Four Convergences and a Trade Funeral?
By Eli M. Noam
Columbia University, Columbia Institute for Tele-Information
Digital convergence, instead of creating bridges, may lead to trade wars; instead of leading to harmony and harmonization, it may create disruption and disagreement.
To reach this conclusion, let us look at the American experience. In the US, the Telecommunications Act of 1996 was supposed to accelerate convergence by allowing previously separated industries to compete with each other[1] The reality of inter-sector convergence however, has been modest. To see this, let us differentiate among four different types of convergence. The first is the convergence of delivery technologies. In this scenario, cable TV operators would enter telephony, and vice versa. Local telecommunication companies would invade long distance, and vice versa. And TV broadcasters would enter digital multimedia, with text and data. So far, however, these developments have asserted themselves only sluggishly. Cable’s entry into voice telephony has been slight, pursued mainly by the medium-sized firms Cox and Cablevision. The 1999 acquisitions of TCI and MediaOne by AT&T (the classic long distance phone company), which presumably anticipate the use of the cable infrastructure for broader telecommunications purposes, may energize this convergence, but it is too early to tell. Local telecommunications firms made little progress in video delivery. Even where a telecommunications firm, US West, temporarily owned a major cable TV distribution network, it did not integrate it with its telecom infrastructure. More recently, the [1] local telecom firms have pursued a broadband upgrade by way of digital subscriber loop (DSL), mostly for Internet purposes but also usable for video applications. These efforts only beginning. Nor have long-distance carriers created rival local infrastructure, except by the acquisition of existing firms. And no local Bell Company has been admitted to long-distance service, as of mid 1999. Lastly, the digitalization of terrestrial broadband TV, essential for multimedia convergence, only started in 1999, but its penetration is likely be miniscule for at least five years. The television sets are expensive, there are few programs aimed at presenting the new technology at its best, and there are presently no advertising revenue streams, only costs. To conclude, therefore, the convergence of delivery modes has been making only slow progress.
The second type of convergence is business convergence: mergers, joint ventures, alliances, etc. And here, too, the reality has been modest. Of course, there have been numerous and large media mergers, but few of them have been of the convergence type. There have been virtually no merger deals linking mass media companies written in the telecommunications sector, or vice versa. The main exception was the AT&T acquisition of cable TV firms. This is obviously a very big exception but, it was partly offset by AT&T’s exit from the computer field. The other exception is Microsoft’s investment in cable TV and in the firm Web TV. But these two types of Microsoft investments and their price make no obvious sense, except perhaps to show that Bill Gates now has more money than places to park it. Microsoft’s aim is to enter its operating software into the set-top boxes that control TV sets. Such an effort makes sense, but does not require ownership stakes. Among mass media firms, GE also has a presence in transmission equipment, but that goes back to David Sarnoff in the 1920s, not to convergence scenarios. The Japanese firm Sony is active in the U.S. in mass media content and equipment as well as computer hardware, but the synergies are uncertain.
The third convergence is that of regulation. Here, too, little convergence happened in the U.S. following the 1996 Act. The FCC created something called Open Video Platform[2], but this status was one option among three, and was not chosen by the carriers. The FCC also established a treatment for the broadband digital subscriber loop offered by telecommunications carriers that is distinctly different from that of cable companies[3], and refrained from imposing on the latter equal access requirements for Internet service provision that phone companies must follow.[4] The common policy principle behind the FCC’s approach is to protect and encourage the emergence of local telephone competition. And because such competition will take many years to emerge, the future may see a continuation of asymmetric, i.e., non-converged, regulation. Lack of flexibility and freedom in the regulatory tools hinder their ability to harmonize across all situations while pursuing multiple policy goals.
This brings us to the fourth convergence - the vertical convergence of the Internet and telecommunications. Here, convergence is moving at full speed. Increasingly, ISP backbones are run by telephone carriers. GTE now owns BBN Planet, MCI Worldcom bought UUNet, and Cable Wireless acquired MCINet. Sprint has had an Internet backbone for a long time. AT&T bought IBM Worldnet. The Bell companies are eager to enter national backbone and ISP service. And now, a whole new breed of carriers is emerging, a hybrid of long distance phone carrier and backbone provider such as Level-3, Qwest, Williams, Metromedia, etc. These carriers aim to provide mostly IP service. They are on the leading edge of transforming telecom networks from circuit-switched to packet-switched, i.e., engineered primarily for data rather than voice. And because of the enormous growth of demand for Internet transmission with reliability and latency, the capacity increases of the new carriers, as well as of their traditional competitors, have been astonishing. This convergence of Internet and telecommunications has major implications. It means moving in short order from scarcity to over-capacity in transmission.
The conventional wisdom up until today has been that of inadequate network capacity slowing down, in particular, the evolution of the Internet. This is still true to some extent, but not for much longer. The reasons are multifold. First, economics comes to the rescue. For historic reasons, the Internet emerged largely outside the market system. In the absence of price signals, supply and demand rarely coincided. However, with demand rising and short supply, market actors will invest to meet the capacity need.
Secondly, technology change comes to the rescue. The decade of the 90s was dominated by the revolution in processing power based on fundamental VLSI technology advances of the 80s. For a while, transmission could not keep up with processing because it was much more expensive to widen the channels than to add more powerful chips, and therefore bottlenecks emerged. But in the next decade, transmission will be the driver instead of the brake. Wave division multiplexing has now reached almost 100 windows; erbium doping amplification technology is increasing throughout multifold. Together, these lead to extraordinary capacities.
Thirdly, huge investments in transmission capacity are being made. The third generation carriers, mentioned above, plus the established first and second generation long-distance carriers are all busily expanding, and the Bell companies are expecting admission into long-distance. These carriers are using fiber whose capacity is doubling approximately annually. Experimentally, the Japanese firm NEC has reached 3.5 terabit per second per fiber strand. Suppose that in five years the off‑the‑shelf technology will be just half of that, 1.7 terabit per second. Suppose that a conduit holds 144 such strands, which is Level 3's plan. Suppose further that the companies who will offer such strands in American are three, traditional and three new‑type long-distance carriers, one Bell company, plus two satellite providers and one terrestrial wireless company. That would add up to a national U.S. network with 2.2 Petabits per second. Per household this amounts to a capacity of 20 Megabits per second, enough for over 10 compressed video channels, for every American household, each watching something entirely different, simultaneously. Even if one scales down this calculation by several orders of magnitude, there will be a tremendous capacity available. Of course, this is long distance backbone capacity, but the local capacity will grow with it, given the increasing demand for high-speed Internet connectivity that is fueling the national capacity.
And what will be the impact of this capacity? The most obvious is that prices will drop and basic transmission will become a commodity, both for domestic and international traffic. Marginal cost will be negligible, and prices will become low, capacity-based, and flat.
What will this capacity be used for, and by whom? Whenever a new media technology comes along, people talk about schools and hospitals and libraries. But if the experience with mass media means anything, then abundant cheap communications will be used to a considerable extent for entertainment-- regular films, games, sports, and adult programs. Many of these can be delivered in the traditional ways of broadcast and satellite, but the new transmission capabilities will permit interactivity which will, in turn, facilitate customization of watching, and even more interestingly, of advertising. Video servers at a distance become possible, and the transmission of video programs can be initiated by the sender. Cable TV will continue to play a role, in particular that of a last mile provider. Moreover, cable headends will consolidate and become large and distant, storing many programs at increasingly distant locations. This will happen because the need to have local headends is purely the result of the cost of transmission costs, plus franchise regulation. If transmission costs drop to near zero, headends will consolidate to national and international locations, much like satellites do today.
In that environment, who will gain? Hollywood. With distribution cheap, premium content becomes king, indeed. Hollywood firms will distribute their products from big video servers, which they or their wholesale allies will run. What this means is that this form of TV will be strongly American in content and ownership. It will bypass the traditional gatekeepers of national TV stations and networks, and of national regulation by licensing.
Low-cost global transmission also leads to a great rise in electronic transactions with great consequences on business. Of course, traditional ways of doing business will not disappear, just as the mom‑and‑pop store did not vanish when supermarkets emerged. But the energy and dynamism will be in electronic modes of commerce. And here, too, it will be US firms that will be most successful. They will be technologically at the leading edge, with risk capital at their disposal, with the advantage of early entrant, and a large home market. Once a firm establishes a successful model for the US market, and invests the fixed costs and once transmission price is near zero, there is no reason to stop at the border.
What this discussion shows, so far, is that US firms are likely to capitalize first and strongest on the fourth convergence, that of telecommunications and the Internet. It suggests that US strength in this area will, if anything, increase. This is not something people like to hear. More common is the rhetoric of the global brotherhood of the Internet. Despite all evidence to the contrary, most Internet advocates, good internationalists almost by definition, deny that the Internet is a deeply American medium in ownership, usage, style, technology. Sure, one can always point to some Europeans on some Internet boards, or to the fact that more Finns per capita are connected to the Internet than Americans. So what? Have you heard any good Finnish music lately over the Internet? Let’s not confuse demand with supply.
However, it is not due to a conspiracy that US firms will become even stronger world-wide, but it is a reflection of a confluence of strengths which exists in America: content; hardware; software; investment capital; high-tech universities; telemarketing firms; a vibrant cable industry; language; and the immigration of vast talent. There is the cultural power that comes with being a superpower, and a multiculturalism that helps to create content for the world. And there are transmission carriers that have been subject to greater competition and performance pressures than elsewhere, and for a longer time.
How does all of this add up? For a start, there will be a lot of losers in addition to the winners. Joseph Schumpeter called this the creative destruction of capitalism. It is characteristic of losers to be able to organize themselves effectively in the political sphere, because they tend to be established. It is always hard to fight modernism, and it helps if the winds of change can be identified with a foreign country. Therefore, as the changes in economic and social patterns caused by cheap information flows will strengthen the US role and weaken that of many other countries, there will be an inevitable backlash.
One can see these tendencies already: in the fights over privacy[5] where some countries require domestic certification agents, instead of a mutual recognition, in a protectionist vein. On the domain name issue, where international belly-aching led to a change in the system and portends other attempts to bring governance into some supra‑government system. On the continued discussions over “national culture” quotas and other forms of protectionism that exist in Europe and North America, and that will only expand their scope. One cannot expect continued world-wide liberalization of e‑commerce and cyber activities if one country gains disproportionately.
It is easy to criticize other countries’ restrictions on e‑commerce in the abstract. But imagine the response in the US if it were faced with a thriving entry by Albanian tele‑doctors, Thai child pornographers, Monaco tele‑gamblers, or Nigerian blue‑sky stock ventures. Each society has a variety of values and interests, for better or worse, which underlie its legal arrangements, and it is not going to drop them just because the new activities are done over computer networks. It is naive to think that the Internet will be a libertarian island in a society that runs on some rules.
Many people deny this likelihood by clutching at technological determinism; they argue that even if one wanted to, one simply couldn’t regulate the Internet. After all, even kids can run electronic circles around flat‑footed, heavy‑handed government regulators. This is wishful thinking. Of course one can regulate the Internet if one wants to. Maybe one can not reach the electronic transactions themselves. But communications are not just about bit streams and transactions, they involve nodes‑ people and institutions with domiciles and assets. If one cannot catch the mobile parts of this system, one go could after the least mobile, such as physical delivery, people, transmission facilities, or assets. This may not be an elegant approach, but neither are income taxes or traffic laws.
What is the conclusion?
The next decade will see the impact of the death of distance that is caused by the radical increase in transmission capacity and the radical drop in transmission prices. All this will have enormous impacts on just about any societal institution. In this transformation, a few countries, especially the US, are gaining disproportionately. Other countries try to accelerate their own transformation, but it will not be easy to catch up. The Developing World, for all the talk about its telecom reform, is actually falling further behind once one moves beyond dumb telephony. They could add to their own transmission capacity but that might only open the highways to Americans. Or they can wait for the US to choke on its change, to glut itself in information. This will happen and will be the long‑term corrective, but it will take a long time.
Instead, the easier route is to slow down the winners, and to do so collectively. And this will lead to future cyber trade-wars. Hence the opening observation, that digital convergence, instead of creating bridges, may create trade wars; that instead of creating harmony and harmonization, it may create disruption and disagreement. The question is, therefore, how can one prevent this curse of success? How can the whole world have more of a stake in change than in the status quo? How can one create a fifth type of convergence, the convergence of global electronic development, so that other countries will be net winners, too? Because only a global electronic convergence of development will prevent a future of cyber trade-wars.
[1] 47 USC §§ 151 et seq.
[2] 47 USC § 573.(1996)
[3] In the matters of Deployment wire line services offering advanced telecommunications capability, Docket No. 98-48, 1999 FCC Lexis 753, (Feb. 25, 1999).
4 AT&T Corp. v. City of Portland, CV 99-65-PA (D. Oregon June 3, 1999).
[5] Communication from the Commission to the Council, the European Parliament, the Economic and Social Committee and the Committee of the Regions on a European Initiative in the Electronic Commerce (COM (97)0157 C4-0297/97)