Kovacs: BDS reform - what happens to competitors after a mandated price cut?

network cables

The Federal Communication Commission (FCC) has proposed re-regulation of the business data services (BDS) market, with price-cuts in markets deemed “non-competitive” as the primary tool.  The vast majority of BDS is sold to wireline, wireless, and cable networks and to large enterprises.   The provision of BDS requires significant capital investment by both incumbents and their competitors.

Until recently, the FCC and commenters in this proceeding have focused on the question of “how many competitors does it take to discipline an incumbent’s prices,” but ignored the question of “what happens to competitors after a mandated price cut?”  That has changed in the last few weeks, since numerous competitive fiber providers (CFPs) have pointed out that any attempt to capture the incumbent will also capture them. 

Echoing Lightower, Lumos, Unite Private Networks, Uniti Fiber, and roughly a hundred other small fiber providers, Wilshire Connection (“Wilcon”) stated in its August 25th filing at the FCC:  “Wilcon faces competition from the incumbent LEC in virtually every location it serves and from other competitive providers in most of its locations.  To induce customers to purchase, Wilcon must meet or beat prices of other providers of BDS.”  Even if the FCC attempts to target only the incumbent’s prices, it will lower the price umbrella over the CFPs because the sophisticated buyers of BDS will force the competitors to match the incumbent’s mandated price cut. 

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As Wilcon and others point out, the combination of lower prices for their services, new regulatory burdens, and regulatory uncertainty will raise their cost of capital and the hurdle rates their projects must meet.  Uniti Fiber’s September 16th filing explains the result of higher cost of capital or lower revenues:  “there are likely to be projects that would be abandoned or never bid on in the first place because the return on investment is insufficient.” 

As I show in a recently published paper, Business data services:  the potential harm to competition, this is not an idle concern.  Lower prices will result in lower and more risky cash flows.  That, in turn, is likely to lower the valuations placed on these companies, whether they are privately or publicly held and reduce their access to capital. 

Thus, rate regulation of BDS is likely to clash with the FCC’s goal of promoting competition.  That, in turn, is likely to hinder the other key goal of this proceeding—advancing the migration of wireless infrastructure from 4G to 5G.  5G is expected to operate at gigabit speeds, up to 100 times as fast as today’s wireless networks.  5G will require a dense mesh of large and small cell sites connected by fiber backhaul.  CFPs are bidding on such projects based on today’s economics, and their continued participation is essential to a healthy 5G environment.  Mandatory price cuts would jeopardize their ability to invest in fiber networks and advance 5G.

Competitive providers are not, of course, the only infrastructure providers likely to be harmed by mandatory rate cuts.  As numerous incumbents that serve rural areas have pointed out, lower prices that result in lower cash flows will impede their ability to invest in their broadband networks.  They are particularly vulnerable to the FCC’s focus on low-speed circuit-switched TDM, which constitutes 74% of incumbents’ BDS revenues according to the FCC’s Further Notice of Proposed Rulemaking in this proceeding.   TDM is far too slow for 5G, so cutting its price will do nothing to advance 5G deployment.  However, it could create a serious hit to the rural incumbents’ cash flows, valuations, and access to capital.  That would impede their investment in their broadband networks in general and 5G backhaul in particular.

The FCC’s BDS proceeding has been so consumed by fights over regression analyses based on obsolete 2013 data that the agency has not taken the time to consider the harm its proposed actions would cause to competition in the BDS market and to 5G deployment.  It is time to take a deep breath and focus on what matters—making sure that America’s infrastructure providers have the capital they need to provide the most modern wired and wireless broadband networks in the world.

Anna-Maria Kovacs, Ph.D., CFA, is a Visiting Senior Policy Scholar at the Georgetown Center for Business and Public Policy. She has covered the communications industry for more than three decades as a financial analyst and consultant. 

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