First Step Reforming FCC’s Universal Service Fund? An Honest Evaluation of the Goals and Trade offs.

The problem of reforming the Universal Service Fund (USF) without Congressional direction means working without clear guidance on what the FCC should, institutionally, hope to achieve. “Broadband!” Is the usual answer from reform proponents. “Basic broadband for everyone! And eliminate waste. And spur investment. And promote innovation. And create jobs. And education. And –“ Well, you get the idea.

Listening to the FCC Commissioners at the open meeting, and reading through the released materials, my sense is the FCC has decided that we ought to maximize the number of people who have access to a threshold level of broadband. That’s not necessarily a bad goal. At the same time, the general impact of the proposed reforms favor larger carriers providing minimal service over smaller, local providers that may provide significantly better service.  That may still end up being the best way to maximize “bang for the buck” and may ultimately benefit the largest number of Americans. But if we are going to make that choice, we ought to do it explicitly, and in a way that minimizes the harm to those who did a good job under the old rules. Even better, we ought to consider whether we will really get the broadband bang for the USF buck the FCC appears to expect by reverting to what is, in essence, a return to the universal service model we had under the AT&T monopoly and the Communications Act of 1934 rather than the more locally-oriented model adopted by Congress in the Telecommunications Act of 1996.

Why Do I Say The Proposals Favor Big Carriers?

Right now, the USF fund goes to telecommunications carriers providing local service (also called “local exchange carriers” or LECs) vetted (in part) by state governments. That puts something of an emphasis on localism, but not to the exclusion of the largest carriers. (AT&T, for example, is the biggest single company recipient of USF funds.)  One of the effects of this is that we have multiple providers with overlapping territories receiving USF money.

The current FCC proposal, supported by a chorus of large carriers, considers this needlessly wasteful and proposes cutting funding to any system in an area with multiple providers. That potentially makes sense given the goal of providing as many Americans as possible with a baseline service. But it ignores situations where smaller carriers receiving USF funds in territory covered by larger carriers use USF to provide better than baseline to residents or who use the territory overlapping with a large carrier to subsidize service in the even more rural/more expensive areas that larger carriers don’t want to serve. These smaller “wasteful” carriers provide competition and better service for their local region.

To take an example: suppose we have territory covered by CenturyLink and local provider.  Because it’s expensive and has lower rate of return than more urban areas, CenturyLink naturally wants to minimize its investment. The total USF fundng it receives is relatively small, and the return on upgrading service is relatively low compared to spending that money investing in wealthier, more densely populated areas. But a local business – supported by a dependable stream of USF funding – may find greater reward in upgrading. This, in turn, pushes the larger provider to invest in the local territory.

Eliminating “wasteful” spending eliminates this kind of above average service and local competition. Mind you, the people receiving no service who could now receive basic broadband service because we freed up more money will probably applaud this as the right choice. But the local folks who experience worse service are likely to disagree. If we are going to say that the needs of the many outweigh the needs of the few, we should not pretend that we do it because the few getting better service under the old rules somehow deserve their fate.

Reverse Auctions: Reverse auctions is another mechanism that favors large carriers and, no surprise, is also favored by large carriers. For those unfamiliar with the concept and how it applies in the USF context, here is a highly simplified explanation. USF is a limited pot of money. How do you get the maximum number of people served? Have carriers come in and submit contractor-type least-cost bids to provide service in a defined region for a set amount of money. The bidder that offers to cover the largest number of people for the money being offered for the region wins.
Large carriers have enormous advantages in such a system. First, they have economies of scale and relationships with vendors. Second, local providers may not extend throughout the proposed service territory subject to the bid. For example, Local Telco serving a portion of the service area might only be able to provide service for 10,000 people, whereas Big Regional Telco may be able to serve 100,000 people for the same money because it is already deployed in much of the territory and realizes significant economies of scale. Again, the 90,000 people getting service where they had none may totally support this result. But the 10,000 getting worse service, the local provider that used to serve them, probably disagree.

(I have other problems with reverse auctions as well, which I will hopefully get to in a future post. For now, it is enough to note that any reverse auction that actually does what it is supposed to do will favor large regional carriers over smaller carriers.)

Intercarrier Compensation Reform. Again, we come to the basic problem of trade offs. Love it or hate it, intercarrier compensation (ICC) was designed to include an explicit subsidy for rural systems.  When we talk about reforming and phasing out ICC, we are indeed talking about (potentially) saving consumers money and rationalizing an arbitrary and inconsistent system. (I say “potentially” because nothing stops carriers from pocketing any money saved rather than kicking it back in lower prices or investment in their networks.) But we cannot ignore the fact that we are also eliminating a major revenue stream for small, rural carriers. – and at exactly the same time we are also making it harder for them to get USF funding.

“It Rains On the Good LEC and the Bad LEC Alike”

I don’t pretend that the current USF system represents some golden age of noble local companies serving local communities. It’s an insanely complicated system that encourages every sort of rip off from genteel “regulatory arbitrage” to outright fraud. Nor does every business that ever existed have a right to keep its business model until the end of days – especially when that business model relies heavily on public subsidies.

But we need to keep in mind that reforms designed to repurpose USF for broadband will absolutely have an impact on those carriers doing a good job under the current rules. For every LEC receiving “wasteful” USF funding and gaming the system, there’s another LEC providing service to its local community that will probably go under – eventually – from the sweeping reforms needed to transition the fund in the way the FCC envisions. To borrow a phrase, USF reform rains on the good LEC and the bad LEC alike.

To his credit, FCC Chairman Julius Genachowski acknowledged up front in his remarks at the open meeting adopting the notice of proposed rulemaking that any transition like this involves pain – and it will involve pain for good people who played by the rules not just for “wasteful” LECs. The FCC ought to embrace this going forward, rather than pretend that this is only about eliminating waste. First, we ought to ask up front what is the goal of USF reform. If it’s to provide the most people with a broadband “floor,” then fine. But do we want to have some way to encourage more then the minimum, or preserve better service where it already exists? Do we care about promoting competition as well?

Next, we ought to ask if we really need to rely on big carriers to get us to this goal. There might be a lot of ways to get to universal (or near universal) broadband that don’t rely quite so heavily on a big carrier model. It may be more efficient to leverage local community efforts, for example, through local coops or public/private partnerships.  At the least, should we encourage multiple approaches rather than rely on a single approach? And if we are going to rely primarily on big carriers, how are we going to make sure they provide good service? It’s a lot easier for Smalltown to hold a local provider accountable than it is for them to take on a mammoth company with billions in revenue (although the record for holding either sort of LEC accountable in USF is nothing to write home about).

Finally, if we are going to put local LECs out to pasture, we ought to consider how to manage it in the least disruptive way possible. Economics is not a morality play, as I’ve observed on a number of occasions, but that doesn’t mean we should act like sanctimonious hypocrites and pretend this only about punishing the profligate and rewarding the efficient righteous. In addition, for purely pragmatic reasons, we ought to soften the blow for the hundreds of thousands who may see poorer service as the price of bringing any service to millions.  Let us have the grown up debate and make the hard choices. If nothing else, it increases the odds we will ultimately make the right choices.

Stay tuned . . . .

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