Good news, bad news

Anna-Maria Kovacs has long been one of the few Wall Street analysts to
really understand the FCC regulatory process and its implications for
the telecom industry. In today’s note ahead of the FCC meeting
expected to take up VOIP issues, she nails the crucial business
implications of the VOIP regulation debate:

  • If the application vendors can ride free and
    the telco and cable network providers are not allowed to block them, then the
    application vendors will have a huge cost advantage vis-à-vis the carriers they
    ride. The carriers will have both
    network and marketing costs, while the pure application vendors will only have
    marketing costs. In such an environment,
    the guestÂ’s end-user rates can be much lower than those of the host. The problem would be most extreme for the
    telcos, who have an existing revenue base at risk and who lack video revenues to
    help support at least a portion of their network. But even the cable-network
    providers would be at a disadvantage vis-a-vis the pure application

  • The good news would be lots more end-user
    choices and lower prices. The bad news
    would be the threat to the financial viability of the underlying carriers who
    make that competition possible.

What Anna-Maria has realized is that the VOIP debate is about two
visions for the future of the Internet. It’s the same point
captured in James Seng’s layers diagram,
and has been a recurring theme in my writings over the past few
years. Vision 1 presumes that applications will be tied to
connectivity platforms. Vision 2 innovation and economic activity
booming when those layers are de-linked. (In case you’re unclear,
I believe in Vision 2.)

Naive expressions of Vision 1, like yesterday’s Wall Street Journal editorial,
simply ignore the lessons of the Internet and telecom competition over
the past two decades. The best case that can be made for tying
applications to network infrastructure is the one Kovacs lays out: it’s
the only way to pay for the network. The critical question is the
one raised in her last sentence: whether the network is financial
viable based on connectivity revenues alone. (Anna-Maria is just
setting out the possibilities; I don’t know whether or not she believes
this viewpoint is accurate.)

I’m convinced that network operators can do quite well based on their
access revenues alone, without any need to suck value out of the
application and content layers. The hard part will be replacing
legacy infrastructure and shifting to a new cost structure. The
Bells spend tens of billions of dollars each year on capital
expenditures, and turning that oil tanker around won’t be easy.

Yesterday, in his New America Foundation speech, AT&T CEO Dave
Dorman described some of the pain AT&T has gone through over the
past five years in migrating from five separate networks to one massive
IP network. It’s a multi-billion dollar annual project, which is
still ongoing. But AT&T believes that pain is necessary to
position itself for the emerging all-IP, converged telecom world.
I think they are dead on.

The incumbent local phone companies haven’t yet made the same
commitment AT&T has. Instead, they are pushing a vision that
removes the pressure for change.
UPDATE: Right after I posted this, I read Ted Shelton’s analysis
of the economics of starting a VOIP telco.  He pegs the initial
capital costs at just $8,000.  This illustrates the discontinuity
I’m talking about.