland security, public safety, diversity of voices, localism, consumer
protection, etc. Given the underlying cost structure of broadband networks — huge
sunk up-front fixed costs — the marketplace will likely support only a limited
number of such networks. Today, the market is largely a duopoly: the telephone
company network and the cable company network. The physical network providers
argue that they will be discouraged from undertaking costly and risky build-outs if
their networks are subject to open access and/or non-discrimination requirements.
On the other hand, independent applications providers argue that in order for them
to best meet the needs of end users and offer innovative services they must have
nondiscriminatory access to the physical network. There is much debate over the
advantages and disadvantages of structural regulation, such as open access, ex ante
non-discrimination rules, ex post adjudication of abuses of market power on a case-
by-case basis, and reliance on non-mandatory principles. There is general agreement
that there would be great benefits from entry by a wireless broadband network to
compete with the telephone and cable networks. There also is debate about how to
modify the universal service program and intercarrier compensation rules in light of
the major market changes. This report will be updated as warranted.

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Contents
Overview . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
The Big Picture . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
Problems with the Current Statutory and Regulatory Framework
for Telecommunications . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
Public Policy Issues to Debate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7
Background: The 1996 Act . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11
Competition and Innovation in the Internet Protocol Environment . . . . . . . . . . . 15
Applications Innovation: Competition Between Integrated Network
Providers and Independent Applications Providers . . . . . . . . . . . . . . . 16
Broadband Network Restrictions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19
Approaches to Regulating Access to Broadband Networks . . . . . . . . . . . . 21
Open Access . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22
Ex Ante Non-Discrimination Rules . . . . . . . . . . . . . . . . . . . . . . . . . . . 23
Ex Post Adjudication of Abuses of Market Power . . . . . . . . . . . . . . . 30
Antitrust Law and Non-Mandatory Principles as the Basis for
Self-Regulation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32
Platform Innovation: Mass Market Competition Among Broadband
Network Providers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34
Traditional Cable vs. IP Video . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35
Reviewing the Current Framework for Cable Franchising . . . . . . . . . 38
Fostering Additional Broadband Networks . . . . . . . . . . . . . . . . . . . . . . . . . 40
Intermodal Competition from Advanced Wireless Networks . . . . . . . 40
Intramodal Competition from CLECs for Large Business
Customers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 46
Antitrust Savings Clause: The Trinko Decision . . . . . . . . . . . . . . . . . . . . . . 47
Intercarrier Compensation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 48
Universal Service in a Broadband Environment . . . . . . . . . . . . . . . . . . . . . . . . . 57
Which Services Should Be Supported by a Universal Service Subsidy
and Who Should Receive the Subsidy? . . . . . . . . . . . . . . . . . . . . . . . 58
Who Should Contribute to a Universal Service Subsidy Fund and How
Should Contributors be Assessed? . . . . . . . . . . . . . . . . . . . . . . . . . . . . 61
Transition Issues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 66
Other Programs and Policies that Contribute to the Universal
Availability of Broadband Networks . . . . . . . . . . . . . . . . . . . . . . . . . . 66
Grant and Loan Programs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 68
Municipal Provision of Broadband Networks . . . . . . . . . . . . . . . . . . . 70
Corollary Issues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 71
Voice over Internet Protocol (VoIP) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 71
Access to 911 and E911 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 72
Law Enforcement (CALEA) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 73
Media Policy: Localism, Competition, and Diversity of Voices . . . . . . . . . 74
Subscription Multi-Channel Video Services . . . . . . . . . . . . . . . . . . . . 74
Multicasting and “Must Carry” Requirements . . . . . . . . . . . . . . . . . . . 75

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List of Figures
Figure 1: Current Intercarrier Compensation Rates . . . . . . . . . . . . . . . . . . . . . . . 51

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Telecommunications Act:
Competition, Innovation, and Reform
Overview
The Big Picture
A comprehensive statutory framework for U.S. communications policy,
covering telecommunications and broadcasting was first created in the
Communications Act of 1934 (“1934 Act”).1 That act created the Federal
Communications Commission (“FCC” or “Commission”) to implement and
administer the economic regulation of the interstate activities of the telephone
monopolies and the licensing of spectrum used for broadcast and other purposes. It
explicitly left most regulation of intrastate telephone services to the states. In the
1970s and 1980s, a combination of technological change, court decisions, and
changes in U.S. policy permitted competitive entry into some telecommunications
and broadcast markets. In 1996, Congress passed the Telecommunications Act
(“1996 Act”),2 which opened up markets to competition by removing unnecessary
regulatory barriers to entry.
The 1996 Act attempted to foster competition among providers that use similar
underlying network technologies (for example, circuit-switched telephone networks)
to offer a single type of service (for example, voice). Thus, there is one regulatory
regime for carriers providing voice telephone service and another regime for cable
television providers. Information services3 are not subject to either regulatory
regime. The subsequent deployment of digital broadband technologies in telephone
and cable networks has resulted in these networks providing services that compete
with one another, but that sometimes are subject to different regulatory requirements.
Voice and video services can now be provided using Internet protocol and thus might
be classified as unregulated information services, but these services compete directly
with regulated traditional voice and video services. Moreover, these digital
technologies do not recognize national borders, much less state boundaries.
There is consensus that the current statutory framework is not effective in the
current market environment, but not on how to reform that framework. Key issues
1 47 U.S.C. 151 et. seq.
2 P.L. 104-104, 110 Stat. 56.
3 The act defines “information service” as the offering of a capability for generating,
acquiring, storing, transforming, processing, retrieving, utilizing, or making available
information via telecommunications.” (Title I, Section 3(20) of the 1934 Act)

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of contention have been identified, however, and various proposals have been put
forward to resolve these issues.
Both houses of Congress have begun debating how to modify the 1996 Act,
most of which resides within the Communications Act of 1934, as amended. That
debate focuses on how to foster investment, innovation and competition in both the
physical broadband network and in the applications that ride over that network while
also meeting the many non-economic objectives of U.S. telecommunications policy:
universal service, homeland security, public safety, diversity of voices, localism,
consumer protection, etc.
The underlying cost structure of broadband networks — huge sunk up-front
fixed costs — can only support a limited number of broadband networks, though
there generally is no similar cost constraint on the number of applications providers.
In this new environment, there will be three broad categories of competition: (1)
intermodal competition among a small number of broadband network providers that
offer a suite of voice, data, video, and other services primarily for the mass market;
(2) intramodal competition among a small number of wireline broadband providers
that serve multi-locational business customers who tend to be located in business
districts; and (3) competition between these few broadband network providers and
a multitude of independent applications service providers.4 These three areas of
competition will all be affected by a common factor: will there be entry by a third
broadband network to compete with the broadband networks of the local telephone
company and the local cable operator?
There are four general approaches to the regulation of broadband network
providers vis-a-vis independent applications providers: structural regulation, such as
open access; ex ante non-discrimination rules; ex post adjudication of abuses of
market power, as they arise, on a case-by-case basis; and reliance on antitrust law and
non-mandatory principles as the basis for self-regulation. At present, the FCC
follows the last approach. In this report, a number of regulatory proposals,
sometimes incorporating elements from more than one of these approaches, are
discussed.
There is consensus that the current universal service and intercarrier
compensation mechanisms need to be modified to accommodate the new market
conditions. For example, the current universal service funding mechanism is
assessed only on telecommunications services, and carriers can receive universal
service funding only in support of telecommunications services. Thus, if services
that had been classified as telecommunications services are re-classified as
information services, as recently occurred for high-speed digital subscriber line
(“DSL”) services, then the universal service assessment base will decline and carriers
that depend on universal service funding may see a decline in support. It therefore
may be timely to consider whether the scope of universal service should be expanded
to include universal access to a broadband network at affordable rates, not just to
basic telephone service.
4 In addition, there will continue to be niche providers that offer consumers users
competitive options for specific services.

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Problems with the Current Statutory and Regulatory
Framework for Telecommunications
Technological change is driving the convergence of a number of previously
distinct telecommunications and media markets. Digital technologies are being
deployed in and carried over wireline, cable, and wireless networks that are
increasingly capable of providing voice, data, and video services over a single
broadband platform.5 The U.S. communications infrastructure is evolving from
circuit-based networks, in which individual applications (such as voice telephony)
are tightly woven into the network architecture, to Internet Protocol (“IP”) networks,
in which multiple applications ride on top of the physical (transmission) network
layer. There is consensus that the current statutory and regulatory framework for
telecommunications is ill-suited for the current market environment. There is
disagreement, however, about what modifications are necessary and how
comprehensive those modifications should be.
At the time of the 1996 Telecommunications Act, the last comprehensive review
of U.S. telecommunications policy, the environment we live in today was barely
contemplated:
! voice, data, and video transported in packets of digitized bits over
routes that pay no attention to state or even national boundaries;
! network “usage” measured in terms of bandwidth rather than time;6
! an end-user service provided over competing wireline, cable, and/or
wireless broadband networks;
! those networks capable of providing multiple services; and
5 There is no single, agreed-upon definition of “broadband.” In its data collection, the
Federal Communications Commission defines “high-speed lines” as connections that deliver
services at speeds exceeding 200 kilobits per second (“kbps”) in at least one direction and
“advanced service lines” as connections that deliver services at speeds exceeding 200 kbps
in both directions. (See “Federal Communications Commission Releases Data on High-
Speed Services for Internet Access,” FCC News release, July 7, 2005.) These speeds would
not be sufficient to offer broadcast-quality video service. Thus, for example, telephone
companies that currently offer digital subscriber line (“DSL”) broadband connections would
have to upgrade those connections in order to offer video service.
6 In circuit-based networks, for the duration of any communication, a circuit is tied up from
the calling party’s premise all the way to the called party’s premise. In IP-based networks,
a communication is converted into digital bits and small packets of bits are transmitted over
whatever route is available. With broadband in place, even the “last-mile” into the calling
and called parties’ premises may accommodate multiple simultaneous applications,
depending on each application’s bandwidth requirements.

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! no knowledge of the next “killer application” (comparable to the
World Wide Web or e-mail) that will drive network and software
investment.
Given the distinct, service-specific networks then in use, the 1996 Act created
distinct vertical regulatory “silos” that equated specific services with specific network
technologies. The statutory framework for regulating telecommunications services
is found in one title of the 1996 Act7 and for cable services in another title.8 In
addition, the 1996 Act defines a category of services, “information services,”
consisting of
the offering of a capability for generating, acquiring, storing, transforming,
processing, retrieving, utilizing, or making available information via
telecommunications.9
These information services are not subject to any of the specific regulatory regimes
in the 1996 Act; FCC jurisdiction over them is limited to its ancillary authority under
Title I of the 1934 Act.10 The distinction in the 1996 Act between
telecommunications services and information services was an outgrowth of a line of
FCC decisions dating back to the 1970s that distinguished between “basic” services
that were subject to regulation and “enhanced” services that the Commission chose
not to regulate in order to foster their development and deployment.11 Keeping with
7 Title I of the 1996 Act, which is incorporated into Title II of the Communications Act as
amended, 47 U.S.C. 151 (“1934 Act”).
8 Title II of the 1996 Act, which is incorporated into Title VI of the 1934 Act.
9 Title I, Section 3(20) of the 1934 Act.
10 47 U.S.C. § 154(i) states: “The Commission may perform any and all acts, make such
rules and regulations, and issue such orders, not inconsistent with this Act, as may be
necessary in the execution of its functions.”
11 See Regulatory and Policy Problems Presented by the Interdependence of Computer and
Communication Services and Facilities, Docket No. 16979, Notice of Inquiry, 7 FCC 2d 11,
1966, (known as the “Computer I Notice of Inquiry”); Regulatory and Policy Problems
Presented by the Interdependence of Computer and Communications Services and
Facilities, Docket No. 16979, Final Decision and Order, 28 FCC 2d 358, 1971, (known as
the “Computer I Final Decision”); Amendment of Section 64.702 of the Commission’s Rules
and Regulations(Second Computer Inquiry), Docket No. 20828, Tentative Decision and
Further Notice of Inquiry and Rulemaking, 72 FCC 2d 358, 1979, (known as the “Computer
II Tentative Decision”); Amendment of Section 64.702 of the Commission’s Rules and
Regulations (Second Computer Inquiry), Docket No. 20828, Final Decision, 77 FCC 2d 384,
1980, (known as the “Computer II Final Decision”); Amendment of Section 64.702 of the
Commission’s Rules and Regulations (Third Computer Inquiry), CC Docket No. 85-229,
Report and Order, 104 FCC 2d 958, 1986, (known as “Computer III”). In its Computer II
Final Decision at pp. 432-435, paras. 126-132, the Commission found that the enhanced
services market was highly competitive with low barriers to entry and therefore declined to
treat providers of enhanced services as common carriers subject to regulation under Title
II of the act.

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this regulatory history, the Commission has chosen to forbear from regulating
information services, again seeking to foster their development and deployment.12
These distinct regulatory regimes did not create significant problems so long as
technological and market forces did not erode the distinctions between cable,
telecommunications, and information services — and so long as it was possible to
unambiguously classify services into these categories. But they became problematic
when technological change made it more difficult to determine which service
category a particular service fell under and when market convergence resulted in
competition between services that were classified, and thus regulated, differently.
Since 1996, the distinctions between these service categories have become
increasingly blurred. For example, some providers are offering voice over Internet
protocol (“VoIP”) services that meet the definition of information services while
competing directly with traditional voice telecommunications services. Similarly,
some providers have announced plans to offer IP video services that arguably would
meet the definition of information services while competing directly with traditional
cable services. Those IP-based service providers assert that their offerings should be
subject only to the limited regulatory oversight of information services, not to the
more intrusive regulation of telecommunications services and cable services,
respectively.
It has proven to be an administrative and legal morass to determine whether an
information service — which, by definition, provides certain capabilities via
telecommunications — is purely an information service, and therefore subject only
to a light regulatory regime, or has a distinct telecommunications service component
that would make it subject to the more rigorous common carrier regulation imposed
on telecommunications services. For example, in 2002 the FCC concluded that the
telecommunications functionality in the cable modem service offered by cable
companies to provide high speed access to the Internet is integral to the service, and
not transparent to the consumer, and therefore cable modem service should be treated
as a pure information service, and not subject to the access requirements imposed on
telecommunications services.13 That decision was upheld by the Supreme Court in
June 2005.14 At the same time, although the FCC had tentatively concluded that DSL
service, which is offered by telephone companies to provide high-speed access to the
Internet, also is an information service, with an integral telecommunications
12 See, for example, In the Matter of Inquiry Concerning High-Speed Access to the Internet
Over Cable and Other Facilities; Internet Over Cable Declaratory Ruling; Appropriate
Regulatory Treatment for Broadband Access to the Internet Over Cable Facilities, 17 FCC
Rcd. 4798, 4799 (March 15, 2002).
13 In the Matter of Inquiry Concerning High-Speed Access to the Internet Over Cable and
Other Facilities; Internet Over Cable Declaratory Ruling; Appropriate Regulatory
Treatment for Broadband Access to the Internet Over Cable Facilities, 17 FCC Rcd. 4798,
4799 (March 15, 2002).
14 National Cable & Telecommunications Association v. Brand X Internet Services, 125 S.
Ct. 2688 (2005). This decision does not preclude the FCC from regulating information
services, such as cable modem service or DSL services, based on its ancillary authority
under Title I of the act.

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component, rather than a telecommunications service,15 it had continued to treat the
transmission component of DSL as a telecommunications service, and therefore DSL
continued for more than three years to be subject to the access and other
telecommunications service requirements. Local telephone companies were required
to unbundle and separately tariff the underlying transmission component of their DSL
Internet access services. On August 5, 2005, the FCC adopted an order that granted
DSL Internet access providers the same regulatory classification and treatment as
cable modem Internet access providers.16
There is an expectation that providers of information services will attempt to
configure their service offerings in a fashion that will maximize the likelihood that
the FCC will classify them as pure information services for regulatory purposes. As
explained in greater detail below in the section on VoIP, however, the Commission
continues to make determinations, based on the underlying network architectures
used, about whether any specific service offering should be classified and regulated
as an information service or as a telecommunications service.
The current siloed statutory and regulatory framework has not been able to
accommodate the rapid pace of market convergence; it sometimes treats differently
providers or services that are in direct competition with one another. The disparate
rules have sometimes created incentives for providers to tailor their investment
decisions and product offerings to avoid/exploit artificial regulatory distinctions
rather than to efficiently serve customer needs. Similarly, the mechanisms currently
embodied in statutes and rules to support such social policy goals as universal service
are based on the pre-1996 market environment and are no longer sustainable or as
effective as they could be.
15 Appropriate Framework for Broadband Access to the Internet over Wireline Facilities,
Universal Service Obligations of Broadband Providers, Notice of Proposed Rulemaking,
adopted February 14, 2002.
16 “FCC Eliminates Mandated Sharing Requirement on Incumbents’ Wireline Broadband
Internet Access Services,” FCC News Release, August 5, 2005. In order not to disrupt
markets, however, the FCC created a one-year transition period during which independent
ISPs would continue to be able to obtain DSL transmission service from incumbent local
exchange carriers and also a 270 day transition period (which could be extended) during
which the DSL revenues would continue to be treated as interstate telecommunications
service revenues for the purposes of funding universal service. The FCC also stated that it
retained ancillary authority to regulate DSL service and adopted a Further Notice of
Proposed Rulemaking to determine whether it should construct consumer protection rules
for broadband services. In addition, the Commission adopted a non-binding policy
statement consisting of four principles: consumers are entitled to access the lawful Internet
content of their choice; consumers are entitled to run applications and services of their
choice, subject to the needs of law enforcement; consumers are entitled to connect their
choice of legal devices that do not harm the network; and, consumers are entitled to
competition among network providers, application and service providers, and content
providers.

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Public Policy Issues to Debate
While there are many dimensions to the debate about reform of the statutory and
regulatory framework for telecommunications, there appear to be two fundamental
underlying issues that affect all others.
First, in this new environment in which applications are no longer tightly woven
into the network architecture, what is the best regulatory framework for fostering
investment and innovation in both the physical broadband network and in the
applications (services) that ride over that network? The physical network providers
(local exchange carriers and cable system operators) argue that they will be
discouraged from undertaking costly and risky broadband network build-outs and
upgrades if their networks are subject to open access and/or non-discrimination
requirements that might limit their ability to exploit vertical integration efficiencies
or to maximize the return on (or even fully recoup) their investments. On the other
hand, the independent applications providers argue that in order for them to best meet
the needs of end users and offer innovative services in competition with the vertically
integrated network providers and, in some cases, services not offered at all by
network providers. They must have the same unfettered open access to the physical
networks that the network providers enjoy or, at the least, be protected by non-
discrimination rules. Similarly, many end users argue that their broadband network
providers should not be allowed to restrict their usage of the broadband network so
long as they do not in any way compromise the integrity of the network.
This big-picture issue raises a number of corollary issues:
! In a complex technical environment in which a broadband platform
typically consists of a physical (transmission) network layer, a
logical layer (usually the TCP/IP17 suite of protocols), an
applications layer, and a content layer,18 and in which services pass
17 TCP/IP stands for Transmission Control Protocol/Internet Protocol. IP is responsible for
moving packets of data from node to node. IP forwards each packet based on a four byte
destination address (the IP number). The Internet authorities assign ranges of numbers to
different organizations. The organizations assign groups of their numbers to departments.
IP operates on gateway machines that move data from department to organization to region
and then around the world. TCP is responsible for verifying the correct delivery of data
from client to server. Data can be lost in the intermediate network. TCP adds support to
detect errors or lost data and to trigger retransmission until the data are correctly and
completely received.
18 Since the 1970s, engineers have developed various network design models incorporating
protocols in a layered manner. While the network configurations have varied somewhat
(there may be different numbers of layers if, for example, network functions are combined
in some network designs and separated in others), there is general agreement that the
broadband networks currently being deployed consist of layers or tiers, starting with the
lowest layer of physical infrastructure and ending with the highest layer of content, with a
logical TSP/IP layer that both can accommodate every type of physical network (DSL, cable
modem, ethernet, fiber optics, satellite, Wi-Fi, Bluetooth, etc.) as well as a multitude of
applications and content. See, for example, Richard S. Whitt, “A Horizontal Leap Forward:
(continued...)

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over both the broadband network provider’s last-mile network and
the Internet, where and how can denied access harm consumers?
What does it mean to have nondiscriminatory access? Should access
be viewed from the perspective of an end user or of an independent
applications provider or of a competing network? Which access
restrictions are justifiable to maintain the integrity and operational
efficiency of the network? Should access regulation take the form
of structural open access requirements or ex ante non-discrimination
rules or ex post adjudication of abuses of market power as they arise
on a case-by-case basis?19 Or should there be no regulation, with
industry voluntarily adhering to non-discrimination principles such
as the Internet Consumer “four freedoms” enunciated by former
FCC Chairman Michael Powell20 or the principles in the non-binding
policy statement adopted by the FCC on August 5, 2005?21
! How many competing physical broadband networks are needed for
market forces alone to ensure that the network providers lack the
incentive and the ability to restrict access or otherwise discriminate
against independent applications providers to the detriment of
consumers? To what extent can federal spectrum policy and
infrastructure programs foster the deployment of multiple
competitive broadband networks, thereby alleviating the need for
access rules?
Second, while market demand appears to be sufficient to generate competitive
broadband network deployment in many urban areas without government
18 (...continued)
Formulating a New Public Policy Framework Based on the Network Layers Model,”
December 2003, available at [http://global.mci.com/about/publicpolicy/presentations/
horizontallayerswhitepaper.pdf], viewed on June 15, 2005. Professor Tim Wu has
suggested, however, that in order to construct simple regulatory rules that would be subject
to minimal administrative and litigative encumbrances, it might be preferable to construct
a regulatory framework that defines just two layers: a physical transport infrastructure layer
and an application services layer. See Tim Wu, “A Flat Model of Telecommunications
Regulation,” forthcoming, Journal of Telecommunications and High Technology, Volume
4, available from Professor Wu, who can be contacted at the website [http://faculty.virginia.
edu/timwu/].
19 Ex ante rules impose explicit requirements, restrictions, or prohibitions to which parties
know in advance they are required to adhere. The regulatory agency typically need not
analyze the impact of a party’s failure to comply with the rule before taking remedial action.
By contrast, ex post adjudication of abuses of market power typically requires the regulatory
agency to make a finding of abuse of market power before taking any remedial action.
20 These four Internet Consumer Freedoms are: freedom to access content, freedom to use
applications, freedom to attach personal devices, and freedom to obtain service plan
information.
21 Appropriate Framework for Broadband Access to the Internet over Wireline Facilities,
Universal Service Obligations of Broadband Providers, Notice of Proposed Rulemaking,
adopted February 14, 2002.

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intervention, that may not be the case in rural or other high cost (or low income)
areas, where high costs and/or limited demand may render it economically infeasible
to deploy multiple broadband networks, or even a single network, without
government intervention. Does Congress want to expand the scope of universal
service to include universal access to a broadband network at affordable rates? If
so, how can the needed universal service support mechanisms accomplish this in an
efficient, sustainable, and competitively-neutral fashion that does not harm other
policy goals, such as competitive neutrality? More basically, how “broad” is the
“broadband” that should be provided as part of universal service? Bigger may be
better, but only at an associated cost. Is it sufficient, for example, to limit a subsidy
program in high cost areas to support for broadband service capable of (relatively low
quality) video streaming if the unsubsidized market is driving companies to deploy
broadband capable of offering (higher quality) broadcast-quality video service in
urban areas? Should the universal service subsidy support access to the physical
broadband network or should it support specific services provided over that network?
There are corollary issues relating to how the universal service program would
be affected by changes in economic regulation. For example, when the FCC recently
re-classified DSL service as an information service rather than a telecommunications
service, it had two effects on universal service. First, the current universal service
assessment base, interstate and international telecommunications revenues, was
immediately reduced. Second, currently federal universal service funding is only
available to support telecommunications services. If DSL services are no longer
telecommunications services, eligible high-cost carriers would no longer be able to
obtain universal service funds in support of those services. Thus, reform of
economic regulation must be undertaken in conjunction with review of existing
universal service programs.
Another important element of the debate is how to develop a regulatory
framework that will not quickly become obsolete as the market continues to
experience rapid technological change. For example, many technologists envision
the development of highly decentralized peer-to-peer networks to efficiently deliver
interactive services in the future; these networks would have no major nodes and
therefore no single points of failure, making them more secure and robust than
current networks that rely on key servers.22 Already there is discussion of the need
to construct a new, more secure Internet.23 Thus, although it would not be
appropriate to base a new regulatory paradigm on a presumption that peer-to-peer
network architecture will predominate, it also would not make sense to construct a
regulatory framework that cannot accommodate that architecture.
Further complicating these issues, it will be necessary to chart a transitional
course as the shift to a digital, broadband environment will not occur instantaneously
22 See, for example, the research projects listed on the website of the Parallel and
Distributed Operating Systems Group at MIT, available at [http://pdos.csail.mit.edu]
(viewed on June 16, 2005).
23 See, for example, Ariana Eunjung Cha, “Viruses, Security Issues Undermine Internet,”
Washington Post, June 26, 2005, at pp. A1, A15.

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CRS-10
and some providers and customers will continue to be dependent on old technology
for some period of time.24
Finally, although the current statutory and regulatory framework allows the FCC
to preempt state laws that restrict competition,25 it generally limits FCC regulatory
authority to interstate and international services,26 leaving jurisdiction over intrastate
telecommunications services to the states. It also gives states or localities the
authority to grant cable franchises and to regulate rights-of-way.27 As voice, data,
and video services increasingly are provided over technologies and networks that do
not follow state, or even national, borders, however, it is becoming less effective to
perform certain types of regulation — and especially economic regulation — at the
state or local level. One task of telecom reform is to identify those regulatory
elements that can continue to be performed effectively at the state or local level and
those that should be centralized.
The purpose of this report is to provide an analytical overview of the market and
technological developments that have rendered the current statutory and regulatory
framework ineffective and, in some cases, contrary to stated U.S.
telecommunications policy objectives, and to present options for reforming the
framework.28 After a background discussion, it addresses the following issues:
! What are the advantages and disadvantages of the various different
approaches to regulating access to broadband networks? Four
options are discussed: open access, ex ante non-discrimination rules,
ex post adjudication of abuses of market power, and self-regulation
based on non-mandatory principles.
24 For example, in order not to disrupt markets, when the FCC adopted an order on August
5, 2005, changing the classification of DSL from a telecommunications service to an
information service, it created a one-year transition period during which independent ISPs
would continue to be able to obtain DSL transmission service from incumbent local
exchange carriers and also a 270 day transition period (which could be extended) during
which the DSL revenues would continue to be treated as interstate telecommunications
service revenues for the purposes of funding universal service. In addition, because a
blanket re-classification of DSL to information service would, under current rules relating
to National Exchange Carrier Association (“NECA”) tariffs and pools that help fund
universal service, reduce the universal service support available to certain rural telephone
companies for the provision of DSL services, those carriers were given the option of
continuing to treat DSL as a common carrier (telecommunications) service.
25 47 U.S.C. § 253.
26 47 U.S.C. §§ 151-152.
27 47 U.S.C. § 522.
28 This report does not address specific proposed legislation. For a brief discussion of a
number of issues potentially under consideration by Congress, please see CRS Report
RL32949, Communications Act Revisions: Selected Issues for Consideration, which
provides, by topic, a listing of relevant available CRS reports.

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CRS-11
! How might the current statutory framework be modified to address
the head-to-head competition developing between the broadband
networks of telephone companies and cable operators?
! How might public policy foster the deployment of additional
broadband networks?
! How might the rules for intercarrier compensation — the payments
that carriers make to one another for terminating the calls originated
by their subscribers — be made competitively neutral without
impinging on other goals of U.S. telecommunications policy?
! In a broadband environment, which services should be supported by
a universal service subsidy, who should receive the subsidy, who
should contribute to a universal service fund, and how should the
contributors be assessed?
! How do other programs and policies, such as federal grant and loan
programs and policies toward municipal provision of broadband
networks, contribute to the universal availability of broadband
networks?
! How might current policies concerning voice over Internet protocol,
access to 911 and E911, CALEA, and localism, competition, and
diversity of voice in media change to better accommodate the current
and future market and technological environment?
Background: The 1996 Act
In 1996, Congress passed the Telecommunications Act, the first major rewrite
of our nation’s telecommunications law since the enactment of the 1934
Communications Act. The general objective of the 1996 Act was to open up markets
to competition by removing unnecessary regulatory barriers to entry.29 Congress
attempted to create a regulatory framework for the transition from primarily
monopoly provision to competitive provision of telecommunications services.
One key provision allowed the FCC to preempt enforcement of any state or local
government statute, regulation, or legal requirement that acted as a barrier to entry
in the provision of interstate or intrastate telecommunications service.30
29 The conference report refers to the bill “to provide for a pro-competitive, de-regulatory
national policy framework designed to accelerate rapidly private sector deployment of
advanced services and information technologies and services to all Americans by opening
all telecommunications markets to competition....”, Conference Report, Telecommunications
Act of 1996, House of Representatives, 104th Congress, 2d Session, H.Rept. 104-458, at p.
1.
30 47 U.S.C. § 253.

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CRS-12
Since the value of a network service, such as telecommunications service,
increases as the number of other parties connected to the network increases,31 new
entrants would have a very difficult time entering the market if they could not
interconnect their networks with those of the incumbent carriers. Competitive
provision of service would benefit consumers most if all carriers’ networks were
interconnected. Thus, another key provision of the 1996 Act set obligations for
incumbent carriers and new entrants to interconnect their networks with one another,
imposing additional requirements on the incumbents because they might have the
incentive and ability to restrict competitive entry by denying such interconnection or
by setting terms, conditions, and rates that could undermine the ability of the new
entrants to compete.32
With competitive provision of service, many calls will originate on the network
of the carrier to whom the calling party subscribes but end up on the network of
another carrier (to whom the called party subscribes). While it might be possible to
have the calling party pay its carrier for originating a call and the called party pay its
carrier for terminating that call, for various reasons it has been traditional in the
United States for the calling party’s carrier to pay the called party’s carrier for
completing the call — this is called intercarrier compensation33 — and, in turn, for
the calling party’s carrier to recover those costs in the rates charged to its subscribers.
The 1996 Act requires that intercarrier compensation rates among competing local
exchange carriers be based on the “additional costs of terminating such calls.”34
However, as discussed below, the framework created by the 1996 Act set different
intercarrier compensation rates for services that were not competing at that time but
do compete today.
To foster competition in both the long distance and local markets, the 1996 Act
created a process by which the Regional Bell Operating Companies (“RBOCs”)
would be freed from the restriction on their offering long distance service (which was
one of the terms of the 1982 Consent Decree settling the government’s antitrust case
against the former Bell System monopoly)35 once they made a showing that their
local markets had been opened up to competition.36
31 Economists call this phenomenon “direct network externalities.” A positive/negative
externality is a benefit/cost that is not accounted for in the price of a good or service. Direct
network externalities are positive externalities because a network connection is more
valuable if it can be used to reach more people, but the subscriber is not charged more as the
number of other subscribers increases. In most situations, pollution is an example of a
negative externality, because it imposes costs on others but the perpetrator generally is not
forced to compensate the harmed parties.
32 47 U.S.C. § 252.
33 For a detailed discussion of intercarrier compensation, see CRS Report RL32889,
Intercarrier Compensation: One Component of Telecom Reform.
34 47 U.S.C. § 252(d)(2)(A)).
35 Modification of Final Judgment, United States v. American Telephone and Telegraph
Company, 552 F. Supp 131 (D.D.C. 1982).
36 47 U.S.C. § 271.

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CRS-13
Because Congress did not believe it would be viable for competitive entrants to
fully build out their networks immediately, it included a provision requiring the
incumbent local exchange carriers to make available to entrants, at cost-based
wholesale rates, those elements of their network to which entrants needed access in
order not to be impaired in their ability to offer telecommunications services.37
Prior to enactment of the 1996 Act, universal service (primarily for high-cost
rural service) had been funded through implicit subsidies in above-cost rates for the
“access charges” that long distance carriers paid as intercarrier compensation to local
telephone companies for originating and terminating their subscribers’ long distance
calls, above-cost business rates, and above-cost urban rates. Recognizing that new
entrants would target those services that had above-cost rates, and thus erode
universal service support, Congress included in the 1996 Act a provision requiring
universal service support to be explicit, rather than hidden in above-cost rates.38 This
requirement has only been partially implemented, however, and therefore significant
implicit universal services subsidies still remain in above-cost rates for certain
services.
The regulatory framework created by the 1996 Act was intended to foster
“intramodal” competition within distinct markets, that is, competition among
companies that used the same underlying technology to provide service, such as the
development of competition between the incumbent local and long distance wireline
carriers plus new competitive local exchange carriers, all of which used circuit-
switched networks to offer voice services. It did not envision the intermodal
competition that has subsequently developed, such as wireless service competing
with both local and long distance wireline service, VoIP competing with wireline and
wireless telephony, IP video competing with cable television. Given the focus on
intramodal competition and the lack of intermodal competition, there was little
concern about statutory or regulatory language that set different regulatory burdens
for different technology modes.
As a result, the current statutory and regulatory framework may be inconsistent
with, or unresponsive to, current market conditions in several ways:
! service providers that are in direct competition with one another
sometimes may be subject to different regulatory rules because they
use different technologies;39
37 47 U.S.C. §§ 251(c)(3) and 252(d)(1).
38 47 U.S.C. § 254(e).
39 For example, for certain long distance calls, if the caller uses a wireless telephone number,
the caller’s wireless carrier is subject to a cost-based “reciprocal compensation” intercarrier
compensation charge for the termination of that call. But if the caller made an identical call,
from the same location to the same called party, using a wireline telephone (and hence a
wireline long distance carrier), that carrier would be subject to above cost “access charges”
for the completion of the call. As another example, when a long distance call is made to a
called party’s wireline telephone, that party’s wireline local exchange carrier can charge the
calling party’s long distance carrier an above-cost access charge for terminating the call; but
(continued...)

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CRS-14
! economic regulations intended to protect against monopoly power
may not be fully taking into account intermodal competition; and
! the framework may not effectively address interconnection, access,
and social policy issues for an IP architecture in which multiple
applications ride on top of the physical (transmission) network layer.
At the same time, it might not be wise to simply replace the statutory provisions
fostering intramodal competition with provisions fostering intermodal competition
on the expectation that intermodal competition will always be effective. For the
foreseeable future, the primary source of competition in the telecommunications
service market for large business customers will be intramodal, rather than
intermodal. Cable networks were constructed to serve residential customers and
therefore tend not to be ubiquitously deployed in business districts. Even the largest
cable companies are only in selected geographic markets in the country, and may not
be able to meet the needs of large, multi-locational business customers. Also, it is
likely to take many years for wireless carriers to construct networks that can meet the
bandwidth and security requirements of large corporations. Competitive provision
of broadband services to large business market customers therefore is most likely to
be intramodal, between the incumbent long distance carriers, incumbent local
exchange carriers, and competitive local exchange carriers (“CLECs”). But recently
announced proposed mergers between SBC and AT&T, and between Verizon and
MCI, may reduce both actual and potential competition in business markets and in
the Internet backbone. The Department of Justice and the FCC will be making
determinations about the competitive effects and public interest consequences of
these proposed mergers, but as part of that process large business customers and
competitive local exchange carriers have raised concerns about having fewer options
to turn to. The large business customers have argued that SBC and Verizon
represented the two companies most likely to compete with AT&T and MCI, the two
largest providers of business services. And the CLECs have argued that they have
relied on AT&T and MCI as the primary alternatives to the RBOCs as sources of
transport facilities needed to compete in business markets.
39 (...continued)
if an identical long distance call were made to ths same called party, from and to the same
physical location, but to the called party’s wireless telephone, the called party’s wireless
carrier is not allowed to charge the calling party’s long distance carrier any access charge
for terminating the call. Indeed, the average intercarrier compensation rate ranges from 0.1
cents per minute for traffic bound to an information service provider (“ISP”) to 5.1 cents per
minute for intrastate traffic bound to a subscriber of a small (rural) incumbent local
exchange carrier; individual rates can be as low as zero and as high as 35.9 cents per minute
— even though in each case basically the same transport and switching functions are
provided. (See CRS Report RL32889, Intercarrier Compensation: One Component of
Telecom Reform, at pp. 2-5.) As another example of distortions in intermodal competition
caused by current rules, the Federal Universal Service Fund is funded through an assessment
on interstate telecommunications service revenues that exceeds 10% (the exact assessment
rate varies from quarter to quarter); information services, even if they compete directly with
the interstate telecommunications services, are not assessed.

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CRS-15
Competition and Innovation in the
Internet Protocol Environment
In a relatively short period of time, the telecommunications sector has evolved
from monopoly provision of services over service-specific networks, to a brief period
of limited intramodal competition (from wireline competitive access providers and
competitive local exchange carriers for the provision of telephone services and from
a small number of cable “overbuilders”) over service-specific networks, to incipient
intermodal (wireline, wireless, and cable) competition over increasingly multiple-
service broadband platforms. These new broadband networks are the physical
vehicle for bringing into the home the applications (services) of both the network
providers, themselves, and the independent applications providers. At this stage of
the transition, however, most customers continue to receive services over legacy
service-specific narrowband networks.
It is important to understand what this new environment — characterized by
convergence of previously distinct markets and government policy focused on
fostering facilities-based intermodal competition — is likely to yield. The market
convergence currently underway will not result in a multitude of broadband networks
because the underlying cost structure for such networks, meaning the huge sunk up-
front fixed costs that can only be recovered if the company can exploit significant
economies of scale and scope, will only support a limited number of networks. This
is the case for wireline or wireless networks. Moreover, market convergence is not
simply the ability to bundle voice, data, and video services into a single product
offering. Rather, it is a technological spillover (from digital technology) that reduces
entry costs so that firms that already have single-use networks providing voice, data,
or video services can now use those networks with relatively inexpensive upgrades
to offer multiple services over a single platform.40 For example, at far less cost than
would be required to build an entirely new network, the incumbent local exchange
carriers can deploy DSL equipment on their copper networks to offer data and video
services or the cable companies can upgrade their networks to offer VoIP. In this
situation, in which underlying costs are likely to limit the number of network
providers, public policy can nonetheless foster competition by removing
impediments to single-use networks expanding into other markets. At the same time,
policy makers should remain vigilant that the few network providers not constrain
the ability of independent applications providers that do not have their own
broadband networks to compete in those applications markets.
In the new environment, there will be three broad categories of competition and
innovation issues, tied together by one common issue. These three categories are:
! intermodal competition and innovation among a small number of
broadband network providers that offer a suite of voice, data, video,
and other services primarily for the mass market;
40 For a full discussion of this, see George Ford, Thomas Koutsky, and Lawrence Spiwack,
“Competition After Unbundling: Entry, Industry Structure and Convergence,” Phoenix
Center Policy Paper Number 21, July 2005, available at [http://www.phoenix-center.org,
viewed] on July 27, 2005.

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CRS-16
! intramodal competition and innovation among a small number of
wireline broadband providers that serve multi-locational business
customers who tend to be located in business districts;41 and
! competition between those few broadband network providers and a
multitude of independent service providers, often for applications
that have a more specialized customer base.
The common issue: how many broadband networks will there be and how will that
affect competition among network providers and competition between those network
providers and the independent applications providers?
Despite all the technological and market changes that have occurred and
continue to take place, competition issues in the telecommunications sector will
continue to focus on the physical transport link into both business and residential
customers’ premises. The new network architectures may allow many applications
to ride on a single physical transmission layer, but access to that layer and
competition among the small number of physical network providers remain the
primary competition issues.
Applications Innovation: Competition Between Integrated
Network Providers and Independent Applications Providers
Integrated network providers and independent applications providers come from
very different traditions. The network providers (the local exchange carriers, cable
companies, and wireless carriers) come from the tradition of employing a vertically
integrated business model, providing, as a single product offering, the network
connection and a specific service or suite of services. They are used to developing
and deploying their networks in the context of a business plan that jointly maximizes
profits from the physical network and the services they provide over that network.
Their network rollout and applications product rollout are coordinated. Network
architecture is driven, at least in part, by the services they intend to offer. Underlying
this approach is the assumption that investment can best be supported and innovation
can best be achieved by giving the vertically integrated network provider free rein
over network architecture, control of network intelligence, and discretion over the
extent to which it gives competing applications providers access to its network.
41 The large business customers are likely to have such great bandwidth demands that they
will have dedicated pipes to their major locations with broadband capability and will be
reliant on the broadband network providers’ general buildout only to connect to their smaller
locations or to their customers’ locations. Some parties have argued, however, that
depending on the terms of the proposed SBC-AT&T and Verizon-MCI mergers, these large
business customers may not have many alternative sources post-merger, especially to the
extent that cable networks tend to be built out to residential neighborhoods rather than
business districts.

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CRS-17
In sharp contrast, many of the independent applications providers (and their
customers) come from the Internet tradition of “network neutrality,” that is, an
Internet that does not favor one application over others. In practice, even the Internet
does not adhere to pure network neutrality; for example, the Internet protocol works
well for data applications, which are insensitive to “latency” (delay), and less well
for voice and video applications that are sensitive to latency, because it lacks a
universal quality of service guarantee.42 Nonetheless, the assumptions that underlie
the Internet tradition are that the innovation process is a survival-of-the-fittest
competition among developers of new technologies, that the most promising path of
innovation cannot be predicted in advance, and that therefore it is not optimal to
allow any private or public entity to direct that path; the network should be “neutral.”
This reasoning supports the need for “end-to-end” design, by which, whenever
possible, communications protocol operations occur at the end-points of a
communications system (i.e., a “dumb network” with “smart terminals”). But since
until 1995 the Internet was supported by government funding, rather than market
funding, this approach has not focused in the past on the task of raising sufficient
capital to build out physical networks.
The vertically integrated network providers and the independent applications
providers are not inherently at odds with one another, however; they share many
goals. The Internet environment is characterized by “indirect network externalities,”
in which independent actions taken by hardware and software providers benefit one
another. The greater the investment in physical network to improve connection speed
and quality of service, the greater the opportunities for software providers to develop
new, potentially profitable applications. At the same time, the greater the number of
software applications available, the greater the end-user demand for broadband
connections. A network provider will have an incentive not to restrict applications
providers’ access to its physical network to the extent that could reduce demand for
connections to that network (though that effect could be limited if end users have no
alternative broadband networks available to turn to).
At the same time, vertically integrated network providers might face a counter-
incentive to restrict or delay network access to applications providers; an example is
if the vertically integrated company is developing an application that would compete
with the independent provider’s application and would like to exploit “first-in”
advantages. They also will have the incentive to deploy a network architecture most
consistent with their own plans for applications, which may not coincide with the
needs of the independent applications providers or with the desire of end users to use
their broadband network for applications (telecommuting, home networking, or other
purposes) that might undermine the ability of the network provider to price
discriminate or in other ways jointly maximize the profits from its network and own
suite of applications. For example, some critics have claimed that the RBOCs
42 For a more detailed discussion of the issues of network neutrality, open access, and
broadband discrimination, see Tim Wu, “Network Neutrality, Broadband Discrimination,”
Journal on Telecommunications & High Technology Law, Vol 2, 2003, pp. 141-178
Professor Wu’s article is one of many in a very lively debate in the academic economic and
legal literature. See footnote 1 and other citations in the Wu article for a list of other
academic articles.

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CRS-18
resisted deploying DSL technology in their networks for more than a decade because
of concern that offering a high-speed DSL service would cannibalize the revenues
and profits that were being generated by their T-1 (large capacity dedicated pipe)
service. According to these critics, despite the fact that the relatively inexpensive
DSL technology had been available for a long time, the RBOCs began deploying
DSL only once there was significant risk of ceding the mass market high-speed
connection market to cable modems. (The RBOCs have responded that they had not
deployed DSL because the market had not yet developed for the high-speed service.)
In a market characterized by economic interdependence between a platform and
applications made for that platform, sometimes an arm’s-length relationship between
the platform provider and the applications providers will be less efficient than a
closer vertical relationship. Academic economists have employed the concept of
internalizing complementary efficiencies (“ICE”) to explain vertical competitive
effects — why sometimes the platform provider chooses an open architecture and
modular design to interact with the full universe of applications providers and
sometimes chooses to interact only with its own vertically integrated applications
subsidiaries or affiliates.43 The ICE theorem suggests that a monopolist broadband
network provider has incentives to provide independent applications providers access
to its broadband platform when it is efficient to do so, and to deny such access only
when access is inefficient. But economic theory further explains that platform
providers will not always make the optimal choice. There are a number of
circumstances when the platform provider’s choice might not be efficient or benefit
consumers.44 Economic theory therefore suggests that there may be pitfalls in either
a blanket requirement for access to the broadband network or blanket deregulation.
In a market characterized by high sunk up-front fixed costs and very low
variable (usage) costs once the up-front costs have been sunk, which is descriptive
both of the physical broadband network and the software applications provided over
that network; it often is efficient for a firm to employ price discrimination to recover
its fixed costs. That is, it may be most efficient to segment customers according to
the intensity of their demand for the broadband connection (or application), charging
43 See Joseph Farrell and Philip Weiser, “Modularity, Vertical Integration, and Open Access
Policies: Towards a Convergence of Antitrust and Regulation in the Internet Age,” Harvard
Journal of Law and Technology, Fall 2003, pp. 85-133.
44 Farrell and Weiser identify 8 such circumstances: (1) if its rates for platform access are
regulated; (2) if the platform monopolist can use otherwise efficient price discrimination to
make even inefficient vertical leveraging profitable; (3) if an applications provider is a
potential competitor at the platform level that the monopoly platform provider wants to
weaken; (4) if the monopoly platform provider can use its market bargaining power to
impose a licensing or other arrangement on an applications provider that discourages future
applications innovations; (5) if the platform monopolist is incompetent and therefore cannot
recognize optimal choices; (6) if the platform monopolist perceives that allowing open
access today would undermine its ability to close access in the future even if it would be
efficient to do so; (7) if, for regulatory strategy considerations, the platform monopolist is
afraid that agreeing to open access for, say ISPs, would raise the risk of having open access
imposed in another market, such as cable video programming; and (8) if the platform is not
essential for all uses of the application and there are economies of scale or network effects
in the application.

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CRS-19
a higher price for the customers with higher intensity of demand. In the case of the
broadband connection, that intensity might be measured in terms of the amount of
bandwidth demanded. As will be discussed below, such price discrimination based
on bandwidth usage need not infringe on network neutrality (need not favor some
applications over others) so long as the market segmentation is based on the amount
of bandwidth used rather than on the specific application and so long as customers
who want to use the network for a bandwidth-intensive application are able to pay
more for that additional bandwidth, rather than being prohibited from using the
network to access bandwidth-intensive applications.
Broadband Network Restrictions.
In 2002, Professor Tim Wu performed a survey of broadband usage restrictions
and network designs for the 10 largest cable operators and six major DSL operators.45
The survey found that, on the whole, broadband providers’ networks and usage
restrictions favored client-server applications (such as the World Wide Web) and
disfavored home networking, peer-to-peer applications, and home telecommuting.
Cable operators tended to impose far more restrictions on usage than DSL operators.
Specifically,
! Nearly every cable operator and one third of DSL operators
restricted end users from operating a server and/or providing content
to the public. This restriction is potentially very significant because
it affects the broadest class of applications: those where the end user
shares content, as opposed to simply downloading content. It favors
a “one-to-many” or “vertical model” of applications over a “many-
to-many” or “horizontal” model. In application design terms, the
restriction favors client-server applications over peer-to-peer
designs. The inability to provide content or act as a server could
serve to restrict a major class of network applications.
! Every cable operator and most DSL operators had some ban on
using a basic residential broadband connection for “commercial” or
“enterprise” use. The most controversial of such restrictions barred
home users from using virtual public networks, which are used by
telecommuters to connect to their work network through a secure
connection.
! When home networking became widespread in 2002, four of the ten
largest cable operators contractually limited the deployment of home
networks by setting restrictions on the number of computers that
could be attached to a single connection. In contrast, some DSL
operators in their agreements explicitly acknowledged that multiple
computers could be connected to the DSL connection, though
sometimes only through a single DSL account and a single IP
address obtained from the DSL operator.
45 See Tim Wu, “Network Neutrality, Broadband Discrimination,” Journal on
Telecommunications & High Technology Law, Vol. 2, 2003, at pp. 158-168.

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CRS-20
! Several cable operators sought to control the deployment of home
wireless networks by banning the connection of Wi-Fi equipment.
! The practice of designing asymmetric networks, with more
downstream bandwidth than upstream bandwidth, favors the
development of applications that are one-to-many or client-server in
design. Applications that would demand residential accounts to
deliver content as quickly as they receive it are limited by
asymmetric bandwidth.
It is not clear how actively network providers have attempted to enforce these
restrictions in their contracts with subscribers, though there is anecdotal evidence of
some enforcement. Nor is it clear yet whether such restrictions will continue when
wireless technology is able to provide greater competition to wireline and cable
network providers. In fact, there appear to be fewer usage restrictions today than
there were in 2002. It is noteworthy, however, that the cable networks imposed more
usage restrictions than did the DSL network. There are two possible explanations for
this: (1) cable is the largest broadband platform provider and can offer greater
bandwidth and these “first-in” and technology advantages may allow it to set
strategic usage restrictions that other platforms could only set at their peril, and (2)
since cable’s broadband architecture requires customers to share bandwidth, there is
greater need for cable to manage the bandwidth usage of its customers. On the other
hand, cable operators have not barred streaming video, despite its potential for
competing with cable television.
It does not appear that these restrictions will go entirely away anytime soon.
Some equipment vendors have begun to market equipment designed to facilitate
application-based screening and control for broadcast networks, such as products
intended to address peer-to-peer traffic and unauthorized Wi-Fi connections and
control over network utilization.46 It is not clear to what extent network providers are
actually purchasing and deploying such equipment, however.
Access and usage restrictions may be justified if they are needed to protect the
integrity of the network or to operate the network efficiently (for example, bandwidth
management needed to maintain quality of service). But there may be situations
where the network provider has chosen an overly restrictive solution that will
discourage applications innovation and competition. For example, if a network
provider must manage bandwidth usage in order to maintain quality of service for
video and voice services, it would be more efficient for the provider to do so by
setting rates that rise as bandwidth usage increases rather than by prohibiting all
bandwidth-intensive applications. The former represents an application of price
46 Tim Wu, “Network Neutrality, Broadband Discrimination,” Journal on
Telecommunications & High Technology Law, Vol. 2, 2003, at pp. 165-166. One
manufacturer claims its product is used on hundreds of university campuses to control peer-
to-peer traffic, but those universities may be motivated by concern about intellectual
property rights infractions as well as by bandwidth management issues.

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CRS-21
discrimination that most economists recognize as efficient; the latter may be
unnecessarily restrictive.
Professor Wu concluded that, on the whole, the evidence from his survey
suggests that the operators were often pursuing legitimate goals, such as price
discrimination and bandwidth management. The problem was they often used
methods, like bans on certain forms of applications, that are likely to unnecessarily
distort the market and the future of application development. The use of restrictions
on classes of application to pursue bandwidth management and price discrimination
may be inefficient and may unnecessarily harm consumers; the objectives may be
attainable through less restrictive means.

Approaches to Regulating Access to Broadband Networks
There are four general approaches to the regulation of broadband network
providers vis-a-vis independent applications providers:
! structural regulation, such as open access;
! ex ante non-discrimination rules;
! ex post adjudication of abuses of market power, as they arise, on a
case-by-case basis; and
! reliance on antitrust law and non-mandatory principles as the basis
for self-regulation.
There have been a plethora of proposals for such regulation, with the proposals
sometimes incorporating elements from more than one of these approaches.
Ex ante rules and ex post adjudication both typically focus on anti-competitive
discrimination that harms consumers, but in distinct ways. Ex ante rules have been
characterized as “positive” anti-discrimination rules in that they create affirmative
legal duties that are intended to remedy either past discrimination or the likelihood
of future discrimination,47 prohibiting certain activities before the fact. By contrast,
“negative” ex post adjudication typically seeks to punish identified episodes of
discrimination on a case-by-case basis, after the fact. Positive schemes impose more
up-front costs: by restricting certain behaviors, some of which might have proven
beneficial to consumers. But, depending on the cost to consumers (in terms of denied
access to potentially highly valued applications) of allowing discrimination to occur
and then adjudicating after the fact, the ultimate cost of positive ex ante rules might
prove lower than ex post adjudication.
47 See Tim Wu, “A Flat Model of Telecommunications Regulation,” forthcoming, Journal
of Telecommunications and High Technology, Volume 4, at p. 9, available from Professor
Wu, who can be contacted at the website [http://faculty.virginia.edu/timwu/].

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Open Access.
Although there is not a single agreed-upon definition of open access, it
generally refers to a structural requirement that would prevent a broadband network
provider from bundling broadband service with Internet access from its own in-house
Internet service provider and would require the network provider to make its
broadband transmission capability available to independent ISPs on a
nondiscriminatory basis. Proponents of open access argue that if a broadband
network provider, such as a cable operator, is allowed to bundle ISP services with its
broadband connection at a single price, and not offer the broadband connection
separately, it would be in a position to foreclose competition among Internet
applications.48 They claim that as ISPs expand the services they offer, bundling
would foreclose competition in an increasing range of services provided over
broadband lines. If the customer has no choice but to accept from the broadband
provider a single bundle that includes both the broadband connection and ISP service,
then an independent ISP would always be at a price disadvantage and could only
compete by offering unique capabilities that are sufficient to overcome that price
disadvantage. This is likely to limit an independent ISP’s customer base to those
customers with unique needs that are not met by the mass market broadband
provider.
Proponents of open access claim that allowing network providers to restrict
independent ISPs’ access will (1) eliminate, or at least reduce, ISP competition; (2)
allow legacy monopoly networks to improperly affect the architecture of the Internet
in an effort to protect their own business plans; (3) discourage innovators from
investing in a market in which a dominant player has the power to behave
strategically against them; and (4) make government intervention to control certain
forms of speech easier and therefore more likely.
Open access has been criticized on several fronts. First, broadband network
providers and a number of academics49 claim that, due to indirect network
externalities and internalizing network efficiencies, network providers do not have
the incentive to restrict independent applications providers access to their networks,
or would do so only where it was efficient. They further argue that even if one group
of network providers — for example, the cable companies — were to restrict access,
wireline broadband providers and other competitors are unlikely to follow suit, so
independent ISPs would have access to customers.
Some critics claim that open access would retard deployment of broadband
networks by reducing the ability of network providers to exploit vertical integration
48 See, for example, Mark Lemley and Lawrence Lessig, The End of End-to-End: Preserving
the Architecture of the Internet in the Broadband Era, 48 UCLA Law Review 925 (2001).
49 See, for example, James B. Speta, “Handicapping the Race for the Last Mile? A Critique
of Open Access Rules for Broadcast Platforms, 17 Yale Journal on Regulation (2000), at
p. 76; Joseph Farrell and Philip Weiser, “Modularity, Vertical Integration, and Open Access
Policies: Towards a Convergence of Antitrust and Regulation in the Internet Age,” 17
Harvard Journal of Law and Technology (2003), at pp. 4-6; Glen Robinson, “On Refusing
to Deal with Rivals,” 87 Cornell Law Review (2002), at pp. 1216-1217.

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efficiencies and also by reducing the revenues network providers could generate from
their applications, thereby making some network investments unprofitable. They also
suggest that the close coordination between a network provider and as applications
provider needed for optimal joint development of network and applications is
sometimes only possible through vertical integration. For example, Professor James
Speta argues that “Vertical integration of access providers may be necessary.
Especially in initial periods of deployment, broadband access providers must ensure
a supply of complementary information services.... [A] broadband provider must
either provide those goods itself or arrange for a source of supply.”50
Also, to the extent open access regulation prevents broadband operators from
architectural cooperation with independent ISPs for the purpose of providing quality
of service (“QoS”) dependent applications, it could harm network neutrality. By
threatening the vertical relationship required for certain application types, it could
maintain IP’s discrimination in favor of data applications.
In response to these criticisms of open access, its proponents have pointed out
a fundamental contradiction among the criticisms.51 On one hand, critics argue that,
due to indirect network externalities, broadband network providers’ self-interest will
lead them to place minimal restrictions on customers’ usage of, and independent
applications providers’ access to, their networks. On the other hand, critics argue
that restricted access is needed to ensure that the network providers generate enough
revenues to recoup their investment in the network.
Ex Ante Non-Discrimination Rules.
The basic principle behind a network non-discrimination regime is to give users
the right, by rule, to use non-harmful attachments or applications, and give innovators
the corresponding right, also by rule, to supply them. Proponents claim that such a
regime avoids some of the costs of structural regulation by allowing for efficient
vertical integration so long as the rights granted to the users of the network are not
compromised.
Proponents contend that the ability of a network provider to discriminate is
greater with a digital broadband network than with an analog narrowband network
offering dial-up service. Analog network operators cannot easily distinguish between
types of digitized packets of information going across their lines. But digital network
operators can distinguish among the packets on their high-speed networks.52 For
example, some universities are performing application-specific screening to identify
students illegally copying entertainment materials and, presumably, similar
50 James B. Speta, “Handicapping the Race for the Last Mile: A Critique of Open Access
Rules for Broadband Platforms,” Yale Journal on Regulation, Volume 17, 2000, at p. 83.
51 See, for example, Mark Lemley and Lawrence Lessig, “The End of End-to-End:
Preserving the Architecture of the Internet in the Broadband Era,” UCLA Law Review,
Volume 48, April 2001, at p. 968.
52 See, for example, Amy Schatz and Anne Marie Squeo, “As Web Providers’ Clout Grows,
Fears Over Access Take Focus,” Wall Street Journal, August 8, 2005, at p. A1.

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capabilities could be used to identify applications the network provider wishes to
restrict or prohibit.
Typically proponents of non-discrimination rules are proponents of network
neutrality — not favoring one application over another.53 They argue that network
neutrality, as embodied in ex ante non-discrimination rules, fosters the goal of
stimulating investment and innovation in broadband technology and services in two
ways: (1) by eliminating the risk of future discrimination, thereby providing
independent applications providers greater incentives to invest in broadband
applications, and (2) by facilitating fair competition among applications, ensuring the
survival of the fittest.
Proponents claim that a network that is as neutral as possible, with such
neutrality ensured by explicit non-discrimination rules, provides entrepreneurs
predictability in that all applications are treated alike. This, they argue, will foster
investment in broadband applications by eliminating the unpredictability created by
potential future restrictions on network usage. Neutrality provides applications
designers and consumers alike with a baseline on which they can rely. Proponents
allege the recent restrictions that cable operators placed on virtual private networks
is indicative of the tendency of some network providers to restrict new and
innovative applications they see as either unimportant or a competitive threat. Such
usage restrictions, they claim, particularly harm those small and startup developers
that are most likely to push the envelope of what is possible using the Internet’s
architecture.54
Proponents also claim that the most promising path of development will be
difficult to predict in advance; neutral network development is likely to yield better
53 The most detailed discussion of network neutrality and non-discrimination rules can be
found in Tim Wu, “Network Neutrality, Broadband Discrimination,” Journal on
Telecommunications & High Technology Law, Vol. 2, 2003, at pp. 141-178 and in an ex
parte letter from Tim Wu and Lawrence Lessig, dated August 22, 2003, submitted to the
FCC in CS Docket No. 02-52, which is available online at [http://faculty.virginia.edu/
timwu/wu_lessig_fcc.pdf], viewed on June 21, 2005. The discussion in this report draws
heavily from those analyses.
54 The independent applications providers and other supporters of enforceable network
neutrality rules are not all small players, however. When the FCC was considering re-
classifying DSL services as information services rather than telecommunications services,
in early August, 2005, representatives from Microsoft, Dell, Yahoo, and the Consumer
Electronics Association (“CEA”), as well as consumer organizations, met with FCC
commissioners and “explained the need for ‘net neutrality’ provisions because network
operators have the opportunity, incentive and ability to violate these net neutrality
principles.” See, for example, the ex parte letter, dated August 2, 2005, from Veronica
O’Connell, Senior Director, Government Affairs, Consumer Electronics Association, to
Marlene H. Dortch, Secretary, Federal Communications Commission, on behalf of
Microsoft Corporation, Media Access Project, Vonage, Dell, and CEA. Similarly, as
entertainment companies seek ways to distribute movies and television shows over the
Internet, they have expressed concern about having to rely on broadband networks owned
by competitors, such as Time Warner, for access to end users. See Amy Schatz and Anne
Marie Squeo, “As Web Providers’ Clout Grows, Fears Over Access Take Focus,” Wall
Street Journal, August 8, 2005, at p. A1.

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CRS-25
results than planned innovation directed by a single prospect holder. Any single
entity will suffer from cognitive biases (such as a predisposition to continue with
current ways of doing business). These proponents conclude that restrictions on
usage, however well-intended, tend to favor certain applications over others. A
regulatory framework that requires network providers to justify deviations from
neutrality would prevent both unthinking and ill-intentioned distortions of the market
for new applications. The proponents of non-discrimination rules argue that the
restrictions that some network providers have imposed on home networking, online
gaming, and VPNs not only directly harm consumers and applications providers
today, but also have a chilling effect on innovators and venture capitalists considering
future applications development and deployment. They argue that the possibility of
discrimination in the future dampens the incentives to invest today.
Two very different proposals for ex ante rules merit discussion; one would
enact a “pure” ex ante regime, the other would enact a hybrid regime that constructs
ex ante rules only where antitrust enforcement might not be sufficient.
Ex Ante Neutrality Regime. Professor Wu has proposed what he calls a
neutrality regime that would set ex ante non-discrimination access rules that would
apply to the “inter-network” portion of a broadband network provider’s network (that
is, the portion that it collectively manages with other network providers), but not to
the local portion of the network that is under the provider’s sole control. Each
broadband network provider is a member of two networks: the local network that
provides the last-mile of transport to its end-user customers and which it owns and
manages by itself, and the inter-network, which it collectively manages with other
service providers. If a broadband network provider imposes local network
restrictions, usually those restrictions will only affect its local network. Such
restrictions are likely to be necessary for good network management. In contrast,
restrictions at the inter-network layer or applications layer will affect the entire
network, inter-network as well as local network, and can cause externality problems.
The ex ante neutrality regime is based on a non-discrimination rule that
distinguishes between discrimination at the local network level (acceptable) and at
the inter-network level (unacceptable); the rule would make operational the network
neutrality principle at the inter-network level.55 The rule prohibits discrimination
55 The specific rule would be as follows:
____
Forbidding Broadcast Discrimination
(a)
Broadband Users have the right reasonably to use their Internet connection in ways
which are privately beneficial without being publicly detrimental. Accordingly, Broadband
Operators shall impose no restrictions on the use of an Internet connection except as
necessary to:
(1)
Comply with any legal duty created by federal, state or local laws, or as necessary
to comply with any executive order, warrant, legal injunction, subpoena, or other duly
authorized governmental directive;
(2)
Prevent physical harm to the local Broadband Network caused by any network
attachment or network usage;
(3)
Prevent Broadband users from interfering with other Broadband or Internet
User’s use of their Internet connections, including but not limited to neutral limits on
(continued...)

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CRS-26
based on such inter-network elements as IP addresses, domain name, and cookie
information. Its general principle is: absent evidence of harm to the local network
or the interests of other users, broadband network providers should not discriminate
in how they treat traffic on their broadband network on the basis of inter-network
criteria.
Thus, for example, under the ex ante neutrality regime, a broadband network
provider concerned about managing bandwidth would be prohibited from blocking
traffic from game sites based on either application information or the IP address of
the application provider. But it would be allowed to invest in policing bandwidth
usage; users interested in a better gaming experience would need to buy more
bandwidth, not get permission to use a given application. As another example,
recently the FCC entered into a consent decree with Madison River Communications,
a rural telephone company, which had been blocking ports used for VoIP
applications, thereby affecting their customers’ ability to use VoIP through VoIP
service providers.56 Under this regime, such discriminatory behavior would be ex
ante illegal.
55 (...continued)
bandwidth usage, limits on mass transmission of unsolicited email, and limits on the
distribution of computer viruses, worms, and limits on denial-of-service or other attacks on
others;
(4)
Ensure the quality of the Broadband service, by eliminating delay, jitter or other
technical aberrations;
(5)
Prevent violations of the security of the Broadband network, including all efforts
to gain unauthorized access to computers on the Broadband network or Internet;
(6)
Serve any other purpose specifically authorized by the Federal Communications
Commission, based on weighing of the specific costs and benefit of the restriction.
(b)
As used in this section,
(1)
“Broadband Operators” means a service provider that provides high-speed
connections to the Internet using whatever technology, including but not limited to cable
networks, telephone networks, fiber optic connections, and wireless transmission;
(2)
“Broadband Users” means residential and business customers of a Broadband
Operator;
(3)
“Broadband Network” means the physical network owned and operated by the
Broadband Operator;
(4)
“Restrictions on the Use of an Internet Connection” means any contractual,
technical, or other limits placed with or without notice on the Broadband user’s Internet
Connection.
56 In the Matter of Madison River Communications, LLC and affiliated companies, DA 05-
543, File No, EB-05-IH-0110, Acct. No. FRN: 0004334082, Consent Decree, undated.
Under this decree, Madison River agreed not to block ports used for VoIP applications or
to otherwise prevent customers from using VoIP applications, and paid a fine of $15,000.
It is possible that Madison River’s primary incentive for blocking Vonage service was to
protect against the loss of access charge revenues. As explained below in the section on
Intercarrier Compensation, rural telephone companies currently get a large portion of their
revenues from above-cost access charges imposed on long distance carriers for originating
or terminating long distance calls. If intercarrier compensation reform were enacted that
removed the implicit subsidies from access charges and placed those subsidies in an
expanded Federal Universal Service Fund, the incentive to block VoIP calls would be
significantly reduced.

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Since Professor Wu would not regulate customer access to the local network
portion of the broadband network, he would allow cable operators to tie cable modem
service (broadband access) to ISP service (an application) and, similarly, would allow
ILECs to tie DSL service (broadband access) to voice service (an application). That
is, ILECs would not be required to offer end users what is sometimes referred to as
“naked DSL” service: DSL service without voice service. But because he would
prohibit discriminatory access to the inter-network, Professor Wu would prohibit a
cable operator from refusing to allow a customer to use its cable modem to obtain
ISP service from another ISP and would prohibit an ILEC from refusing to allow a
customer to use its DSL service to obtain voice service from another voice provider.
Ex ante non-discrimination rules have been subject to criticism from parties that
argue that such rules would intrude too much into the business plans of broadband
network providers. These critics argue that non-discrimination rules impinge on the
ability of broadcast network providers to fully exploit efficiencies from vertical
integration or to use price discrimination or other pricing strategies to maximize
return on investment. Professor Wu responds that his proposal, which limits the non-
discrimination prohibition to the inter-network portion, minimizes that effect by
allowing the network provider to take advantage of those economies of scope and
vertical integration advantages (such as offering service level guarantees not provided
on a shared network) that come with building one’s own physical network — so long
as no restrictions (such as prohibiting access to certain IP addresses) are placed on
use of the shared portion of the Internet network. On the other hand, some parties
have been concerned that by allowing the broadband network providers unlimited
control over the local portion of their networks, those providers still could distort
applications markets to their advantage, though it might be more difficult or more
expensive to do so.
Another criticism of ex ante non-discrimination rules is that they inherently lead
to delays, litigation, and other regulatory costs, as parties fight over interpretation of
the rules. The complexity of communications networks, it is argued, renders it
difficult, if not impossible, to construct clear ex ante rules. These critics point to the
industry experience implementing the 1996 Act. Professor Wu has responded that
delays, litigation, and other regulatory costs of administering an ex ante non-
discrimination rule could be minimized by identifying only two network layers — the
transport infrastructure layer and the application services level57 — and by restricting
the rules to the inter-network portion of the network.
The other major criticism is that ex ante rules of any sort, and especially those
relating to network access, will artificially aid an independent applications provider
in its contractual negotiations with a broadband network provider by allowing it to
threaten to bring a regulatory complaint and attendant costs if the network provider
does not accept its terms. According to this argument, the network provider often
might be forced to accept unfavorable or inefficient access terms to avoid the threat
of litigation.
57 Tim Wu, “A Flat Model of Telecommunications Regulation,” forthcoming, Journal of
Telecommunications and High Technology, Volume 4, p. 7, available from Professor Wu,
who can be contacted at the website [http://faculty.virginia.edu/timwu/].

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The European Union Framework. The European Union (“EU”) has
adopted a legislative framework for the regulation of electronic communications
(“EU Framework”) that includes creation of ex ante rules to supplement an antitrust
approach to regulation.58 The EU Framework creates a single regulatory structure
that covers all electronic networks and services within its scope, without regard to
underlying technology.59 It aims to “reduce ex-ante sector-specific rules
progressively as competition in the market develops.”60 The rules, requirements, or
obligations imposed on providers are service-specific and are determined by the level
of competition in the market.61 The EU Framework calls for periodic review of all
regulatory obligations,62 although no time period is specified.
Under the EU Framework, specific ex ante regulatory obligations are imposed
only on those providers that:
! have significant market power; and
! are operating in markets where competition is not effective; and
! where national and European Community competition law (i.e.,
antitrust) remedies are not sufficient to address the problem.63
The Framework Directive equates “significant market power” with
“dominance.” It states that a provider “shall be deemed to have significant market
power if, either individually or jointly with others, it enjoys a position equivalent to
dominance, that is to say a position of economic strength affording it the power to
58 The single document most concretely laying out the Framework is Directive 2002/21/EC
of the European Parliament and of the Council of 7 March 2002 on a common regulatory
framework for electronic communication networks and services, OJ L 108, 24.4.2002, pp.
33-50. The complete Framework consists of four additional EU directives plus two
documents prepared by the Commission of the European Communities, as required by
Article 15, paragraphs 1 and 2, of the Framework Directive (at p. 44).
59 All transmission infrastructures used to offer electronic communications services to the
public (including those used to carry broadcasting content, such as cable television
networks, terrestrial broadcasting networks, and satellite broadcasting networks) are within
the scope of the new regulatory Framework. (Framework Directive at p. 33, paragraph 5.)
Content services (such as broadcast content and e-commerce services), electronic
communications equipment, and private networks that are not used to offer services to the
public, are outside the scope of the Framework (Framework Directive at pp. 33-34,
paragraphs 5-6 and 8-10, and p. 39, Article 2, Definition d.)
60 Commission of the European Communities, “Commission Recommendation of 11
February 2003 on relevant product and service markets within the electronic
communications sector susceptible to ex ante regulation in accordance with Directive
2002/21/EC of the European Parliament and of the Council on a common regulatory
framework for electronic communication networks and services” (Commission
Recommendation), OJ L 114, at p. 45, paragraph 1.
61 Framework Directive at p. 45, Article 16, paragraphs 3-4.
62 Framework Directive at p. 36, paragraph 27, and at p. 38, paragraph 39.
63 Framework Directive at p. 36, paragraph 27.

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CRS-29
behave to an appreciable extent independently of its competitors, customers, and
ultimately consumers.”64
As required by the Framework Directive, the Commission of the European
Communities (a body of the EU) has prepared Commission Guidelines that describe
in detail how to measure effective competition and significant market power,65 and
also a Commission Recommendation that identifies 18 product and service markets
in which ex ante regulation may be warranted because of a lack of effective
competition.66
The Commission, itself, does not devise specific rules, requirements, and
obligations for electronic communications providers. Rather, the National
Regulatory Agencies of each of the EU’s member states must perform market
analysis within their national boundaries to determine which providers have
significant market power and, based on that market analysis, create the appropriate
specific regulations, rules, or obligations to impose on those providers.67 To date,
very few of the member states have performed this market analysis or implemented
regulations, rules, or obligations, and thus there is no empirical evidence on the
impact of this regulatory framework.
The Commission Guidelines state that, although a high market share alone is not
considered sufficient to establish possession of significant market power, concerns
about single firm dominance arise with market shares of 40% or above.68 Providers
with market share of 25% or less are deemed unlikely to have significant market
power. Emerging markets, where de facto the market leader is likely to have a
substantial market share, should not be subject to inappropriate ex ante regulation.69
Proponents of the EU Framework argue that telecommunications regulation
should be viewed as an applied case of antitrust and therefore should adhere to
antitrust principles.
64 Framework Directive at p. 44, Article 14, paragraph 2.
65 “Commission guidelines on market analysis and the assessment of significant market
power under the Community regulatory framework for electronic communications networks
and services,” (Commission Guidelines), OJ C 165, 11.7.2002, pp. 6-30. These detailed
guidelines describe the relationship between the Framework and EU competition law. They
include discussions of the criteria for defining the relevant product market (including
demand-side substitution and supply-side substitution) and relevant geographic market, and
criteria for assessing significant market power (including dominance, collective dominance,
and the leverage of market power).
66 Commission of the European Communities, “On Relevant Product and Service Markets
within the electronic communications sector susceptible to ex ante regulation in accordance
with Directive 2002/21/EC of the European Parliament and of the Council on a common
regulatory framework for electronic communication networks and services” (Commission
Recommendations), OJ L 114, pp. 45-49.
67 Commission Guidelines at p. 7, paragraph 9, and p. 8, paragraph 19.
68 Commission Guidelines at p. 15, paragraph 75.
69 Commission Guidelines at p. 10, paragraph 32.

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Critics of the EU Framework claim that although the rules are set ex ante, they
fail to provide either network providers or independent applications providers the
type of certainty that fosters innovative activity because they are determined on a
case-by-case basis and do not take advantage of characteristics common to most
communications markets. As one critic explains:
...what distinguishes telecommunications problems is that they share consistent
features found in some but not all antitrust cases. Most telecommunications
problems feature many if not all of the following economic features: (1) a
physical infrastructure of high fixed cost, that is (2) a large source of both
positive externalities including network externalities, that (3) can be used to
provide a range of services, and (4) in an environment of rapid technological
change that makes the infrastructure useful for different services than those for
which it was originally designed.70
Given these common market characteristics, it might be possible to construct general
rules that provide certainty for network providers and independent applications
providers alike.
Another criticism of the EU Framework is that reliance on antitrust principles
simply replaces the current contentious battle over the classification of services with
a new contentious battle over proper market definition, since any determination of
whether a firm has significant market power is likely to depend heavily on the
geographic and product market definitions chosen.
Ex Post Adjudication of Abuses of Market Power.
The Regulatory Framework Working Group of the Digital Age Communications
Act Project of the Progress and Freedom Foundation (“PFF Working Group”) has
proposed replacing the current statutory and regulatory framework that relies heavily
on proscriptive rules that set ex ante structural and behavioral requirements (such as
access requirements or non-discrimination rules) with a system that would adjudicate
alleged abuses of market power ex post, as they arise, on a case-by-case basis. It
proposes enacting a new statute, the Digital Age Communications Act (“DACA”),71
modeled after the Federal Trade Commission Act, 72 that would give the FCC (or a
successor agency) the authority to adjudicate allegations of “unfair methods of
competition ... and unfair or deceptive acts in or affecting electronic communications
networks and electronic communications services.” These unfair practices could
include interconnection-related practices (such as the refusal to interconnect or unfair
terms, conditions, and rates of interconnection):
70 Tim Wu, “A Flat Model of Telecommunications Regulation,” forthcoming, Journal of
Telecommunications and High Technology, Vol 4, at p. 4.
71 Digital Age Communications Act: Proposal of the Regulatory Framework Working Group
of the Digital Age Communications Act Project of the Progress and Freedom Foundation,
June 2005, available at [http://www.pff.org/issues-pubs/other/050617regframework.pdf],
viewed on July 27, 2005.
72 15 U.S.C. §§ 41-51.

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! if such practices were shown to pose a substantial and non-transitory
risk to consumer welfare;
! and if the Commission determined marketplace competition were
not sufficient to protect consumer welfare;
! and if the Commission considered whether requiring interconnection
would affect adversely investment in facilities and innovation in
services.
Under the proposal, the Commission could require the guilty party to pay
damages to the harmed party if any violation were found. Also under the proposal,
the Commission would have very constrained authority to prescribe rules, which
would automatically sunset after five years. The FCC’s authority to approve an
application to assign or transfer control of a license (that is, to review mergers) would
be limited to ensuring that any such change in control did not violate existing FCC
rules.
The PFF Working Group claims that the potential harm to consumers from bad
regulation far exceeds the potential harm from badly functioning markets and
therefore the burden of proof must fall on the regulator for imposing any regulation.
It seeks to “codif[y] a presumption that regulation is unnecessary to protect
consumers and provide[] tools that can adequately address competition problems that
arise in communications markets.” It states that even inefficient market outcomes
are likely to be less problematic than regulatory solution because (1) markets are
effective at responding to and overcoming their own inefficiencies, (2) government
may not have the incentive to improve matters, and (3) policy makers are likely to
lack the information needed to make efficient decisions. Thus, it proposes ex post
rather than ex ante regulation and the five-year sunset provision. The PFF Working
Group further argues that a new statute is needed in order to replace the current
model of regulation based on vague standards such as the “public interest” and “just
and reasonable” with the well-established “unfair competition” standard of the FTC.
It explicitly seeks, in each and every provision of its proposed statute, to minimize
the FCC’s regulatory authority.
The PFF Working Group proposal for ex post regulation has been subject to
several criticisms. First, it is based on the assumption that consumer welfare loss
from bad regulation is always far greater than consumer welfare loss from badly
performing markets, and that it is therefore best to err on the side of under-regulating.
This may or may not be true in the case of markets characterized by networks where
the platform provider and applications providers must cooperate to maximize
consumer welfare. There is a large and growing academic law and economics
literature on these unique markets; there is no consensus in the literature, or from
empirical evidence, that in these markets there is less risk from erring on the side of
under-regulation than on the side of over-regulation. Nor is there theoretical or
empirical proof that the potential harm to consumers from distortions created by ex
ante rules are greater than those created by ex post adjudication. It is possible that
a narrowly crafted ex ante non-discrimination rule could create less distortion than
ex post adjudications that will inherently result in some, and potentially many,
innovative independent applications providers being driven from the market, thereby

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denying customers the benefit of their services. The PFF Working Group proposal
appears implicitly to recognize that possibility by giving the FCC rulemaking
authority, which, although constrained, would allow the Commission to consider
adoption of ex ante rules where appropriate.
More generally, critics claim that ex post regulation distorts the business plans,
and undermines the negotiating position, of independent applications providers by
placing the burden of proof for network access on them if they seek to develop and
introduce an application that may not fit into the business plan of the network
provider. According to this argument, the independent applications provider might
be forced to modify its planned application or accept unfavorable or inefficient access
terms to avoid the threat of being denied access to the broadband network.
Some critics also oppose the PFF Working Group proposal to eliminate the
public interest standard, claiming reliance on what is basically an antitrust standard
fails to take into account non-economic objectives of U.S. telecommunications
policy, such as localism and diversity of voices.
Antitrust Law and Non-Mandatory Principles as the Basis for Self-
Regulation.
The broadband network providers have argued that they should not be subject
to access regulation because they face strong market incentives not to restrict the
access of independent applications providers to their networks. They cite the
existence of indirect network efficiencies, which reward network providers for
keeping their network open, and the availability to most Americans of at least two
broadband networks. They argue that any access regulation would cause harm, by
curtailing their ability to vertically integrate to exploit efficiencies such as ensuring
quality of service levels needed for video and voice services.73 They argue that where
they have placed usage restrictions on customers those restrictions were needed to
ensure quality of service and other bandwidth management objectives and to make
it feasible to undertake their huge infrastructure investments. They also claim that
they remain subject to the antitrust laws, which would constrain them from
undertaking any anticompetitive activities that are harmful to consumers.
These arguments have been subject to a number of attacks. Critics have pointed
to the widespread, documented usage restrictions that network providers have placed
on end users, which the critics claim have harmed consumers, for example, by
denying access to virtual private networks needed for telecommuting. Critics claim
that these usage prohibitions are far more restrictive than needed to manage
bandwidth, and often are imposed for strategic purposes, not for network efficiency
reasons. They also claim that not regulating access will harm innovation by giving
73 See, for example, ex parte letter dated February 21, 2003, from Daniel L. Brenner and
Michael Schooler, counsel for the National Cable & Telecommunications Association, to
Marlene Dortch, Secretary of the Federal Communications Commission, submitted in CS
Docket No. 02-52, available at [http://www.ncta.com/pdf_files/022103_02-52_exparte.pdf],
viewed on July 27, 2005.

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the broadband network providers the ability to strategically constrain independent
applications.
Former FCC chairman Michael Powell has suggested that it might not be
necessary to impose regulations if the industry were to agree to follow certain
“Internet Freedom” principles as the basis for self-regulation. Mr. Powell has
constructed guiding principles,74 noting that:
Promoting competition among high-speed Internet platforms is only half of our
task, however. We must ensure that the various capabilities of these technologies
are not used in a way that could stunt the growth of the economy, innovation and
consumer empowerment. Thus, we must expand our focus beyond broadband
networks — the so-called “physical layer” of the Internet’s layered architecture.
Referring explicitly to the research and analyses performed by Professors
Weiser, Farrell, and Wu, cited earlier, Mr. Powell explained that there are
circumstances in which broadband network providers might choose to restrict usage
on their network, and that some troubling restrictions have appeared in broadband
service plan agreements. But he stated that he did not believe that there was yet a
case for government imposed regulations regarding the use or provision of broadband
content, applications, and devices. Instead, he challenged the industry to avoid future
regulation by embracing what he called the four Internet Freedoms. These are:
! Freedom to Access Content: Consumers should have access to their
choice of legal content.
! Freedom to Use Applications: Consumers should be able to run
applications of their choice.
! Freedom to Attach Personal Devices: Consumers should be
permitted to attach any devices they choose to the connection in their
homes.
! Freedom to Obtain Service Plan Information: Consumers should
receive meaningful information regarding their service plans.
In presenting these principles, Mr. Powell indicated that broadband network
providers have a legitimate need to manage their networks and ensure a quality
experience; thus reasonable limits sometimes must be placed on service contracts.
Such constraints, however, should be clearly spelled out and should be as minimal
as necessary. Since no one can know for sure which “killer” applications will emerge
to drive deployment of the next generation high-speed technologies, the industry
must let the market work and allow consumers to run applications and attach devices
unless they exceed service plan limitations or harm the provider’s network. (The
broadband network providers have not explicitly opposed Mr. Powell’s proposal; nor
have they explicitly endorsed it.)
74 Remarks of Michael K. Powell, Chairman, Federal Communications Commission, at the
Silicon Flatirons Symposium on “The Digital Broadband Migration: Toward a Regulatory
Regime for the Internet Age,” University of Colorado School of Law, February 8, 2004.

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In its August 5, 2005 order and related actions, the FCC, in effect, implemented
Mr. Powell’s proposal. It ruled that DBS service, like cable modem service, is an
information service and therefore not subject to any of the access requirements in
Title II of the Communications Act. It also adopted a non-binding policy statement
consisting of four principles: consumers are entitled to access the lawful Internet
content of their choice; consumers are entitled to run applications and services of
their choice, subject to the needs of law enforcement; consumers are entitled to
connect their choice of legal devices that do not harm the network; and, consumers
are entitled to competition among network providers, application and service
providers, and content providers.75
Critics have challenged Mr. Powell’s proposal — and, by extension, the FCC’s
August 5, 2005, order and policy statement — on several grounds. They point to the
many documented instances of usage restrictions placed on end users as proof that,
left unregulated, market forces are not robust enough to ensure unrestricted access.
They argue that the search for the killer application that might drive investment in
both infrastructure and applications is more likely to be successful in a regulatory
regime that fosters network neutrality than in a regime that allows the few broadband
network providers to determine the direction of the network. They argue that it is
impossible to undo harm after it has occurred and that, in light of the identifiable
reasons why network providers might have both the incentive and the ability to
restrict access, it is dangerous to move forward based on non-mandatory principles
that the network providers have not, in any case, endorsed.
Critics also claim that antitrust laws, which generically address monopoly
behavior and anticompetitive practices, are inefficient vehicles for addressing the
impediments to competition and innovation that are most common in
communications markets. These critics argue that there is abundant empirical
evidence that there are greater opportunities for firms to erect barriers to entry in
“network” markets than in traditional markets and that as a result relying primarily
on ex post antitrust enforcement leaves consumers subject to unnecessary risk. They
also oppose elimination of the public interest standard.
Platform Innovation: Mass Market Competition Among
Broadband Network Providers
Currently, in most locations, the incumbent local exchange carrier (“ILEC”) and
the local cable company are the only broadband network providers serving the mass
market. Wireless (including satellite) carriers, cable overbuilders, or power line
companies may provide a relatively ubiquitous third broadband connection some
time down the road, but in the next few years are likely to offer mass market
customers a competitive option in scattered locations at most. Nor have the ILECs
demonstrated tangible plans to extend their broadband networks beyond their current
service areas to compete head-on with other ILEC broadband providers.

75 “FCC Eliminates Mandated Sharing Requirement on Incumbents’ Wireline Broadband
Internet Access Services,” FCC News, August 5, 2005.

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It appears that the competition that is developing between telephone and cable
providers is taking the form of “triple play” offerings of voice, data, and video
services. At present and in the near future, the telephone companies will be bundling
re-sold satellite video services with their voice and DSL services to compete with
cable companies’ triple play. But the largest ILECs and even many small rural
carriers have announced plans to upgrade their networks to have the bandwidth
capacity to offer video services themselves.76 Broadband network providers will seek
to distinguish themselves by offering premium services such as video on demand,
bundles that include wireless service (with that service provided over a separate
wireless network, though perhaps using hybrid telephones that can be used on
wireless and wireline networks), access to advanced electronic games, etc. A key
will be to offer a broadband connection with sufficient bandwidth to accommodate
whatever service becomes the killer application, or at least an important application.
As explained earlier, these broadband networks actually consist of two parts:
the last-mile local network privately owned and operated by the broadband network
provider and the inter-network that is jointly operated by multiple Internet backbone
providers. Success for any broadband network provider will depend on the
bandwidth, security, and service quality it can ensure over its local network.
Although currently all ubiquitous broadband networks provide hard wires into
the customer premise, the various network providers are each deploying unique
network architectures. Most of the large cable companies have upgraded their
coaxial cable networks and now are offering video, data, and voice services in many
areas of the country, especially in urban areas. Their cables into customers’ premises
often have sufficient bandwidth to “broadcast” to customers’ premises hundreds of
video channels for the customers to choose among and their set-top boxes allow
customers to select video on demand, although the video choices available at any
particular point in time may be limited. Currently deployed cable modem
technology, however, requires clustered customers to share bandwidth capacity, so
that connection speeds fall as more neighbors use the network.
Traditional Cable vs. IP Video.
The two largest ILECs, SBC and Verizon, are pursuing quite distinct
architectures, with the Verizon architecture in many ways more like cable
architecture than like the SBC architecture. Verizon reportedly will spend $6 billion
over five years to bring optical fiber directly to as many as 16 million homes in its
service areas.77 Verizon has begun deployment of its “FiOS TV” network, which will
require the replacement of current copper wires into the household premise with
optical fiber. This requires a truck roll to physically replace the copper with fiber.
But that fiber has such high capacity that it is likely to allow Verizon to bring as
much or more bandwidth to the home as cable systems, thus allowing Verizon to
76 Deployment by small rural telephone companies of broadband networks capable of
providing voice, data, and video is discussed below in the section entitled “Other Programs
and Policies that Contribute to the Universal Availability of Broadband Networks.”
77 Michael Totty, “Who’s Going to Win the Living-Room Wars?”, Wall Street Journal,
April 25, 2005, at p. R4, citing a UBS analyst report.

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simultaneously “broadcast” a large number of video channels and offer video on
demand. At the customer premise, the viewer will use the remote control to the set-
top box to choose the channel to be watched at any point in time, just as is done for
cable service today. Also like cable, the signals for premium channels will be
“broadcast” in coded form, and households that do not subscribe to particular
premium channels will not be able to decode the signals. Verizon will use a
particular wavelength on their fiber to implement QAM, a cable protocol used as a
transport mechanism. This architecture appears to be consistent with the definitions
of “cable service” and “cable system” in Section 602 of the Communications Act.78
In contrast, SBC reportedly is spending $4 billion over the next three years to
string optical fiber cable to neighborhoods totaling as many as 18 million homes, and
plans to deliver television services using Internet technology called IPTV.79 Rather
than “broadcasting” a constant stream of all available programs, as cable does and
Verizon plans to do, IPTV stores a potentially unlimited number of programs on a
central server, which users then call up on demand. SBC will not replace the copper
lines that currently run into customer premises. Instead, to make sure there is
sufficient bandwidth between the neighborhood node where the optical fiber
terminates and the household premise, it will upgrade the DSL equipment currently
at those nodes and in households with VDSL technology. At the household, the
viewer will use the IP technology to send a signal to the SBC end-office to send a
particular channel or video on demand selection. That signal will be sent over the
same bandwidth used for data and VoIP service. In SBC’s system, a single customer
line will have enough bandwidth to support up to four active television sets per
household at a time, or up to two HDTV channels at a time.
The Verizon and SBC broadband network architectures each have their
advantages and disadvantages. For example, SBC’s IP approach has greater two-way
capability and therefore probably can better accommodate two-way applications than
the Verizon architecture. On the other hand, SBC’s architecture provides far less
bandwidth into the household, and thus may not be able to accommodate some
bandwidth-intensive applications that the Verizon architecture could accommodate.
SBC may face customer resistance to an IP system that may experience some delay
when changing channels. SBC’s reliance on DSL technology also may create
problems with home networking. Telephone wires currently enter the house and then
the inside wiring goes to the various telephones. But television sets may not be
located near the telephones. SBC’s plan requires 20-25 megabits of bandwidth into
the home, but with its architecture — deploying optical fiber to the neighborhood
node, and then continuing to use copper into the home with VDSL — bandwidth falls
as the distance to a customer’s house increases. It may be that only those homes
within a couple of thousand feet of the neighborhood node will be able to be fully
served. On the other hand, Verizon’s choice of deploying optical fiber all the way
to the home, which requires a very large investment in optical cable, labor-intensive
truck rolls, and in some cases digging up of land to replace the copper with optical
78 47 U.S.C. § 522.
79 Michael Totty, “Who’s Going to Win the Living-Room Wars?”, Wall Street Journal,
April 25, 2005, at p. R4, citing a UBS analyst report.

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cable, will be far more expensive per household served and thus may be constrained
both by limits on Verizon’s capital budget and by customer resistance to digging up
their yards to lay fiber. Some observers have questioned whether Verizon’s fiber to
the home approach can prove out financially, even as they concede that the huge
bandwidth provided could give it a leg up in the long run.
Unlike current copper networks, both the SBC architecture and the Verizon
architecture could leave customers without telephone service if their electricity goes
out, though for different reasons. Fiber to the home technology does not incorporate
line powering, so Verizon might have to provision the optical interface at its
customers’ premises with back-up batteries. But even then, the batteries would
probably last at most 8 to 16 hours, less time than might be needed in case of natural
disruptions such as hurricanes. At the same time, DSL modem systems of the sort
used by SBC require active electric power at the customer premise, which may not
be available during emergencies. In both cases, customers might have to rely on
wireless telephone service during time of electric power loss.
The marketplace will determine which of these network strengths and
weaknesses are most important to end users. These architectural differences, in
addition to creating competing platforms for triple play service, offer platform
diversity to independent applications providers. Where the competing networks have
distinct characteristics that better meet the needs of some sets of applications and are
less effective for other sets of applications, applications providers are not constrained
in their product development to the characteristics of a single platform. Thus,
competing distinct broadband networks fosters applications innovation.
SBC claims that since it will be using IP technology to offer video service, it is
not subject to cable television regulation, most notably, franchising requirements.
Under federal law, franchise authorities:80 may require a cable operator to pay a
franchise fee of up to 5% of cable service revenues;81 may establish requirements for
designation of channel capacity for public, educational, or governmental (“PEG”) use
and for the construction of “institutional networks” that serve educational and
governmental functions of the franchiser;82 may require the franchisee to provide
facilities or financial support for PEG access;83 may require a cable system to
designate channel capacity, up to maximum levels based on system capacity, for
80 Although franchising is most commonly performed by local jurisdictions, and it is
common to talk of “local franchising authorities,” there is no statutory language explicitly
requiring that franchising be performed at the local level, as opposed to the state level.
According to Sec. 601 of the Communications Act, “the term ‘franchising authority’ means
any governmental entity empowered by the Federal, State, or local law to grant a franchise.”
(47 U.S.C. § 521) At the same time, Sec. 601 also explicitly identifies a local purpose for
regulation of cable television: “[to] establish franchise procedures and standards which
encourage the growth and development of cable systems and which assure that cable
systems are responsive to the needs and interests of the local community” (47 U.S.C. § 521)
81 47 U.S.C. §§ 542(a) and 542(b).
82 47 U.S.C. § 531.
83 47 U.S.C. § 541(a)(4)(B).

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commercial use by persons unaffiliated with the cable system;84 must allow the cable
system a reasonable period of time to build out its system to cover all households in
the franchise area;85 and must prohibit the redlining of low income neighborhoods.86
Clearly, if SBC were not subject to a 5% franchise fee and other cable
franchising requirements, but its competitors were, it would enjoy a significant
competitive advantage. To the extent such advantage would artificially raise the
relative costs or otherwise harm competing broadband network providers, or
otherwise weaken them, then their ability to foster innovation by providing a unique
alternative broadband platform could be undermined.
Verizon has agreed that it is subject to franchise requirements, but argues that
a streamlined state-wide or nationwide franchising process is needed because the
extremely time consuming process of negotiating literally thousands of individual
franchise agreements could slow down its entry into video by years and could
endanger its planned upgrade to a broadband network.
Reviewing the Current Framework for Cable Franchising.
These potential inconsistencies suggest that it is timely to review the current
statutory and regulatory framework for cable, found primarily in Title VI of the
Communications Act, to determine whether it would be in the public interest to
streamline the franchising process (for example, by consolidating it at the state or
federal level) and/or to lessen or eliminate some current regulations. For example:
! Is the potential for competition from the new telephone company-
based video providers sufficient to lighten or eliminate the
remaining economic regulations of cable? (Already, the only cable
rates subject to regulation are basic cable rates and cable equipment
rates.)
! Is there a need for more stringent economic regulation of the
incumbent cable companies than of new subscription video
providers?
! Which current regulations are intended to “assure that cable systems
are responsive to the needs and interests of the local community”?
To what extent can competitive provision of subscription video
create market forces that would, on their own, force video providers
to be responsive to local community needs and interests? To what
extent can centralized (state or federal) regulation, rather than local
franchise regulation, address local needs?
84 47 U.S.C. § 532.
85 47 U.S.C. § 541(a)(4)(A).
86 47 U.S.C. § 541(a)(3).

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! If there already is a ubiquitous provider of broadband video service
— the local cable system — in a municipality, does the public
benefit from requiring new entrants also to provide ubiquitous
service? On one hand, the existing telephone networks do not
conform to municipal boundaries, so even a complete broadband
buildout of a telephone company’s network might not provide
ubiquitous coverage of a particular political jurisdiction. On the
other hand, less than ubiquitous coverage might leave some
households without a competitive alternative and also might allow
the new entrant to strategically “cherry-pick” the most valuable
neighborhoods.
! If the underlying public interest objectives that are served by the
current PEG and institutional network requirements are fully met by
the incumbent cable companies, such that there would be little
public benefit to imposing the same requirements on new entrants,
how could these requirements be maintained on the incumbents
without placing them at a competitive disadvantage?
! With respect to the long-standing media policy objective of
diversity of voices, the media ownership rules address horizontal
ownership relationships, not vertical ones. Congress enacted
sections 611 and 612 of the Communications Act87 to ensure diverse
sources of video programming on cable television if cable
companies are vertically integrated into program production.
Section 612 allows franchising authorities to require a cable system
to designate channel capacity, up to maximum levels based on
system capacity, for commercial use by persons unaffiliated with the
cable system. Section 611 allows franchising authorities to require
the designation of channel capacity for public, educational, or
governmental use. The public access channels, in particular, are
intended to ensure that diverse voices are heard. How should these
be applied to telephone company-based video providers?
Some observers have argued that fairness in the marketplace requires that the
new telephone-based video providers be subject to the same requirements as the
incumbent cable operators. In particular, some have argued that the new entrants
should be subject to the same buildout requirements as the cable operators. But
economists have explained that the costs of a particular regulatory requirement may
be very different for an incumbent and a new entrant, and if imposed in exactly the
same fashion may act as a barrier to entry and increase the “first mover” advantage
already enjoyed by the incumbent.88 For example, a buildout requirement is one of
87 47 U.S.C. § 531 and 532.
88 See, for example, George Ford, Thomas Koutsky, and Lawrence Spiwack, “Competition
After Unbundling: Entry, Industry Structure and Convergence,” Phoenix Center Policy
Paper Number 21, July 2005, available at [http://www.phoenix-center.org], viewed on July
27, 2005, at pp. 36-39.
(continued...)

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the costs of entry into the market. For the incumbent cable operator, the buildout
requirement may have been imposed at a time when cable operators received an
exclusive franchise and thus it represented a cost of entry into a monopoly market.
Moreover, that cost is now sunk and likely has long since been recovered. In
contrast, for a new telephone-based entrant, a buildout requirement would represent
an entry cost into a competitive market environment and would not be viewed as
sunk when it makes the decision to enter or not enter. Thus, the imposition of
identical franchise (or other regulatory) requirements on an incumbent and a new
entrant might not represent an equal burden in the marketplace.
At the same time, the advent of IP video potentially raises a new regulatory
issue. While it is unlikely that an independent applications provider would be able
to put together a suite of video programming to compete head-on with SBC, Verizon,
or cable operators for the provision of multiple channels of subscription video
service, it is possible that an independent applications provider might be able to offer
specialty video programming, perhaps independent films or local sports
programming, using IP technology. While a single applications provider of this sort
might not be a threat to the business plan of the large cable and telephone companies,
a plethora of such independent video providers — or, in the future, the development
of a direct link between content providers and end users via peer-to-peer connections
— might be a threat. The network providers might then have the incentive to restrict
end user access to these services. This raises the non-discrimination issues discussed
earlier: should vertically integrated broadband network providers have the right to
restrict IP video or other applications that challenge their own video services or
should end users’ have nondiscriminatory access to all applications that do not
threaten the integrity of the network be mandatory?
Fostering Additional Broadband Networks
Intermodal Competition from Advanced Wireless Networks.
In the debate among proponents of the various approaches to regulation of
broadband networks — structural requirements, ex ante non-discrimination rules, ex
post adjudication of abuses, and reliance on antitrust law and non-binding principles
— the only point of agreement is that end users would benefit, and the need for
regulation would be reduced, if customers had more than two broadband networks
to choose among.89
88 (...continued)
89 Some parties that have voiced concern about a duopoly market structure have pointed to
the history of the wireless telephone industry. According to those commentators, for a
decade, when there were only two cellular telephone providers in any geographic area (the
incumbent local exchange carrier and a second carrier), there was little investment,
innovation, or market success and no attempt to position wireless service as a direct
competitor with wireline telephone service. Only when the FCC made additional spectrum
available for wireless service (allocating spectrum in the 1900 MHz band for personal
communications service), allowing several additional carriers to offer service in most
(continued...)

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In almost all geographic markets today, however, the mass market broadband
market structure is characterized by duopoly provision of broadband network services
(cable modem service from the local cable system or DSL service from the local
telephone company), plus competition among independent applications service
providers and the two vertically integrated broadband network providers for the
provision of broadband applications (services). All parties agree that the dynamics
in both the network market and the applications market would likely change if there
were three or more network providers. For example, as discussed earlier, network
providers face countervailing incentives. On one hand, due to indirect network
externalities, they have the incentive to minimize restrictions on independent
applications providers’ access to their networks. On the other hand, they sometimes
have the incentive to restrict such access when to do so would yield them first-in
advantages or other strategic advantages in the applications market or would aid in
their ability to bolster profits through price discrimination. A third network provider,
entering the market after the first two have been established, is likely to seek
customers by pursuing the strategy of offering access to those independent
applications providers that had been denied access by the incumbents and allowing
end users to use the network for applications that they were not allowed to use on the
incumbents’ networks.90 Thus, a third network is likely to strengthen the market
forces for nondiscriminatory network access and to reduce the need for regulatory
intervention.
Entry by a third broadband network provider would threaten the profits of
incumbent wireline and cable broadband network providers to the extent they lose
customers to the entrant and to the extent a third network reduces their negotiating
strength vis-a-vis independent applications providers and end users. The incumbent
network providers might benefit, however, if such entry justified the easing of
regulatory requirements. The incumbents have argued that regulation of their
networks inevitably introduces inefficiencies, distortions, and unnecessary costs. If
entry of a third broadband network created market forces that decreased both the
perceived and the actual need for regulation of the broadband networks, and if such
regulation did indeed impose those inefficiencies on network providers, then
regulatory relief induced by competitive entry could benefit the incumbents.
While ultimately broadband may be provided over power lines (“BPL”) and/or
satellite, there is general agreement that a third ubiquitous broadband network option
is most likely to be provided using terrestrial wireless technology. In recognition of
that fact, the FCC created a Wireless Broadband Access Task Force that issued a
89 (...continued)
geographic areas, did wireless begin to experience rapid technological and market advances
that redounded to the benefit of consumers. Other commentators, however, claim that the
rapid changes of the 1990s were due to technological change lowering costs to the point that
wireless service could become a substitute for traditional fixed telephone service, not due
to change in the market structure.
90 See, for example, Christine Vestal, “Wireless Is Key to Post-Brand X Broadband
Competition, FCC Staffers Say,” Communications Daily, June 30, 2005, at pp. 2-4, and
Dinesh Kumar, “Utilities Set to Benefit from Brand X Ruling, BPL Officials Say,”
Communications Daily, June 30, 2005, at pp. 5-6.

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report in February 2005.91 The report identified two policy reasons for fostering
deployment of wireless broadband networks:92
! Terrestrial wireless technology provides both mobility and
portability, efficiently connects devices within short distances, and
bridges longer distances more efficiently than wireline and cable
technologies. Wireless technologies frequently are a more cost-
effective solution for serving areas of the country with less dense
population, and provide rural and remote regions new ways to
connect to critical health, safety, and educational services.
! Terrestrial wireless networks can provide competition to existing
broadband services delivered through the currently more prevalent
wireline and cable technologies. Wireless broadband can create a
competitive broadband marketplace and bring the benefits of lower
prices, better quality, and greater innovation to consumers.
There appears to be consensus that one objective of U.S. telecommunications
policy should be to foster the deployment of wireless broadcast networks. But any
actions to foster deployment should not take the form of industrial policy favoring
any specific wireless technology, since there are a variety of technologies that can
offer broadband capability. Nor should it provide wireless technology an artificial
advantage over other broadband technologies.
Wireless broadband can be provided using fixed or portable technologies (such
as Bluetooth or ultra-wide band for short-range communications, Wi-Fi for medium-
range, and WiMAX for longer-range) or by using mobile technologies (such as those
used for third-generation (“3G”) or forthcoming fourth-generation (“4G”) mobile
cellular service). Currently, Wi-Fi primarily provides wireless Internet access for
laptop computers and personal digital assistants; WiMAX expands networks with
wireless links to fixed locations; and 3G brings Internet capabilities to wireless
mobile phones.93 Over time, the capabilities of all these technologies are likely to
expand. The short and medium range technologies share unlicensed spectrum with
other technologies. WiMAX and 3G operate on designated, licensed frequencies
(though it may soon be possible for WiMAX to operate on unlicensed spectrum).
Proponents of each of these technologies share the concern that there may be
insufficient spectrum available for their technologies to be developed to full market
potential, though recent FCC actions have at least started the process for making such
spectrum available. It is not yet clear whether these various wireless technologies
ultimately will be competing for customers or complementing one another by
91 “Connected on the Go: Broadband Goes Wireless,” Report by the Wireless Broadband
Access Task Force (“FCC Wireless Broadband Task Force Report”), Federal
Communications Commission, GN Docket No. 04-163, February 2005.
92 FCC Wireless Broadband Task Force Report, at pp. 13-14.
93 For a more detailed discussion of terrestrial wireless technologies, see CRS Report
RS20993, Wireless Technology and Spectrum Demand: Advanced Wireless Services, and
CRS Report RS21508, Spectrum Management and Special Funds.

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providing a broader base and greater choice of devices for wireless communications
and networking.
Wi-Fi, or wireless fidelity, is the most widely employed of the family of Institute
of Electrical and Electronics Engineers (“IEEE”) standards for frequency use in the
unlicensed 2.4 GHz and 5.4/5.7 GHz spectrum bands. Those are the bands on which
wireless local area networks operate. The FCC’s Wireless Broadband Access Task
Force and others have identified a variety of actions to foster Wi-Fi usage, including
managing spectrum in a fashion that eliminates artificial restrictions on the
availability of unlicensed spectrum, promoting voluntary frequency coordination
efforts by private industry, considering increasing the power limits in certain bands
available for use by unlicensed devices in order to improve their utility for license-
exempt wireless Internet service providers.
WiMAX is an industry coalition of network and equipment suppliers that have
agreed to develop interoperable broadband wireless based on IEEE standard 802.16.
It can transmit data up to 30 miles and may ultimately be used to provide the
broadband “last mile” to end users, that is, a means to provide fixed wireless services
to locations that are not connected to networks by cable or high-speed wires.
WiMAX uses multiple frequencies around the world, an impediment to
interoperability. In the United States, the 700 MHz band is being used in some
WiMAX deployments and there is industry interest in expanding to additional 700
MHz frequencies to create national access. But the 700 MHz band is currently held
by television broadcasters and will not be available until the transition from analog
to digital television has been completed. That transition is one of the most
contentious communications policy issues before Congress today.94 But the potential
benefits to business customers, and perhaps individual consumers as well, of making
a portion of that spectrum available sooner rather than later for fixed or portable
broadband wireless access are huge.
Today’s mobile wireless networks can only provide voice and limited data
service. The next major advance in mobile technology, referred to as 3G, has been
deployed overseas and is beginning to be introduced in the United States. It
dramatically increases communications speed. Fourth generation networks, which
may be available in the near future, are expected to deliver wireless connectivity at
speeds up to 20 times faster than 3G. Some U.S. providers may choose to leapfrog
directly from second to fourth generation technology. Third generation and future
developments in wireless technology will be able to support many services for
business and consumer markets, such as: enhanced Internet links, digital television
and radio broadcast reception, high-quality streaming video, and mobile commerce,
including the ability to make payments.
The National Telecommunications and Information Administration (“NTIA”),
within the Department of Commerce, has responsibility for the management of
spectrum used by the federal government, and the FCC has responsibility for
management of spectrum used commercially and by state and local governments.
94 For a full discussion of the Digital Television Transition, see CRS Report RL31260,
Digital Television: An Overview.

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Aided by an Intra-Government 3G Planning Group, in 2001 the FCC and NTIA
announced plans to reallocate the 1710-1755 MHz and 2110-2155 MHz spectrum
bands to use for commercial advanced wireless services (“AWS”), including 3G.
Since the 1710-1755 MHz band was being used by federal agencies, particularly the
Department of Defense, the plan included a process for making new spectrum
available for the government users who would have to give up spectrum and for
funding those users’ transfer costs. In addition, use of the 2110-2155 MHz band
required moving certain commercial multipoint distribution service licensees from
the 2150-2150 MHz band to new spectrum (as part of a larger reorganization plan
creating the broadband radio service and educational broadband service in the 2.5
GHz band)95 and certain fixed microwave licensees (using a long-established process
for moving these licensees).
Frequencies in the 1710-1755 MHz and 2110-2155 MHz bands will be made
available to the private sector through spectrum auctions conducted by the FCC, and
the auction proceeds will be placed in a Spectrum Reallocation Fund to be used to
cover the costs of transferring the government users to new spectrum. This required
modification of the Communications Act of 1934 to permit the affected agencies
direct access to the auction funds, which was accomplished with the passage of the
Commercial Spectrum Enhancement Act, Title II of P.L. 108-494. Key provisions
of that act include the requirements that the auctions recoup at least 110% of the
projected transfer costs and that unused funds revert to the Treasury after eight
years.96 The Spectrum Relocation Fund was created within the Treasury to hold
auction proceeds as designated. The fund is to be administered by the Office of
Management and Budget. The Commercial Spectrum Enhancement Act requires that
the FCC start the process by notifying the NTIA at least 18 months in advance of a
planned auction. The FCC notified the NTIA of plans to auction frequencies in the
1710-1755 MHz band as early as June 2006.
In addition, in September 2004, the FCC provided an additional 20 megahertz
of spectrum for advanced wireless services, including 3G. It redesignated the 1915-
1920 MHz band for advanced wireless services from unlicensed personal
communications services and paired this block of spectrum with the 1995-2000 MHz
band, which was previously allocated for the mobile satellite service. Also, it
concluded that an additional ten megahertz of spectrum at 2020-2025 MHz and 2175-
2180 MHz, previously allocated for mobile satellite service, should be made
available for AWS.97 The Commission adopted a reimbursement plan to compensate
UTAM, Inc. for relocation expenses it will incur to relocate incumbents from the
1915-1920 MHz band. The FCC is still developing service rules needed to
implement this spectrum reallocation.
95 One gigahertz is 1,000 times one megahertz. Thus 2.5 GHz is the same as 2500 MHz.
96 Specific frequencies mentioned in the act include not only the 1710-1755 MHz band but
also other federally-used frequencies scheduled for reallocation and possible auction.
97 In the Matter of Amendment of Part 2 of the Commission’s Rules to Allocate Spectrum
Below 3 GHz for Mobile and Fixed Services to Support the Introduction of New Advanced
Wireless Services, including Third Generation Wireless Systems, ET Docket No. 00-258,
Sixth Report and Order, adopted September 9, 2004, released September 22, 2004.

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The FCC has taken steps to make other licensed and unlicensed spectrum
available for advanced wireless services. As mentioned earlier, much of the
spectrum in the 700 MHz band that will be affected by the broadcast television
digital transition is expected to be used for AWS, including WiMAX. Some
spectrum will be available in the 70, 80, and 90 GHz bands on a quasi-licensed basis
capable of providing pencil beams between commercial office buildings of as much
as a mile in length. In addition, ultra wide band technology, using small amounts of
available spectrum across multiple bands, will allow users to employ Bluetooth and
other technologies for wireless personal area networks.
The reallocation of spectrum to make more available for advanced wireless
services is a specific example of a broader public policy objective: the management
of spectrum in a fashion that promotes its efficient use to provide innovative services
to Americans. There is a very lively debate about how best to manage the spectrum
to maximize consumer welfare. There has been much criticism that legacy
command-and-control regulation of spectrum — under which spectrum is assigned
to specific uses and access to that spectrum for other uses is prohibited — does not
take into account advances in technology that have created the potential for systems
to use spectrum more intensively and to be much more tolerant of interference than
in the past.98 Two proposed alternative approaches have been the subject of much
discussion: the granting of exclusive, tradeable spectrum usage rights through
market-based mechanisms and creating open access to unlicensed spectrum
“commons.” The three approaches are not necessarily mutually exclusive; some
portions of the spectrum could remain subject to command-and-control, while other
portions are allocated by the market and the remainder is held as commons. The
debate about how best to allocate spectrum, however, is beyond the scope of this
report.
Some observers have suggested that a third network provider might have less
incentive to provide strong price and service competition — to challenge the network
access status quo — if it shared ownership or a strategic alliance with one of the
incumbent networks. For example, if the new network were an advanced wireless
network that shared ownership with one of the RBOCs (Verizon Wireless/Verizon
or Cingular/SBC/BellSouth) or if the wireless network had a strategic relationship
with the major cable companies (there have been discussions of an alliance between
some of the major cable companies and Sprint/Nextel to offer bundled “quadruple
play” voice/data/video/wireless in competition with the RBOCs), then there might
be some reluctance on the part of the new entrant to employ an entry strategy that
disrupts the market. This might suggest that, in any auction of spectrum for 3G or
4G services, some preference be given to bidders that are independent of the RBOCs
and major cable companies, or that some portion of the auctioned spectrum be set
aside for independent providers.
On the other hand, there appear to be strong incentives for any broadband
wireless network provider, even if it were owned by a telephone company or in a
marketing relationship with a cable company, to be an aggressive competitor. First,
98 For a detailed discussion of spectrum management issues, see Spectrum Policy Task Force
Report, Federal Communications, ET Docket No. 02-135, November 2002.

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wireless service is growing faster than wireline service, so it would not seem to be
in a company’s long term strategic interest to constrain its wireless activities to
protect its wireline business. Second, the broadband wireless networks are likely to
extend geographically beyond the geographic reach of any telephone company or
cable company network and therefore wireless providers will in many instances not
be competing against an affiliated network. It would be difficult for a national
wireless carrier to strategically provide two levels of competition: aggressive
competition outside an affiliated network’s region and passive within. Third, there
will probably be multiple broadband mobile wireless networks — at the national
level, Cingular, Verizon, Sprint/Nextel, and perhaps T Mobile, and at the regional
level Alltel/Western Wireless — so any single network will face intramodal
competitive pressure on price and service access. There also may be competition
from a nationwide WiMAX network.
Intramodal Competition from CLECs for Large Business
Customers.
Much of the criticism of the 1996 Act has focused on those provisions that
attempted to facilitate the transition from monopoly to competitive provision of
telecommunications services, most notably the provisions requiring the incumbent
local exchange carriers to make elements of their networks available to new entrants
under certain conditions. Those provisions were intended to foster intramodal
competition with the understanding that new entrants could not instantaneously build
out ubiquitous networks like those of the incumbent monopolies.
Nine years after enactment of the 1996 Act, no intramodal entrant has been able
to construct a ubiquitous network. It has not proven viable to replicate the local loop
(“last mile” connection) between a network’s switch and a customer’s premise,
except in the case of large business customers whose traffic volume is sufficient to
justify deploying a large pipe to the premise. As a result, the competitive local
exchange carriers’ (“CLECs”) networks typically consist largely of fiber rings in
business areas that connect directly to their major customers’ locations. Nor has it
proven viable for the CLECs to fully replicate the RBOCs’ transport networks, the
connections between the nodes in their networks, through which aggregated traffic
is routed. Even the CLECs serving the most multi-locational business customers,
such as AT&T and MCI, have not been able to capture sufficient traffic to create the
scale economies needed to support a ubiquitous transport network. Rather, they have
continued to rely on the RBOCs for transport facilities on many routes.
Cable networks were constructed to serve residential customers and therefore
tend not to be ubiquitously deployed in business districts. Even the largest cable
companies are only in selected geographic markets in the country, and may not be
able to meet the needs of large, multi-locational business customers. Also, it is likely
to take many years for wireless carriers to construct networks that can meet the
bandwidth and security requirements of large corporations. Competitive provision
of broadband services to large business market customers therefore is most likely to
be intramodal, between the long distance carriers, incumbent local exchange carriers,
and CLECs. But recently announced proposed mergers between SBC and AT&T,
and between Verizon and MCI, may reduce both actual and potential competition in
business markets and in the Internet backbone. The Department of Justice and the

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CRS-47
FCC will be making determinations about the competitive effects and public interest
consequences of these proposed mergers, but as part of that process large business
customers and competitive local exchange carriers have raised concerns about having
fewer options to turn to. Some large business customers have argued that SBC and
Verizon represented the two companies most likely to compete with AT&T and MCI,
the two largest providers of business services. And the CLECs have argued that they
have relied on AT&T and MCI as the primary alternatives to the RBOCs as sources
of transport facilities needed to compete in business markets.
It therefore might not be wise to simply replace the statutory provisions
fostering intramodal competition with provisions fostering intermodal competition
on the expectation that intermodal competition will always be effective. Intramodal
competition will remain important, especially for large business markets. But given
the inability of facilities-based CLECs to attain the economies of scale needed to
support ubiquitous transport networks, there might be reason to maintain some of the
current statutory provisions intended to foster that competition.
Antitrust Savings Clause: The Trinko Decision
The 1996 Act includes an “antitrust savings clause” stating that neither the act
nor any amendments made by it “shall be construed to modify, impair, or supersede
the applicability of any of the antitrust laws.”99 In a recent decision,100 involving an
antitrust suit brought against Verizon, an incumbent telephone company that had
been disciplined by both the FCC and the New York Public Service Commission
(“PSC”) for breaching its duty under the 1996 Act to adequately share its network
with competitive providers, in which the plaintiff alleged that such breaches
represented exclusionary and anticompetitive behavior, the Supreme Court ruled that
the breached FCC and PSC rules affirmatively required Verizon to aid its competitors
and that failing to meet those requirements was not a sufficient basis for finding a
violation of antitrust law. The Court found that “the Act does not create new claims
that go beyond the existing antitrust standards.” The Court also found that the
plaintiff, a customer of one of the CLECs, did not have standing to bring the case.
Congressional reaction to the Trinko decision was mixed. House Judiciary
Committee Chairman Sensenbrenner stated concern that the decision not be
“perceived as giving a green light to all manner of anticompetitive behavior by the
Bells.... The Committee on the Judiciary ... will not hesitate to develop legislative
responses to competitive problems that may arise as a result of this decision.”101
House Judiciary Committee ranking minority member Conyers reportedly called for
99 P.L. 104-104, § 601(b)(1).
100 Verizon Communications v. Law Offices of Curtis V. Trinko, 540 U.S. 398 (2004). For
a full discussion of this case, see CRS Report RS21723, Verizon Communications, Inc. v.
Trinko: Telecommunications Consumers Cannot Use Antitrust Law to Remedy Access
Violations of Telecommunications Law.
101 “Sensenberenner Statement on Supreme Court’s Trinko Decision,” U.S. House of
Representatives Committee on the Judiciary, January 14, 2004, available at
[http://judiciary.house.gov/legacy/news011404.htm], viewed on July 25, 2005.

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legislation to address the “Supreme Court’s serious blunder.”102 On the other hand,
Representative Tauzin, then-chairman of the House Energy and Commerce
Committee, expressed his approval that the Supreme Court had “decisively reiterated
... that the regulation of the telecommunications industry should be the purview of
the FCC and the state [public utility commissions], rather than judges all across the
country.103
It may be that, when Congress inserted the “antitrust savings” clause in the 1996
Act, many Members believed that the clause was preserving an unlimited private
right of action on the part of other-than-directly affected parties to sue under the
antitrust laws. But, as this case indicates, the clause may be of little effect in
instances such as this in which it is found that traditional antitrust
principles/standards are not implicated. Given the Verizon decision, there are at least
three congressional options that might have the effect of providing the breadth of
private action some members of Congress apparently thought they had assured. First,
Congress could amend the savings clause to clarify that the phrase, “the antitrust
laws,” means the literal words of the statutory provisions, but excludes any judicial
interpretation of them. Second, Congress could amend the “enforcement” provisions
of the 1996 Act so that even if there had already been regulatory action, certain
provisions of the act would remain enforceable by private individuals who are not
competitors of local exchange carriers, but, rather, their customers or customers of
would-be or actual competitors. Third, Congress could characterize a violation of any
(or some) mandatory, competitive obligation(s) of the act as prima facie evidence of
violation of the antimonopoly provision of the antitrust laws (15 U.S.C. § 2).
Congress could also choose to allow the current law to remain unchanged.
Intercarrier Compensation
Since the value of access to a network or of a network service, such as a
telecommunications service, increases as the number of other parties connected to the
network increases, new entrants would have a very difficult time entering the market
if they could not interconnect their networks with those of the incumbent carriers
under nondiscriminatory terms and conditions. Thus a key provision of the 1996 Act
set obligations for incumbent carriers and new entrants to interconnect their networks
with one another, imposing additional requirements on the incumbents because they
might have the incentive and ability to restrict competitive entry by denying such
interconnection or by setting terms, conditions, and rates that could determine the
ability of the new entrants to compete.104
With multiple networks interconnecting to provide service, a necessary
component of a competitively neutral regulatory regime is nondiscriminatory
102 “Trinko: Supreme Court Changes the Landscape for Section 2 Liability,” Update:
Antitrust January 2004, Hogan & Harts on LLP, available at [http://www.hhlaw.com/
articles/ 809_0401_antitrust_update.pdf], viewed on July 25, 2005.
103 “Sensenbrenner: Verizon Ruling May Require Legislation,” Congress Daily, January 14,
2004.
104 47 U.S.C. § 252.

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CRS-49
intercarrier compensation — the payments that interconnected carriers make to one
another when more than one carrier’s network must be used to complete a call or
other electronic communication.105 When Congress passed the 1996 Act, there was
very limited competition across the boundaries of local exchange service, long
distance service, and wireless service, and thus the act did not focus on intercarrier
compensation rates, though it did prescribe that intercarrier compensation rates
between competing local exchange carriers be based on the “additional costs of
terminating such calls.”106 Primarily, though, the 1996 Act left in place existing
intercarrier compensation rates.
But that system of intercarrier compensation was implemented on a piecemeal
basis, as specific existing telecommunications services were opened to competitive
provision or providers offering entirely new services (such as wireless service) were
allowed to interconnect with the public switched telephone network. Today, these
intercarrier compensation payments vary widely, depending on the following:
! whether the interconnecting party is a local exchange carrier
(“LEC”),107 an interexchange (long distance) carrier, a commercial
mobile radio service (“CMRS” or wireless) carrier, or an
information service provider, and
! whether the service is classified as telecommunications or
information, local or long distance, or interstate or intrastate,
even though in each case basically the same transport and switching functions are
provided.
As shown in Figure 1, a chart prepared by the Intercarrier Compensation Forum
(“ICF”),108 today the average intercarrier compensation rate ranges from 0.1 cents per
minute for traffic bound to an ISP to 5.1 cents per minute for intrastate traffic bound
to a subscriber of a small (rural) incumbent local exchange carrier; individual rates
105 For a detailed discussion of intercarrier compensation issues, see CRS Report RL32889,
Intercarrier Compensation: One Component of Telecom Reform.
106 47 U.S.C. § 252(d)(2)(A).
107 These payments vary even among LECs, depending on whether the carrier is an
incumbent local exchange carrier, that is one of the legacy LECs that was a government
sanctioned local monopoly provider prior to the implementation of the 1996 Act; a small
LEC (sometimes referred to as a rural LEC), that is an ILEC serving a small rural area; or
a competitive local exchange carrier, that is a new competitive provider of local exchange
service that was allowed to enter the market as a result of enactment of the 1996 Act.
108 The ICF is a group of carriers from different segments of the telecommunications
industry that has submitted a proposal for comprehensive intercarrier compensation reform
in a proceeding currently open at the FCC: In the Matter of Developing a Unified
Intercarrier Compensation Regime, CC Docket No. 01-92, Ex-Parte Brief of the Intercarrier
Compensation Forum in Support of the Intercarrier Compensation and Universal Reform
Plan (“ICF Plan”), October 5, 2004.

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CRS-50
can be as low as zero and as high as 35.9 cents per minute.109 These intercarrier
compensation charges can represent a substantial portion of the costs of providing
certain services and, in the case of long distance calls that interexchange carriers are
required by statute and FCC rule to offer at a single rate nationally,110 can exceed the
retail price for the service.111

109 ICF Plan at Appendix C, p. 2. In Figure 1, “RC” refers to “reciprocal compensation,”
the cost-based system for intercarrier compensation between providers of local service
mandated by the 1996 Act (47 U.S.C. §§ 251(b)(5), 252(d)(1)(A), and 252(d)(2)(A)).
“IntraMTA” and “InterMTA” refer to the distinction between those calls originating on
wireless networks that are treated as local vs. long distance for intercarrier compensation
purposes, as discussed in greater detail below. All classifications with the words
“intrastate” or “interstate” refer to intercarrier compensation rates for long distance calls.
110 In section 254(g) of the 1996 Act, 47 U.S.C. § 254(g), Congress instructed the FCC to
“adopt rules to require that the rates charged by providers of interexchange
telecommunications services to subscribers in rural and high cost areas shall be no higher
than the rates charged by each such provider to its subscribers in urban areas. Such rules
shall also require that a provider of interstate interexchange telecommunications services
shall provide such services to its subscribers in each State at rates no higher than the rates
charged to its subscribers in any other State.” To implement this statutory instruction, the
FCC adopted a geographic rate averaging rule and a rate integration rule. (47 C.F.R. §
64.180.)
111 The “access charges” that some rural local exchange carriers charge long distance
carriers for originating the long distance calls made by customers located in those rural
areas, or for terminating the long distance calls made to customers located in those rural
areas, exceed the nationally averaged price that the long distance carriers charge their
subscribers for those calls, and thus the long distance carriers lose money on each long
distance call into or out of those rural exchanges. As a result, long distance carriers are
reluctant to make available to customers in those areas service packages that are likely to
be attractive to heavy long distance users.

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CRS-51
Figure 1: Current Intercarrier Compensation Rates
Source: Intercarrier Compensation Forum
Given the wide variation in intercarrier compensation rules applied to carriers
and technologies that are now competing with one another, the FCC adopted a
Further Notice of Proposed Rulemaking in February 2005 to review and reform its
rules with the goal of constructing a unified intercarrier compensation regime.112 The
FCC seeks public comment on nine comprehensive intercarrier compensation reform
proposals or sets of principles that have been submitted to the FCC as well as a staff
proposal.113 The issues raised in the ICC FNPRM are not new to the Federal
112 In the Matter of Developing a Unified Intercarrier Compensation Regime, Further Notice
of Proposed Rulemaking (“ICC FNPRM”), adopted February 10, 2005, released March 3,
2005.
113 See the following documents filed with the FCC in the Intercarrier Compensation
proceeding: The National Association of Regulatory Utility Commissioners (“NARUC”)
Study Committee on Intercarrier Compensation Goals for a New Intercarrier Compensation
System, May 5, 2004; Cost Based Intercarrier Compensation Coalition (“CBICC”) Proposal,
September 2, 2004; Ex Parte Brief of the Intercarrier Compensation Forum in Support of the
Intercarrier Compensation and Universal Service Reform Plan, October 5, 2004; The
Intercarrier Compensation and Reform Plan of the Alliance for Rational Intercarrier
Compensation, October 25, 2004; A Comprehensive Plan for Intercarrier Compensation
Reform Developed by the Expanded Portland Group, November 2, 2004; Western Wireless
Intercarrier Compensation Reform Plan, December 1, 2004; Updated Ex Parte of Home
Telephone Company, Inc. and PBT Telecom, November 2, 2004; Ex Parte of CTIA — The
Wireless Association, November 29, 2004; the National Association of State Utility
Consumer Advocates (“NASUCA”) Intercarrier Compensation Plan, December 17, 2004;
(continued...)

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Communications Commission. In 2001, the FCC opened a rulemaking proceeding
and adopted a Notice of Proposed Rulemaking seeking information on how to
develop a unified intercarrier compensation regime.114
There is general agreement that intercarrier compensation reform is needed
because:
! The current regime distorts investment decisions and undermines
e f f i c i e n t c o m p e t i t i o n b y p r o v i d i n g a r t i f i c i a l
advantages/disadvantages to those service providers that happen to
be subject to favorable/unfavorable intercarrier compensation rules.
For example, for non-local calls made within any of the 51
Metropolitan Trading Areas (“MTAs”) in the United States,115 if the
caller uses a wireless telephone, the caller’s wireless carrier is
subject to a cost-based “reciprocal compensation” charge for the
termination of that call; but if the caller made an identical call, from
the same location to the same called party, using a wireline
telephone (and hence a wireline long distance carrier), that carrier
would be subject to an above cost “access charge” for the
termination of the call. As another example, when a long distance
call is made to a called party’s wireline telephone, that party’s
wireline local exchange carrier can charge the calling party’s long
distance carrier an above-cost access charge for terminating the call;
but if an identical long distance call were made to the same called
party, from and to the same physical location, but to the called
party’s wireless telephone, the called party’s wireless carrier is not
allowed to charge the calling party’s long distance carrier any access
charge for terminating the call.
! The current regime fails to provide innovators certainty about the
intercarrier compensation regime to which their services will be
subject. For example, since VoIP service is, on one hand, an
113 (...continued)
“A Bill-and-Keep Approach to Intercarrier Compensation Reform,” ICC FNPRM, Appendix
C.
114 In the Matter of Developing a Unified Intercarrier Compensation Regime, Docket No.
01-92, Notice of Proposed Rulemaking (“ICC NPRM”), 16 FCC Rcd at 965.
115 Rand McNally & Co. has formulated 493 non-overlapping Basic Trading Areas
(“BTAs”) that cover the entire United States and its territories. Each BTA represents a
geographic region, defined by a group of counties that surround a city, which is the area’s
basic trading center. The FCC has used these BTAs to determine service areas for PCS
wireless licenses. In turn, these 493 BTAs are aggregated into 51 Major Trading Areas
(“MTAs”), usually composed of several contiguous basic trading areas. Individual MTAs
are quite large, and can encompass several states. For a map showing the MTA boundaries,
see [http://wireless.fcc.gov/auctions/data/maps/mta.pdf] (viewed on 4/14/05). The
intercarrier compensation rules are different for intraMTA wireless calls that originate and
terminate within an MTA and interMTA wireless calls that originate and terminate in
different MTAs.

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CRS-53
application of an information service and, on the other hand,
functionally equivalent to a traditional voice telephone call, it
arguably fits into two different classifications for the purposes of
intercarrier compensation. Information services are not subject to
access charges; long distance telephone calls are. As discussed in
the section on VoIP below, the FCC has begun to make decisions,
on a case-by-case basis, about the classification of specific voice
product offerings that use IP technology to varying degrees. The
business plans of VoIP providers will be strongly affected by the
ultimate decision about how they are classified for intercarrier
compensation purposes.
! The current regime encourages uneconomic arbitrage; that is,
providers making business decisions based on the artificial rates set
for intercarrier compensation, rather than on true underlying costs.
For example, because of the traffic patterns of ISPs and some
anomalies in the rules,116 some CLECs have pursued the market
strategy of targeting ISPs as customers. They have offered ISPs
service at what may have been below-cost rates because they could
more than recoup any losses by charging above-cost rates to the
carriers of the ISPs’ subscribers for terminating the large volume of
subscriber calls to those ISPs.117 Regulators also may seek to exploit
uneconomic arbitrage. For example, state regulators as well as rural
LECs may have the incentive to limit the scope of rural local calling
areas since calls that are classified as long distance will generate
more revenues (through toll charges or access charges) than they
would if classified as local and also will tend to move the burden of
cost recovery from local rural customers to urban long distance
customers (since long distance rates are averaged and thus urban
customers who can be served at low cost face higher averaged rates
that contribute to the recovery of higher rural costs).
! The current regime creates an artificial cost structure, based on
minutes of use, which appears to be inconsistent with actual cost
causation in networks and which renders it difficult for carriers to
116 Specifically, (1) ISPs are treated like end users; (2) ISPs receive far more calls than they
make, so an ISP’s LEC will terminate far more calls from the ISP’s subscribers than it
originates from the ISP; (3) for many of those terminated calls, the ISP’s LEC can charge
the carriers serving the ISP’s end user customers above-cost access charges; and (4) the
ISP’s LEC can choose a single point of interconnection with the carriers serving the ISP’s
end user customers in a way that requires those carriers to bear most of the costs of
transporting the traffic to the ISP. The specifics of this are discussed in the section below
on “Where should networks be allowed, or required, to interconnect with one another?”
117 In its 2001 ISP Report and Order, the FCC found that “under the current carrier-to-carrier
recovery mechanism, it is conceivable that a carrier could serve an ISP free of charge and
recover all of its costs from originating carriers.” The ILECs were somewhat constrained
in their ability to compete with the CLECs for these ISP customers because in certain
situations they are not allowed to negotiate individual contracts with customers, but rather
are limited to offering services through tariffs that are generally available to all customers.

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CRS-54
meet the preferences of many consumers for offerings consisting of
large baskets of minutes or unlimited calling at a fixed price. For
example, under the current access charge regime, interexchange
carriers are charged on a per-minute-of-use basis for the switching
used to originate and terminate their customers’ calls, making the
interexchange carriers’ underlying cost structure usage-sensitive
even though the preponderance of those switching costs appear not
to be usage-sensitive.118 But by facing these artificially imposed
usage-based costs, long distance carriers are discouraged from
offering large baskets of minutes or unlimited calling at a fixed price
since they would lose money when serving high usage customers,
who are the customers most likely to select such packages.119
! The current regime requires carriers to expend millions of dollars
and scarce information technology resources developing systems to
identify, measure, monitor, bill, reconcile, audit and dispute the
classification of traffic as local or toll, intrastate or interstate,
intraMTA or interMTA,120 information service or
telecommunications service, etc., in order to determine which
intercarrier compensation rules apply. It also encourages wasteful
litigation as carriers fight among themselves about that classification
of traffic. These costly nonproductive activities will continue to
grow as providers respond to consumer demand for bundled
offerings of services that fit into different classifications.
! The current regime undermines the stability of universal service
subsidy funds. Where ILECs rely at least in part on the profits from
above cost access charges to defray the cost of providing universal
service, this funding source is in jeopardy because the number of
minutes subject to access charges is declining as carriers with more
favorable intercarrier compensation treatment (for example, wireless
and VoIP carriers) are gaining market share and traditional long
118 A more detailed discussion of switching costs in presented below in the section entitled,
“What is the underlying cost structure of the transport and switching functions?”
119 The long distance carriers assert that the Bell operating companies, which are now
allowed to offer long distance service and typically do so as part of a package of local and
long distance service, do not face the same problem. The long distance carriers claim that,
even if the Bell companies’ long distance arms must pay the same usage-based access
charges to their local operating companies as the long distance carriers pay, the underlying
costs to the Bells are not usage-sensitive. That is, any losses that the Bells’ long distance
arms might suffer, when serving a high usage customer, by having to pay minute-of-use
access charges while offering large baskets of minutes or unlimited calling at a fixed price,
are matched by the additional profits that the Bells’ local operating companies generate from
those minute-of-use access charges (since their underlying costs are not increasing with
usage).
120 The intercarrier compensation rules are different for intraMTA wireless calls that
originate and terminate within an MTA and interMTA wireless calls that originate and
terminate in different MTAs.

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CRS-55
distance carriers have an incentive to manipulate the complex
packages of services that they offer to minimize their exposure to
access charges.
At the same time, in some quarters there is resistance to comprehensive
intercarrier compensation reform because of concerns that some carriers and some
consumers may be harmed by the changes. In this view:
! If the access charges currently imposed by local exchange carriers on
interexchange carriers to originate and terminate long distance calls
were reformed to more accurately reflect the low proportion of
switching costs that appear to be usage-sensitive (and the high
proportion that appear to be fixed), per-minute access charges
imposed on the long distance carriers would fall, but the fixed costs
of switching would likely be recovered by raising the subscriber line
charge imposed on end users for connecting to the network.
Consumer groups have consistently opposed line charges of any sort,
arguing that such charges unfairly burden low usage and low income
customers.121
! The access charges that long distance carriers must pay to small rural
local exchange carriers for originating or terminating the long
distance calls of the rural carriers’ customers tend to be higher than
the access charges paid to urban carriers. This is in part because the
small rural carriers’ underlying costs are higher than those of urban
carriers due to the lack of population density and lack of scale
economies and in part due to efforts by regulators to keep rural end
users’ local rates low. Also, the rural carriers’ local calling areas
tend to be narrowly defined and to serve only a small number of
households. Many of their customers’ incoming and outgoing calls
therefore are classified as toll (long distance) calls, for which the
rural LECs receive above-cost minute-of-use access charges from
long distance carriers, rather than the fixed end-user charge typical
of local service. As a result, the small rural LECs historically have
generated a much larger portion of their total revenues from access
charges than have urban LECs.122 Since the access charges of rural
LECs exceed costs by more than those of urban LECs, and since
rural LECs have depended on access charges more than urban LECs,
reforming access charges to bring them down to cost would place a
greater revenue burden on rural LECs than on urban LECs. Absent
121 See, for example, “Jessica Zufolo: Emerging VoIP Policy is Driving Investment,”
Telecom Policy Report, September 29, 2004.
122 The ICC FNPRM, at paragraph 107, states: “According to NTCA [the National
Telecommunications Cooperative Association], rural LECs receive on average 10 percent
of their revenue from interstate access charges and 16 percent from intrastate access charges.
In comparison, it asserts that the BOCs [Bell Operating Companies] receive only four
percent of their revenue from interstate access charges and six percent from intrastate access
charges.”

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another revenue source, end-user line charges would have to be
raised more in rural areas than in urban areas. To keep line charges
from growing to the point where local service becomes unaffordable
or non-comparable with urban rates, a new universal service funding
mechanism would be needed to replace the implicit universal service
funding currently in the rural carriers’ access charges. Although all
the proposals for intercarrier compensation reform have included
new universal service funding mechanisms, the rural LECs prefer
not to have to rely so heavily on an explicit universal service funding
mechanism. They generally prefer to have three revenue sources —
line charges, universal service funds, and above-cost access charges
— rather than just the first two. In part, this is because they prefer
to recover a larger portion of their costs from long distance carriers
(whose averaged rates subsidize rural customers) than from their
own end-user customers in subscriber line charges. And in part it is
because they are concerned about relying too heavily on universal
service funds, which they consider a potentially unstable source of
revenue, especially now that rural wireless carriers are seeking these
same universal service funds.
! Although section 254(e) of the 1996 Act requires universal service
support to be explicit and sufficient,123 many state regulators
continue to set intrastate access charges, and especially the intrastate
access charges of rural carriers, at above-cost rates that exceed
interstate access charges, in order to create a revenue source
(ultimately borne primarily by customers of long distance carriers
that do not live in rural areas) that will help keep local rates low.
Some parties question whether the FCC has the authority to modify
intrastate access charges (as part of comprehensive intercarrier
compensation reform) without the formal involvement of the states.
The rural telephone companies have an additional problem relating to
intercarrier compensation. They claim that they are unable to receive compensation
for the termination of a very substantial portion of the traffic they receive from
outside their service areas because they are unable to identify the originating carrier.
This problem, referred to as “phantom traffic,” has grown in recent years. Typically,
it occurs when traffic is passed from an originating local or long distance carrier to
an intermediate or “transiting” carrier (most typically the Regional Bell Operating
Company located closest to the rural telephone company), which then passes the
traffic on to the terminating rural carrier. The transiting carriers sometimes, however,
will not pay the rural carrier for terminating the call, but rather will insist that the
terminating carrier seek payment directly from the originating carrier. Unfortunately,
at times the information identifying the originating carrier has been stripped away
before the call reaches the terminating carrier.124 This allegedly happens most
123 The 1996 Act states at § 254(e): “Any such support should be explicit and sufficient to
achieve the purposes of this section.”
124 See, for example, Josh Long, “Rural Telcos Grapple to Identify Phantom Traffic,” posted
(continued...)

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frequently when the originating carrier is a long distance or wireless carrier, which
must pay above-cost access charges for the termination of the call but would prefer
to transit the call through an intermediate local exchange carrier, since the latter
would only have to pay cost-based reciprocal compensation rates for the termination
of the call.125 It is likely that intercarrier compensation reform that equalizes the
termination rates for long distance and local calls would reduce this phantom traffic
problem, but it still is essential that the identification problem be corrected as it
places an unfair burden on rural carriers.
Given the many affected interests with conflicting views and the impact of
intercarrier compensation on such fundamental public policy objectives as
competition and universal service, Congress might choose to use its deliberations on
reform of the Communications Act as an opportunity to provide the FCC statutory
guidance on how to proceed with its intercarrier compensation reform efforts.
Universal Service in a Broadband Environment
The universal availability of basic telecommunications service at affordable
rates has been a fundamental element of telecommunications policy in the United
States since the enactment of the Communications Act in 1934. To achieve this, a
universal service subsidy system has been employed to keep end user rates affordable
for low income households and for households and small businesses in high cost
areas (and, since 1996, to provide discounts to schools and libraries for telephone
service, Internet access, and internal network wiring, and to public and non-profit
rural health care providers for telecommunications services and installations and for
long distance Internet connections).
This policy goal can be fully compatible with the development of a competitive
market for telecommunications services, including the last mile into customers’
premises, so long as the universal service funding mechanism is constructed in a
competitively neutral and efficient fashion. That cannot be accomplished if any of
the universal service subsidy is hidden in above-cost rates for certain services that are
intended to subsidize the below cost rates for other services. In that situation, a
competitor could successfully enter the market by undercutting the above-cost prices
for those services whose rates are raised to include implicit subsidies, but could not
compete in the provision of those services whose rates are set below cost.
The policy goal also cannot be achieved if the universal service subsidy is not
available on the same basis to all competitors in the market. This is especially
124 (...continued)
April 1, 2004, available at [http://www.xchangemag.com/articles/441coverstor3.html].
viewed on July 21, 2005.
125 The long distance and wireless carriers claim that the rural telephone companies are
responsible for the phantom traffic problem because they have not deployed facilities with
the signaling system (SS-7) capable of identifying the originating carrier and have chosen
to route traffic in a fashion that does not transfer billing information. See Communications
Daily, August 5, 2005, at pp. 6-7.

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important today, with competing wireline, cable, mobile wireless, and fixed wireless
technologies all potentially able to offer service to rural customers. In addition, if the
universal service funding mechanism is not efficient — and therefore requires more
resources than is necessary to provide universal availability — it will place an
unnecessary burden on telecommunications markets (or on the general public, if
supported by general tax revenues).
The 1996 Act took a major step in the direction of reconciling universal service
with competitive markets by requiring that “[a]ny such support should be explicit and
sufficient to achieve the purposes....”126 This requirement has not yet been achieved,
however. Although competitive market forces have driven some above-cost rates
down toward cost, especially for business services, and an explicit Federal Universal
Service Fund (“FUSF”) funding mechanism has been created that provides a
significant portion of total universal service subsidies,127 many rates continue to be
set above cost in order to include hidden universal service subsidies; for example, the
intrastate access charges of many rural telephone carriers discussed earlier in the
section on intercarrier compensation.
Which Services Should Be Supported by a Universal Service
Subsidy and Who Should Receive the Subsidy?
The 1996 Act instructs the FCC and a Federal-State Joint Board on Universal
Service to base policies for the preservation and advancement of universal service on
seven principles. One of those principles is: “Access to advanced
telecommunications and information services should be provided in all regions of the
Nation.”128 The act is not specific about how this should be accomplished and does
not explicitly include advanced services among those that should be subsidized to
achieve universal service. To date, the Joint Board and the FCC have not included
advanced services in the definition of universal service. But there has been
considerable national discussion of the role of broadband networks in stimulating
economic development and some Members of Congress believe the time is ripe to
debate the inclusion of access to a broadband network in universal service.

While market demand appears to be sufficient to generate competitive
broadband network deployment in many urban areas without government
intervention, that may not be the case in rural or other high cost (or low income)
areas, where high costs and/or limited demand may render it economically infeasible
to deploy multiple broadband networks, or even a single network, without
government intervention.
126 47 U.S.C. § 254(e).
127 The FCC has reported that, for the third quarter of 2005, total projected FUSF program
support will be $1.770 billion, and the total FUSF program collection will be $1.679 billion.
See “Proposed Third Quarter 2005 Universal Service Contribution Factor,” CC Docket No.
96-45, Federal Communications Commission Public Notice DA 05-1664, released June 14,
2005, at p. 2.
128 47 U.S.C. § 254(b)(2).

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If Congress wants to expand the scope of universal service to include universal
access to a broadband network at affordable rates, it must address a number of issues.
Most basically, how “broad” is the “broadband” that should be provided as part of
universal service? Bigger may be better, but only at an associated cost. As explained
earlier, one of the primary drivers of broadband deployment has been network
providers’ desire to bring sufficient bandwidth to customer premises to support the
triple play of voice, data, and subscription video services. Of these three
applications, video is the one that requires the most bandwidth, but it also is the one
that has the least nexus to public safety or economic development. Thus, it may be
difficult to establish a public interest justification for subsidizing the additional
bandwidth needed for video. On the other hand, one of the principles in the universal
service section of the 1996 Act states that “Consumers in all regions of the Nation
...should have access to telecommunications and information services, including
interexchange services and advanced information services, that are reasonably
comparable to those services provided in urban areas and that are available at rates
that are reasonably comparable to rates charged for similar services in urban areas.”129
Is it sufficient, for example, to limit a subsidy program in high cost areas to support
for broadband service capable of (relatively low quality) video streaming if the
unsubsidized market is driving companies to deploy broadband capable of offering
(higher quality) broadcast-quality video service in urban areas — even though
subscription video is needed neither for public safety nor for economic development?
Also, the sparse population and longer distances in rural areas translate into low
density of demand, limited economies of scale, and hence higher costs, such that
there is uncertainty whether even a single broadband network can be sustained. Is it
possible, then, to construct a universal service subsidy program that is open to all
competing technologies (and thus competitively neutral) without creating incentives
for the deployment of multiple networks, none of which can exploit economies of
scale to constrain costs?
Historically, universal service has been limited to basic telephone service, but
the subsidy has been given to the provider, rather than to the end user. (The latter
might be accomplished in the form of a voucher that could be used to reduce a cost-
based rate to an affordable rate.). Since wireline, wireless, and cable companies all
may offer local telephone service in a particular high cost area, all three can
potentially qualify as “eligible telecommunications carriers” (“ETCs”) in that locality
and receive universal service funds. The competing carriers only receive funds for
those customers they capture, but since a customer can elect to obtain service from
more than one carrier at the same time, more than one carrier can receive universal
service funding for serving that customer. Typically, customers do not receive basic
voice service from both the local telephone company and the local cable operator, so
it is unlikely that those two carriers would each receive universal service funds for
serving the same customer. But many customers do receive both fixed telephone
service (from a telephone company or a cable operator) and mobile telephone service
(from a wireless carrier), and in that case both the fixed and the mobile telephone
service provider would receive the universal service subsidy. Thus, competitive
entry in that situation will increase the total size of the universal service fund. Data
129 47 U.S.C. § 254(b)(3). Emphasis added.

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from the 2004 annual report of the Universal Service Administrative Corporation
(“USAC”), which administers the federal universal service fund, corroborates this.130
High cost funds in 2004 were distributed as follows: $3,154 million to local
exchange carriers, $323 million to wireless carriers, and $10 million to competitive
access providers.131
The potential growth in the size of the federal universal service fund from
customers being able to subscribe for services from multiple carriers, with more than
one of those carriers becoming eligible for FUSF payments, might be exacerbated if
the scope of universal service were expanded to include advanced services or the
connection (access) to a broadband network. One possible way to limit the increase
in subsidy requirements would be to expand the definition of universal service to
include the connection to a broadband network, but, at the same time, to require each
customer in a high cost area eligible for universal service support to choose a single
broadband provider as its “principal” provider and only that chosen provider would
be eligible for the subsidy.132 This approach would have the advantage of
constraining the size of the universal service fund. But it also likely would reduce
the total flow of subsidy dollars to rural areas and might distort the market by
encouraging consumers to choose broadband service even if they do not seek it.
Having invested in a broadband network, each network provider will seek to
maximize its return from that investment, most likely by enticing its customers to
choose bundled packages of “value added” services for which it can charge prices
that reflect that value. Network providers are likely to avoid the alternative pricing
strategy of setting separate charges for the network connection (access) and for
individual services for several reasons: (1) most consumers prefer a single bill; (2)
there is risk that network access could become a low-markup commodity if
competing networks eventually are deployed and the revenues generated by value-
added applications then might flow to independent services providers; and, (3) it
might not be easy to set up a discriminatory pricing scheme for access that would
allow them to maximize their profits. This raises an interesting issue. Today,
universal service is defined in terms of providing basic local telephone service and
typically only providers that offer, as one option, basic voice service (a connection
plus limited local service) are eligible for FUSF funds. If the universal service
definition were changed to cover access to broadband, would it be appropriate to
make universal service funds available only to those carriers that offer their
130 Universal Service Administrative Corporation 2004 Annual Report at p. 27.
131 According to a chart in the USAC 2004 Annual Report (at p. 2), total high cost funding
increased from approximately $1.6 billion in 1998 to just under $3.5 billion in 2004. Total
funding to wireless carriers and other new competitors in 2005 was only $333 million. The
bulk of the increase in the fund is attributable to two proceedings at the FCC that removed
implicit universal service funds from two categories of rural local exchange carriers — very
small carriers subject to rate-of-return regulation and somewhat larger carriers subject to
price cap regulation — and replaced those implicit subsidies with new or expanded explicit
universal service funding mechanisms.
132 This approach, requiring the end user to identify a single “principal” carrier eligible to
receive FUSF, could be followed even if the definition of universal service were not
expanded to include broadband services or broadband access.

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customers, as one option, a basic service package consisting only of the broadband
connection (or of the connection plus basic local voice service)? If that were a
requirement for receiving FUSF support, however, network providers would not be
able to tie broadband access to the purchase of value-added services and thus might
not be able to compel customers to select those service packages that maximize the
providers’ profits.
Currently, the Federal Universal Service Fund subsidy is made directly to those
carriers that qualify as ETCs. The specific payments made to individual carriers are
subject to a number of very arcane accounting rules, some of which limit funding to
wireline providers because only those providers are eligible for certain pools of
money.133 The various mechanisms use different costing methodologies, but where
the subsidy is available to the incumbent wireline telephone company and new
entrants, the payments to all are based on the costs of the wireline company. The
latter have complained that some of the new entrants, in particular the wireless
carriers, have lower costs and therefore should receive lower subsidies; otherwise,
they claim, the wireless carriers will enjoy a windfall. The lower cost carriers have
countered that, for competitive neutrality, each provider should be given the same
level subsidy and then allowed to compete on an equal footing in the market. A low
cost provider might be able to set lower rates since it needs less subsidy to meet the
higher cost provider’s rates, and over time the subsidy could be reduced or eliminated
if lower cost rural providers could offer affordable service with little or no need for
a subsidy. Economists argue that to base universal service payments on providers’
costs — so that high cost providers receive higher subsidy payments — is to
subsidize the inefficient at the expense of whoever is paying the subsidy.
The incumbent local exchange carriers have made another argument for why
they should enjoy superior, or even exclusive, access to the universal service subsidy:
they have made a commitment to be the carrier of last resort and serve every
customer in their serving area. But those states that have awarded ETC status to
other carriers have tended to require such a commitment from those carriers as well
(though there may remain issues of the geographic reach of each ETC’s services).
Who Should Contribute to a Universal Service Subsidy Fund
and How Should Contributors be Assessed?
There are several sources of universal service funding. At the federal level,
there is currently a 10.2% assessment on interstate and international
telecommunications service revenues.134 This assessment provides the bulk of
133 There currently are a number of components of the high cost fund, each with specific
eligibility requirements. A competitive ETC is only eligible to receive a particular
component if the ILEC in its service area is eligible to receive support for that component.
The components are: high cost loop support, safety net additive support, safety valve
support, local switching support, interstate access support, high cost model support, and
interstate common line support.
134 See “Proposed Third Quarter 2005 Universal Service Contribution Factor,” CC Docket
No. 96-45, Federal Communications Commission Public Notice DA 05-1664, released June
(continued...)

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universal service funds. In addition, at the federal level, some interstate access
charges and other service charges, particularly those of some rural carriers, may still
be set above cost in a fashion to contribute to universal service. At the state level,
some states have created state universal service funds financed by assessments on
certain intrastate and interstate telecommunications revenues. Also, most states
maintain some intrastate rates, in particular the intrastate access charges imposed by
rural carriers, above cost to contribute to universal service.
There is consensus in the industry that continued reliance on interstate and
international telecommunications revenues as the funding base would threaten the
predictability, sufficiency, competitive neutrality — and very stability — of the
Federal Universal Service Fund, for a variety of reasons.
! Interstate and international telecommunications service revenues are
falling in a steady pattern. They reached a peak of more than $76
billion in 2000, fell to less than $54 billion in 2003, and continue to
decline.135 This fall in revenues is attributable to a number of
factors: the continued fall in rates for interstate and international
calls, which no longer generate additional minutes of use (indeed
total minutes of use are falling); the growth in mobile wireless
telephone usage; the rise in substitutes for long distance service,
such as e-mail and other Internet applications; and, most recently,
the classification of DSL service and certain VoIP services as
information services, rather than telecommunications services.
! It has become increasingly difficult to identify (and audit) individual
companies’ interstate and international telecommunications service
revenues because these services are being offered to both business
and residential customers as part of bundled packages that include
other services. Both customers and service providers have the
incentive to understate the proportion of total revenues generated by
these bundled services that are attributable to interstate and
international telecommunications services.
! The convergence of formerly distinct markets and the introduction
of new technologies has resulted in some interstate and international
telecommunications services, which are subject to the 10.2%
134 (...continued)
14, 2005, at p. 2. The assessment rate is modified quarterly, to take into account changes
both in the size of the revenue base and in the quantity of subsidy dollars needed. Some
international revenues are excepted from the assessment and some interstate
telecommunications revenues that are recovered as part of a bundled offering of interstate
telecommunications services and other services, for example those from wireless carriers,
are assumed to be a specific percentage of the total revenues, and only that percentage is
assessed the 10.2%.
135 See Trends in Telephone Service, Federal Communications Commission, Wireline
Competition Bureau, Industry Analysis and Technology Division, Tables Compiled as of
April 2005, at Table 9.2, at p. 9-7, available at [http://www.fcc.gov/wcb/trends.html].

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assessment, having to compete directly with VoIP and other services
that are not subject to the assessment. Thus, the current assessment
mechanism is not competitively neutral. Moreover, indirect
substitutes, such as e-mail, are not subject to the assessment.
! As a result of the significant market changes and substantial revenue
shifts, the assessment percentage has not been predictable, further
complicating business decisions by adding a regulatory uncertainty
to the mix.
There are a number of alternatives to an assessment on interstate
telecommunications revenues to provide the funding needed for universal service that
might better meet the policy objectives articulated by Congress. Some of these could
not be implemented without congressional action. These include:
! an assessment on all telecommunications service revenues:
interstate, international, and intrastate. Since telecommunications
services increasingly are being offered as bundled packages of
interstate and intrastate minutes, at a fixed price, expanding the
assessment base in this fashion would have the advantages of both
increasing the total subsidy base and eliminating the problem of
determining the proportion of a fixed monthly charge that should be
attributed to interstate service. Assessing all telecommunications
service revenues would not eliminate the problem of competitive
non-neutrality, however, as those VoIP services that are classified as
information services, but compete directly with traditional voice
services that are classified as telecommunications services, would be
given an artificial competitive advantage. Because of a court
decision prohibiting the FCC from assessing intrastate revenues,136
Congress would have to modify the Communications Act before the
FCC could include intrastate revenues in the assessment base.
! as assessment on all telecommunications service and information
service revenues. This would increase the assessment base and
eliminate the disparate treatment of telecommunications services and
information services that compete directly with one another. But it
would impose an assessment on information services, which would
be inconsistent with congressional and FCC policy to foster the
development of these services by minimizing regulatory burdens on
them. It also might prove very difficult to determine which
information services should be subject to the assessment since
information services cover such a wide range of applications. This
option also would require modification of the Communications Act
before the FCC could include all these revenues in the assessment
base.
136 In Texas Office of Public Utility Counsel v. FCC, 183 F.3d 393 (5th Cir. 1999), the U.S.
Court of Appeals for the Fifth Circuit overturned the FCC order assessing intrastate as well
as interstate revenues to fund the schools and libraries portion of the FUSF.

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! an assessment on the revenues of all services and equipment that
benefit from the subsidies provided by the Federal Universal Service
Fund, such as revenues from the services and products that receive
discounts under the schools and libraries fund, as well as on
services. This option would assess not only telecommunications and
information service providers, but also companies that manufacture
goods or provide other services that are subsidized by the Fund.
This would increase the assessment base, but it would be
inconsistent with congressional and FCC policy to foster the
development of information services and it likely would be
extremely difficult to identify the portion of revenues of non-
telecommunications service companies that would be subject to the
assessment. This option, too would require modification of the act
before the FCC could include all these equipment and service
revenues in the assessment base.
! an assessment on all connections to the public switched network,
weighted by the bandwidth of those connections. Ultimately, all
telecommunications users must connect to the public switched
network to complete communications. Thus, a per connection
assessment, based on bandwidth, would significantly widen the
assessment base and could be structured in a way that is
competitively neutral.137 There would be issues about how to assign
different assessment weights to connections of various capacity
(bandwidth). Consumer groups have opposed this approach, arguing
that it harms end users who have very low network usage, including
low income households. Proponents have responded that since
universal service is intended to subsidize connection to the public
switched network, a per connection charge is appropriate. They also
argue that many low income households are actually large
telecommunications users; many of them make calls to family
members in the military or (for immigrants) living overseas or calls
from retirees living in the Sun Belt to family members living in more
northern climes. There are differences of opinion about whether the
Communications Act would have to be modified before the FCC
could use connections as the assessment base.
! an assessment on all telephone numbers in use. Just as every end
user needs a connection to the public switched network, every end
user needs a telephone number identifier. A per telephone number
connection would significantly widen the assessment base and could
137 For example, a medium or large business customer may receive service either by
installing its own switch (called a PBX), which requires a smaller number of lines into the
premise because traffic is aggregated into a smaller number of large pipes at the PBX, or by
using a portion of the local telephone company’s end office switch (known as Centrex
service), which requires a larger number of lines because the traffic is not aggregated at the
customer premise. An appropriate weighting ratio would have to be set for Centrex vs. PBX
service, but such weighting has been performed many times in FCC rules.

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be structured in a way that is competitively neutral.138 Consumer
groups have had the same criticisms of a per number assessment as
they had for a per connection assessment, and proponents have made
the same responses. There is also some possibility that future
technological changes will lead to use of a customer identifier other
than the telephone number. There are differences of opinion about
whether the Communications Act would have to be modified before
the FCC could use telephone numbers as the assessment base.
! dedicating the existing 3% federal excise tax on all telephony
revenues to funding the FUSF. Depending on the potential growth
of the FUSF, the federal excise tax might raise sufficient revenue to
meet all or most universal service subsidy needs. It is easy to
collect, imposing virtually no administrative costs. But the federal
excise tax, which was originally enacted during the Spanish-
American War on what was then a luxury item, currently funnels
revenue into the general tax fund and many parties argue either that
these revenues are needed to address the federal deficit or that this
tax is ripe for elimination. It also might prove difficult to increase
the tax rate if revenues did not prove great enough to meet FUSF
needs. This option would require Congress to pass tax legislation
before it could be implemented.
! using funds from general tax revenues. Since universal service is a
subsidy program that is intended to benefit all sectors of the U.S.
economy and all segments of the population, some have argued that
it should be funded from general tax revenues. This would eliminate
the market distortions inevitable when an assessment is imposed
only on a subset of competitors or consumers and thus economists
have argued this is the most efficient option. But this would make
universal service funding subject to annual appropriations, which
particularly in times of budget deficits might place such funding at
risk. This option requires annual or multi-year appropriations action
by Congress to be implemented.
! continue to fund universal service in part by allowing rural carriers
to set above-cost intercarrier compensation rates as a way to
maintain lower local rates. Some rural carriers are very concerned
about relying entirely on external sources of universal service
funding, especially at a time when competitors, such as wireless
carriers, are seeking certification as ETCs to compete for those
funds. These rural LECs would prefer to be able to ensure an
internal funding source by maintaining above-cost rates for
138 Just as in the case for connections, the number of telephone numbers required by a
medium or large business customer will depend on the internal telecommunications
architecture chosen by that customer, with certain configurations requiring more, and certain
fewer, telephone numbers. This might require construction of weights for business customer
telephone numbers.

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originating or terminating certain traffic where the other carrier
involved with the call is a captive customer. This, however, would
maintain the market distortions that exist today that hamper
competition. This option would not require prior congressional
action, but it might be challenged in court by parties that seek to
remove all implicit universal subsidies from the rates of
telecommunications services.
Transition Issues
As explained earlier, in order not to disrupt markets, when the FCC adopted an
order on August 5, 2005, changing the classification of DSL from a
telecommunications service to an information service, it created a 270 day transition
period (which could be extended) during which the DSL revenues would continue
to be treated as interstate telecommunications service revenues for the purposes of
funding universal service. In addition, because a blanket re-classification of DSL to
information service would, under current rules relating to National Exchange Carrier
Association (“NECA”) tariffs and pools that help fund universal service, reduce the
universal service support available to certain rural telephone companies for the
provision of DSL services, those carriers were given the option of continuing to treat
DSL as a common carrier (telecommunications) service. Whichever universal
service reforms are adopted, given the heavy reliance of rural telephone companies
and their customers on universal service funding, there will have to be a transition
period to minimize disruptions.
Other Programs and Policies that Contribute to the Universal
Availability of Broadband Networks
According to the latest FCC data139 on the deployment of high-speed Internet
connections,140 as of December 31, 2004, high-speed Internet subscribers were
reported to be present in 99% of the most densely populated zip codes and in 74%
of zip codes with the lowest population densities.141 The FCC found that 99% of the
U.S. population lives in the 95% of zip codes where a provider reports having at least
one high-speed service subscriber.
Section 706 of the 1996 Act requires the FCC to determine whether “advanced
telecommunications capability [i.e., broadband or high-speed access] is being
deployed to all Americans in a reasonable and timely fashion.” If this is not the case,
139 High-Speed Services for Internet Access: Status as of December 31, 2004, Industry
Analysis and Technology Division, Wireless Competition Bureau, Federal Communications
Commission, released July 7, 2005, available at [http://www.fcc.gov/Bureaus/
Common_Carrier/Reports/FCC-State_Link/IAD/hspd0707.pdf], viewed on July 15, 3005.
140 The FCC defines a high-speed line as a connection to an end-user customer that is faster
than 200 kilobits per second (“kbps”) in at least one direction.
141 The FCC identified the most densely populated zip codes as the top decile, with more
than 3,147 persons per square mile, and the least densely populated zip codes as the bottom
decile, with fewer than 6 persons per square mile.

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the act directs the FCC to “take immediate action to accelerate deployment of such
capability by removing barriers to infrastructure investment and by promoting
competition in the telecommunications market.”142 In its most recent report pursuant
to Section 706, the Commission concludes that “the overall goal of section 706 is
being met, and the advanced telecommunications capability is indeed being deployed
on a reasonable and timely basis to all Americans.”143 Two commissioners, however,
dissented from that conclusion, claiming that the FCC’s continuing definition of
broadband as 200 kilobits per second is outdated and is not comparable to the much
higher speeds available to consumers in other countries, and that the use of zip code
data does not sufficiently characterize the availability of broadband across geographic
areas.144
Many rural telephone companies already are deploying broadband networks, and
some of those are deploying networks capable of offering IP video. According to an
article in Rural Telecommunications,145 by the end of 2003, 100 independent
telephone companies were offering digital video content services, another 60 were
expected to do so by the end of 2004, and it was projected that between 500 and 800
additional independent telephone companies would be doing so in the next four to
five years. According to a report in Broadcasting & Cable,146 two small, rural
telephone companies — Farmers Telephone Cooperative in Kingstree, SC, and
Progressive Rural Telephone in central Georgia — are upgrading their copper
networks with IPTV technology to offer video service as well as voice and data
services, and will be offering service before SBC and Verizon do. Farmers will send
three video streams to member households so each can have up to three television
sets receiving IPTV signals. It will send standard-definition video signals over DSL
lines and high-definition television content over ADSL lines.147 Progressive will
deliver IPTV and music content across its access lines. Its service will include 141
television networks, six local channels, and 35 music channels. Similarly, Rural
Telecommunications reports that Dakota Central Telecommunications (“DCT”) of
Carrington, ND, is using IPTV to offer voice, data, and video services both to the
5,000 customers in its own service area and to 16,000 customers in the neighboring
city of Jamestown.148 A Yankee Group analyst reportedly has stated that, while
142 P.L. 104-104, § 706. See 47 U.S.C. § 157 note.
143 Availability of Advanced Telecommunications Capability in the United States, Fourth
Report to Congress, Federal Communications Commission, GN Docket No. 04-54, FCC 04-
208, September 9, 2004, at p. 8. Available at [http://hraunfoss.fcc.gov/edocs_public/
attachmatch/FCC-04-208A1.pdf], viewed on August 3, 2005.
144 Id., pp. 5, 7.
145 Rachel Brown, “Now Playing: Television Over the Telephone Lines,” Rural
Telecommunications, July-August 2004, at pp. 14-20.
146 Ken Kerschbaumer, “Telco TV: Smaller is Quicker,” Broadcasting & Cable, Volume
135, Issue 24, June 13, 2005, at p. 28.
147 Asymmetric digital subscriber line is a DSL technology that is expected to be especially
effective for the provision of video on demand and similar services.
148 See John Griffin, “Bundling for Success: A Pitch for the Triple Play,” Rural
(continued...)

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smaller, rural telephone companies have a disadvantage in terms of available capital
and the ability to get the best rates for cable networks, they are likely to be competing
with a local cable system that, even if it is owned by a large cable operator, is not
technologically cutting-edge.149 This suggests that the scope of the current universal
service subsidy program, in conjunction with various grant and loan programs
targeted on rural development, may be sufficient to support deployment of broadband
network platforms capable of offering triple play voice, data, and video bundles in
many rural areas.
At the same time, some industry observers have claimed that broadband
deployment is occurring more rapidly in those rural areas served by small telephone
companies and cooperatives than in those rural areas served by the RBOCs and other
large incumbent telephone companies. For example, in their announcements
concerning deployment of broadband networks capable of offering video as well as
voice and data services and in their testimonies before Congress, neither Verizon nor
SBC was willing to commit to deployment in their more rural service areas.150
Grant and Loan Programs.

In addition to the Federal Universal Service Fund, there are a number of federal
programs intended to foster deployment of broadband networks and services.151
! The Farm Security and Rural Investment Act of 2002 (P.L. 107-171)
authorized the Rural Broadband Access Loan and Loan Guarantee
Program for eligible entities for facilities and equipment providing
broadband service in rural communities. Section 613 makes
available, from the funds of the Commodity Credit Corporation, a
total of $100 million through FY2007 ($20 million for each of fiscal
years 2002 through 2005, and $10 million for each of fiscal years
2006 and 2007). P.L. 107-171 also authorizes any other funds
appropriated for the broadband loan program. The FY2005
Consolidated Appropriations Act (P.L. 108-447) provided $11.75
million for the cost of broadband loans, representing $550 million
in lending authority.
148 (...continued)
Telecommunications, March-April 2005, at pp. 14-19.
149 Ken Kerschbaumer, “Telco TV: Smaller is Quicker,” Broadcasting & Cable, Volume
135, Issue 24, June 13, 2005, at p. 28.
150 See, for example, the testimonies and responses to questions of Lea Ann Champion,
Senior Executive Vice President, IP Operations and Services, SBC Services, Inc., and of
Robert E. In galls Jr., President, Retail Markets Group, Verizon Communications, on “How
Internet Protocol-Enabled Services are Changing the Face of Communications: A Look at
Video and Data Services,” before the House Committee on Energy and Commerce,
Subcommittee on Telecommunications and the Internet, April 20, 2005.
151 For a detailed discussion of these programs, see CRS Report RL30719, Broadband
Internet Access and the Digital Divide: Federal Assistance Programs.

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! Complementing the broadband loan program, the Rural Utilities
Service has established a broadband pilot grant program that issues
grants to applicants proposing to provide broadband service on a
“community-oriented connectivity” basis to rural communities of
under 20,000 inhabitants. The program targets rural, economically-
challenged communities by providing support for broadband service
to schools, libraries, education centers, health care providers, law
enforcement agencies, public safety organizations, residents, and
businesses. The FY2005 Consolidated Appropriations Act (P.L.
108-447) provided $9 million for broadband grants.
! The Telecommunications Development Fund, created in Section 714
of the 1996 Act, is a private, non-governmental venture capital
corporation whose purpose is threefold: to promote access to capital
for small businesses in order to enhance competition in the
telecommunications industry; to stimulate new technology
development and promote employment and training; and to support
universal service and enhance the delivery of telecommunications
services to rural and underserved areas. It is authorized to provide
financing to eligible small businesses in the telecommunications
industry through loans and investment capital. At this time the TDF
is focusing on providing financing in the form of equity investments
ranging from $375,000 to $1 million per investment. Initial funding
for this program is derived from interest earned from the up-front
payments bidders submit to participate in FCC auctions. As of
December 1, 2004, the TDF had $50 million under management.152
In addition to these programs, RUS, NTIA, the Economic Development
Administration in the Department of Commerce, several offices in the Department
of Education, several organizations in the Department of Health and Human
Services, several offices in the Department of Homeland Security, the National
Foundation on the Arts and Humanities, the Appalachian Regional Commission, and
the Denali Commission all have programs that could help fund the deployment of
broadband network infrastructure or of broadband customer premises equipment.
These programs are being used by rural telephone companies to construct
broadband networks. For example, Dakota Central Communications (“DCT”), a
telephone cooperative serving 5,000 customers has used the RUS broadband program
to fund its deployment of IPTV architecture to offer triple play service both to its
own customers and to 16,000 households in a nearby town. As reported in Rural
Telecommunications,153
When money became available through the Rural Utilities Service (RUS)
broadband program, moving into triple-play services with residential customers
152 For additional information on this program, see the TDF website at [http://www.td
fund.com].
153 John Griffin, “Bundling for Success: A Pitch for the Triple Play,” Rural
Telecommunications, March-April 2005, at p. 16.

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seemed like a natural next step. “We applied for and received a loan from RUS
totaling $15.5 million, then supplied an additional $3.5 million of our own, [DCT
general manager Keith] Larson said.
Municipal Provision of Broadband Networks.
A growing number of municipalities, in both rural and urban areas, have
announced plans to undertake deployment, or already have begun deployment, of
broadband networks in their jurisdictions. Some have taken this step to provide
broadband access in locations that the private sector has not shown an inclination to
serve, typically small towns or low income neighborhoods in larger cities. Others
have chosen to follow the model of Starbucks and other retailers by providing Wi-Fi
hot spots as a “loss-leader” to attract upscale customers to retail districts. These
municipal networks have used a variety of technologies, ranging from optical fiber
to Wi-Fi. But at least 15 states have adopted laws banning or limiting these
municipal networks.154
Proponents of municipal broadband networks argue that the marketplace, on its
own, will steer broadband network to those locations that will be most profitable to
serve, leaving less financially attractive locations unserved and placing those
locations at a disadvantage in terms of attracting and supporting businesses and
providing first quality education and health care. They claim government
intervention is justified in support of economic development.155
Critics of municipal broadband networks argue that it is too soon to conclude
that the marketplace will not serve all locations, that municipal networks enjoy an
artificial advantage over private networks because of cost of capital and rights-of-way
advantages, that many of the proposed broadband networks are based on unrealistic
financial assumptions that will leave local taxpayers paying for mistakes, and that
municipal networks are less likely than private networks to be upgraded as
technological advances make improvements possible.156 Some critics are concerned
that with the development of WiMax technology, municipalities with small Wi-Fi
networks will upgrade and expand to WiMax, which is potentially capable of
providing the “last mile” connection to residents in competition with private
154 “Principles for an Open Broadband Future: A Public Knowledge White Paper,” Public
Knowledge, July 6, 2005, at p. 5, available at [http://www.publicknowledge.org/pdf/open-
broadband-future.pdf], viewed on July 21, 2005.
155 For example, on October 24, 2003, the High Tech Broadband Coalition and Fiber-to-the-
Home Council filed an amicus brief with the Supreme Court in the case of Jeremiah W.
Nixon, Attorney General of Missouri, et.al., v. Missouri Municipal League, et. al.,
supporting the continued deployment of municipal broadband communications networks.
In their brief, the two organizations argued that municipalities are an important link in
enhancing broadband penetration, especially in rural and less densely populated areas that
are not an investment priority for private sector service providers.
156 See, for example, Thomas M. Lenard, “Wireless Philadelphia: A Leap Into the
Unknown,” The Progress & Freedom Foundation, Release 12.3, April 2005, available at
[http://www.pff.org/issues-pubs/pops/pop12.3lenardwifi.pdf], viewed on July 26, 2005.

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networks. The RBOCs and cable companies have been supporting efforts at the state
and federal level to prohibit municipal broadband networks.
In an interview with the Wall Street Journal,157 FCC chairman Kevin Martin
stated:
I grew up in what was then a rural area in North Carolina and my parents lived
on a gravel road. I think it’s critical that we make sure that people who live in
rural areas are able to be connected to all the advances in technology that are
available. If you’re asking about the role that local and city governments can
play trying to deploy their own equipment, I think there is, at times, a role for
them in that. There’s always a balance. You prefer private sector deployment
whenever possible and you want to make sure we don’t get in a situation where
the private sector players are trying to compete with government-sponsored
players who have easier access to rights-of-way and government-backing. On the
other hand, there are instances and communities where there aren’t any private
companies that want to deploy. No one is coming to deploy and I think in those
instances people need to be able to make sure they can provide a service to their
citizens. You have to have the right balance.
Corollary Issues
Voice over Internet Protocol (VoIP)
Today, the vast majority of Americans still obtain voice services over traditional
circuit-switched networks that are subject to the common carrier regulations in Title
II of the Communications Act. These regulations include specific network
interconnection, access, intercarrier compensation, public safety, and law
enforcement requirements, as well as assessments on all interstate and international
telecommunications services to fund universal service. At the same time, a small,
but growing number of customers obtain voice services from VoIP service providers.
The FCC has ruled that a particular type of VoIP service — provided only to
customers that already separately receive broadband Internet access service, so that
their VoIP provider does not, itself, offer transmission service or transmission
capacity, and requiring the customer to have enhanced premise equipment or
downloaded software — (1) is neither a “telecommunications service” nor
“telecommunications,” but rather is an “information service” that should be
unregulated; and (2) cannot be characterized as purely intrastate and therefore is
subject only to federal jurisdiction.158 As a result, that service is not subject to the
interconnection, access, intercarrier compensation, public safety, law enforcement,
and universal service requirements in Title II. But the FCC has ruled that voice
services that are provided partly through IP technology, but that use ordinary
157 Amy Schwarz, “Questions for Kevin J. Martin,” Wall Street Journal Online, July 18,
2005.
158 In the Matter of Petition for Declaratory Ruling that pulver.com’s Free World Dialup is
Neither Telecommunications Nor a Telecommunications Service, WC Docket No. 03-45,
Memorandum Opinion and Order, adopted on February 12, 2004 and released February 19,
2004, at paragraph 5.

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customer premises equipment without enhanced functionality, originate and
terminate on the public switched telephone network, undergo no net protocol
conversion, and provide no enhanced functionality to end users due to the provider’s
use of IP technology, are telecommunications services and subject to Title II
regulation.159
As a result, today competing voice services are subject to different regulatory
regimes depending on whether they are classified by the FCC as telecommunications
services or information services. The Commission is attempting to address one
aspect of this issue — how to determine the classification of IP-enabled services —
through a rule making proceeding.160 But it is constrained by current statute in its
ability to provide regulatory parity to competing voice services when one subset of
those services clearly meets the current statutory definition of telecommunications
service, a second subset clearly meets the current statutory definition of information
service, and a third subset is ambiguous as to its classification. While the FCC can
choose to forbear from regulating those competitive interstate services that are
classified as telecommunications services, it may not have the authority to require
state jurisdictions to forbear on regulation of intrastate telecommunications services.
This suggests that it may be timely to review the Title II telecommunications
requirements. That review might address which requirements may be applicable to
all voice services, regardless of the technology and network architecture used to
provide those services, which may only be relevant for dominant firms, and which
may not be relevant at all with the advent of competition.
Access to 911 and E911
Competition in the provision of applications (services) is developing today
between integrated network providers that have ubiquitous networks and independent
applications providers that have more limited networks and capabilities. In some
situations, it would be inefficient, if not impossible, for a new entrant to replicate the
facilities of a network provider. For example, for public safety reasons, the FCC has
determined that all interconnected VoIP providers must be able to provide their
customers access to 911 and E911 service, and that for this to happen there is need
for cooperation between VoIP providers and ILECs. The FCC thus has required all
interconnected VoIP providers to:
! deliver all 911 calls to the customer’s local emergency operator (as
a standard, not optional, feature);
! provide emergency operators with the call back number and location
information of their customers (i.e., E911) where the emergency
operator is capable of receiving it. Although the customer must
159 In the Matter of Petition for Declaratory Ruling that AT&T’s Phone-to-Phone IP
Telephony Services are Exempt from Access Charges, WC Docket No. 02-361, Order, 19
FCC Rcd 7457 (2004), at paragraph 1.
160 In the Matter of IP-Enabled Services, WC Docket No. 04-36, Notice of Proposed
Rulemaking, FCC 04 28 (March 10, 2004).

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provide the location information, the VoIP provider must provide the
customer a means of updating this information, whether he or she is
at home or away from home; and
! inform their customers, both new and existing, of the E911
capabilities and limitations of their service.161
At the same time, the FCC has required ILECs to provide access to their E911
networks to any requesting telecommunications carrier. They must continue to
provide access to trunks, selective routes, and E911 databases to competing carriers.
Although some proponents of minimal government intervention have argued
that customers should be allowed to choose low-cost options that do not include
public safety features such as access to 911 and E911 service, the FCC had
determined that in this case government intervention was justified by the public
safety concern. At the same time, without rules in place to ensure all voice providers
access to the E911 network, new entrants could be denied entry into the market.
Some observers have argued that the VoIP providers currently are enjoying a “free
ride” and an artificial marketplace advantage because their services are not subject
to state taxes imposed on telecommunications services to support the E911 call
centers (sometimes referred to as public safety answering points or “PSAPs”) run by
municipalities or states. These PSAPs are the physical locations where emergency
calls are received and then routed to the proper emergency services.
Law Enforcement (CALEA)
In 1994, Congress enacted the Communications Assistance for Law
Enforcement Act (“CALEA”),162 to preserve the ability of law enforcement officials
to conduct electronic surveillance effectively and efficiently despite the deployment
of new digital and wireless technologies that have altered the character of such
surveillance.163 CALEA requires telecommunications carriers to modify their
equipment, facilities, and services, wherever achievable, to ensure that they are able
to comply with authorized electronic surveillance actions. In implementing CALEA,
the FCC adopted an order on August 5, 2005 concluding that CALEA applies to
facilities-based providers of any type of broadband Internet access service —
including wireline, cable modem, satellite, wireless, and power line — and to VoIP
providers that offer services permitting users to receive calls from, and place calls to,
the public switched public network (these providers are sometimes referred to as
“interconnected VoIP providers”) because these providers offer services that are a
161 In the Matter of E911 Requirements for IP-Enabled Service Providers, WC Docket No.
05-196, First Report and Order and Notice of Proposed Rulemaking, FCC 05-116, released
June 3, 2005.
162 P.L. 103-414, 47 U.S.C. 1001-1010.
163 For a detailed discussion of CALEA, see CRS Report RL30677, Digital Surveillance:
The Communications Assistance for Law Enforcement Act.

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replacement for a substantial portion of the local telephone exchange service.”164 The
FCC also adopted a Further Notice of Proposed Rulemaking that will seek more
information about whether certain classes or categories of facilities-based broadband
Internet access providers, notably small and rural providers and providers of
broadband networks for educational and research institutions, should be exempt from
CALEA.
The important law enforcement objectives of CALEA potentially can conflict
with the goals of competition and innovation. Some technologies and network
architectures may be able to accommodate the CALEA requirements more readily —
more quickly, less expensively, or with less impact on efficiency — than others.
Also, CALEA requirements might impose substantial up-front costs on new
technologies, architectures, or services that could be an impediment to their
successful entry into the market, thus slowing innovation. There may be some
tension in the future if network technologies and architectures migrate away from
centralized networks to peer-to-peer networks, which have potential benefits to
consumers both in terms of security and of allowing service providers and end users
to interact more directly, but which may not be very accommodating to law
enforcement concerns.
Media Policy: Localism, Competition, and Diversity of Voices
Localism,165 competition, and diversity of voices have long been the
fundamental goals of U. S. media policy. With the convergence of media,
telecommunications, and information service markets, these goals may now have to
be considered when developing telecommunications policy as well.
Subscription Multi-Channel Video Services.
As discussed earlier, Section 601 of Title VI of the Communication Act
explicitly identifies a local purpose for regulation of cable television: “[to] establish
franchise procedures and standards which ... assure that cable systems are responsive
to the needs and interests of the local community.” Key sections in Title VI related
to localism and diversity of voices allow franchise authorities to (1) require cable
systems to set aside channels for public, educational, or governmental (“PEG”) use
and to provide facilities and/or financial support for PEG access;166 (2) set aside
channels for commercial use by persons unaffiliated with the cable system;167 and (3)
place safety and convenience restrictions on the construction of cable systems over
164 “FCC Requires Certain Broadband and VoIP Providers to Accommodate Wiretaps,” FCC
News, August 5, 2005, In the Matter of Communications Assistance for Law Enforcement
Act and Broadband Access and Services, written order not yet released.
165 For a detailed discussion of statutes and rules affecting localism, see CRS Report
RL32641, “Localism”: Statutes and Rules Affecting Local Programming on Broadcast,
Cable, and Satellite Television.
166 Section 611, 47 U.S.C. § 531 and Section 621(a)(4)(B), 47 U.S.C. § 541(a)(4)(B).
167 Section 612, 47 U.S.C. § 532.

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public rights-of-way and easements.168 If new entrants begin to offer subscription
multi-channel video services in a fashion that does not meet the definition of cable
service — for example, as an IP application that might meet the definition of an
information service that is not subject to Title VI regulation — policy makers might
want to consider whether the new service offering should be subject to the
requirements in these provisions in order to foster the policy goal of localism, or
whether the localism concerns are being fully met by the incumbent.
In addition, as discussed earlier, policy makers might want to consider the
implications, from the perspective of diversity of voices, of a broadband network
provider that offers its own subscription multi-channel video service refusing to
allow its customers access to the IP video services provided by an independent
applications provider.
Multicasting and “Must Carry” Requirements.
As part of the transition to digital television, television broadcast licensees have
been given 6 MHz of spectrum on which to operate digitally and at some point in
time will have to return the spectrum on which they currently operate in analog
mode. With digital technology, one option available to licensees is to use their 6
MHz of spectrum for multicasting — that is, to broadcast multiple programming
streams. In support of the goal of localism, cable operators have been required to
carry the “primary” signals of the local broadcast stations in their service areas. The
FCC recently ruled that a television broadcaster that is multicasting video signals
must identify one signal as its primary signal that cable systems must carry, but that
cable systems have no obligation to carry additional multicast signals.169 This
decision was based in part on the concern that multicast “must carry” might infringe
on the first amendment rights of cable operators and in part on the concern that the
multicast signals might tend to be duplicative and might not meet the desires of
viewers as well as cable channels.

Some observers have suggested that limiting must carriage to a single, primary
signal might result in missing an opportunity to foster localism. For example, in
considering what public interest obligations might be consistent with allowing
broadcasters to air multiple signals, the FCC might consider modifying the current
rule that requires cable operators to carry only the primary programming stream of
each local television broadcaster by requiring cable operators to carry each
programming stream that offers distinct programming aimed at a different, previously
unserved geographic portion of the broadcaster’s serving area. This could explicitly
address those situations in which a broadcaster’s serving area crosses state borders,
awarding the broadcaster must carry rights for a second signal if the programming on
that signal specifically addresses the needs and interests of the viewing households
in the second state. If the FCC were to consider this approach, it would want to take
into account the impact on cable systems of requiring them to carry additional
168 Section 621(a)(2), 47 U.S.C. § 541(a)(2).
169 In the Matter of Carriage of Digital Television Broadcast Signals: Amendments to Part
76 of the Commission’s Rules, CS Docket No. 98-120, Second Report and Order and First
Order on Reconsideration, released February 23, 2005.

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broadcast channels.170 It also would want to determine how best to construct a rule
that did not artificially encourage or discourage broadcasters from choosing
multicasting over other potential applications of digital technology to their 6 MHz
of spectrum, such as high definition television. Congress might choose to direct the
FCC to study and construct recommendations for rules (and, if necessary, statutory
changes) to address the potentially related issues of mandatory carriage of multiple
broadcast signals and better serving the needs and interests of viewers in different
governmental jurisdictions.
170 For example, in his July 12, 2005 testimony (at pp. 3-4) on “The Digital TV Transition”
before the Senate Commerce, Science, and Transportation Committee, Kyle McSlarrow,
president and chief executive officer of the National Cable and Telecommunications
Association, claimed that cable systems only have finite capacity and mandatory carriage
of multicast broadcast signals would command channel capacity that could be better used
providing innovative new applications sought by consumers.

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