Let Schumpeter Rule

Recently, most of the headlines for the CRTC relate to broadcast permits, whether it be CHOI or Al-Jazeera. But behind the scenes, the CRTC plays a fundamental role in the prices we pay and the choices we have for such mundane (and essential) services as telephone, Internet access and cable television. For the past decade, injecting competitive forces into wireline telephone service has been its primary quest.

But this focus diverted attention from other important developments in the telecom industry. During the speculative telecom bubble of the late 1990s, regulatory actions could have mitigated the boom-bust roller coaster so common with the advent of new technologies. More importantly, wireless and cable technologies have developed to a point that they, much more than rules regarding the opening of competition in traditional wireline telephone networks, will be the primary source of competitive pressures in the industry.

Canada’s telecom meltdown was not as spectacular as in the United States, but it was large enough to cause a broad economic slowdown. 360 Networks, AT&T Canada and Teleglobe went into bankruptcy, and Nortel and JDS Uniphase saw their stocks plummet, laid off thousands of workers and continue to run losses. The fundamental cause was overbuilding of infrastructure, based on faulty business models that were often little more than “build the bandwidth and they will come.” For instance, the large US telecom companies were each building networks on far too optimistic assumptions of Internet traffic and electronic commerce growth. Infrastructure redundancy in the context of faulty demand projections opened a yawning gap between supply and demand. It began to show in 2000, as thousands of dot-coms began running out of startup capital and as telecom companies discovered that when prices go down in the context of excess supply, income is far more difficult to generate.

The telecommunications revolution has all the hallmarks of a Schumpeterian wave of innovation. The Austrian economist observed over 60 years ago that major innovations underpin long-term prosperity as well as the evolution of society itself – though it is difficult to predict how. Thus, the commercialization period can be tumultuous. Backed by enthusiastic investors, new and existing firms adopt new technologies, often without knowing exactly how they will improve profitability. The combination of cheap capital, business optimism and market uncertainty is a recipe for overinvestment. It is useful to recall during the advent of electricity in the 1890s – another Schumpeterian wave – a similar speculative bubble inflated and popped, and it took decades for companies to fully harness the new technology and for consumers to reap the benefits.

Although the there is a boom-bust element inherent in all technological revolutions, the regulatory authorities could have mitigated to some extent the telecom collapse in north America by providing some guidelines to competitors in the market. In particular, following the well-known principle of infrastructure sharing in the telecom industry, they could have issued operating permits to encourage carriers to share network capacity. This would have curbed the wasteful investment in duplicative data transmission networks.

In the local loop, following the US example, the CRTC focused on rules to promote competition. This was to be accomplished by setting rates that new entrants must pay to access the networks of the former monopolists (including Bell, Telus and a handful of others). When an innovation wave is in full swing, rate-setting is perilous, because there is a gap between the actual cost structure of the former monopolists (who are saddled with networks based on older, more costly technologies) and the cost structure of state-of-the-art network technologies.

The CRTC essentially split the difference, setting access rates on the basis of state-of-the-art technology, but allowing the ex-monopolists to recoup a large portion of their historical costs. In doing so, the CRTC paved the way for permanent tensions in the telecom market. In particular, new entrants continue to maintain that access rates to incumbents’ networks are too high to be profitable.

With ex-monopolists still controlling 98 percent of the local wireline telephone market, despite years of regulatory efforts to encourage competition, it may simply be the case that the Canadian wireline market is too small to support several profitable competitors. That has certainly been the experience with long-distance service: in twelve years, few, if any, new competitors have been consistently profitable, despite considerable industry consolidation.

In Canada, the competitive forces in telecommunications are happening outside of traditional telephone service, and this is where the CRTC’s attention should be. With the advent of voice-over Internet Protocol, cable companies and other Internet access providers will soon be in a position to compete in telephone markets. Strong competition among wireless telephone providers already offers consumers choice, and further technological progress may eventually enable voice and data services that entirely bypass the wireline telephone infrastructure.

Rather than try to force competition where it may not naturally flourish, the CRTC should encourage the forces of innovation across the technological spectrum to shape the future of telecom markets. Such a Schumpeterian wave may well be able to accomplish what complex regulation of the local market could not.

Yves Rabeau, PhD, is Professor of Business Strategy in the Faculty of Management Science at the UQAM, Director at the MEI, and author of the study entitled “The Schumpeterian Wave in Telecommunications: Policy Implications” published by the Institute for Research on Public Policy.

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