This debate was central to the fascinating discussion at the State of Telecom event at Columbia’s Instititue of Tele-Information, held in mid-October. I attended the afternoon sessions.

Wall Street’s vision

Simon Flannery, managing director at Morgan Stanley, described the challenges that are eroding the margins of the cellcos. Of course, the top two cellcos are doing better than the rest. Flannery said that margins at Verizon at about 45 percent, while margins at Sprint are about 16 percent. Apps that are eroding core revenues include free text messaging and free calling.

Meanwhile, cellcos are selling advanced services that require more bandwidth. “Backhauling fiber to towers requires a massive build,” said Flannery. “Smaller carriers lack the cash flow to reinvest, and there is no financing for newtowkrs that are without returns.”

The market is trending towards a duopoly.

Craig Moffett, senior analyst at Bernstein Research, said that the services that people pay for are the easiest to provide: internet access, phone calls, and so on. “People are less willing to pay for information and entertainment, which are services that cost more to provide.”

Voice may require 9.6 Kbps and people will pay $50 per month for it. People will only pay about $30 per month more for the next generation services that multiply data usage by 10 or 100 times. “The sale price per bit is falling faster than the cost per bit.”

At the bottom end of the market, Moffett said, there is the “poverty problem” where households whose net income is negative after paying for food, clothing, and shelter account for perhaps 40 percent of all homes. “Retailers can depend on the upper two quintiles, but telcos have to sell to the full 100 percent of the population,” Moffett claimed.

The consumer advocate concurs

Mark Cooper of the Conumer Federation claimed that he disagreed with everyone on all sides of this debate. He said that in some poor countries, there are 75 cell phones per 100 people. “People who have no electric power at home may have cell phones.”

If a cellco is just adding voice customers, it’s easy to grow. “It is easy to add subscribers but it is expensive to add capacity. Users, uses, and usage all add costs to wireless mobile networks.”

He agreed with the Wall Street analysts that the marginal sale price of bandwidth drops rapidly.

He added, however, that unlicensed wireless spectrum is the great success story of the past two decades. Even AT&T is now selling Wi-Fi. “Unlicensed has no champion in the scrum for spectrum.” Cooper said that at most 10 percent to 20 percent of spectrum should be sold to the cellco monopolies, so that the Washington can avoid the next monopoly and the next “100 year mistake.”

The Economist Magazine has the data

In an article entitled The Limits of Frugality, The Economist magazine warns that those rural cellphone users who have no electricity in their homes will soon be paying higher prices. “Sunil Mittal, the boss of Bharti Airtel, the mobile-phone operator … said the extra cost of servicing rural customers, and their low usage levels, had made things unprofitable. Prices are now expected to go up across the industry, after two decades of decline. India’s low-cost telecoms revolution has, it seems, reached its limit.”

Buildouts will now focus on the urban rich. “Today perhaps 17 percent of India’s population has half of its spending power, according to the Asian Development Bank …. One proxy for the difference in profitability between the urban rich and the rural poor is the price paid for mobile-telecoms spectrum. In the 2010 auctions for 3G telecoms licences, operators bid ten times more for a slice of the airwaves in affluent Delhi, with 18m people, than in east Uttar Pradesh, with 120m people.”

Washington, D.C.’s policymakers should expect fixed wireless and wireline internet to connect the rural poor at an affordable price. The true price of cellular broadband is going up fast, worldwide, and like all price rises, it will harm the poorest the most.

However, the VoIP services that exist today are a shadow of what the technology makes possible. VoIP has been choked so that it no longer disrupts telephone service. VoIP has been fenced in by the FCC so that it offers no more than telephone, a move that was intended to protect cellular and wireline phone companies.

I remember that in 2004, we held ISPCON Spring in Washington, D.C. The vendors brought their office phones with them to their booths. They were thrilled to be able to answer their office phones while on the road. While this was a boon to the CEOs of small companies, it was a miracle for road warrior salespeople. All of these businesspeople were using a feature of VoIP that wireline service cannot provide — and that directly competes with cellular too.

In 2005, the FCC ruled that VoIP service must support 911 emergency service (the E911 order). This was the beginning of the end. For nomad businessmen such as those who had been so happy at ISPCON in 2004, there was no need for 911 on their VoIP service. Residential users who had taken their home phones with them on vacations could no longer do so. A key advantage of VoIP technology over traditional wireline phone and cellular services was eliminated by FCC fiat.

At the time, VoIP expert Jeff Pulver said, “It is my hope that the FCC’s E911 rules for Interconnected VoIP providers do not extend to services that no user would expect to offer localized emergency response capabilities, such as a circumstance where a computer has both SkypeIn and SkypeOut downloaded … [the order] might relegate America to a VoIP ghetto, where anyone wishing to use both an inbound and outbound voice application on her computer had better not step foot in America. Should Skype consider turning off either its inbound or outbound service in America?”

In 2006, the FCC attacked VoIP’s inherent price advantage by forcing VoIP providers to pay universal service fees. This rule hit the smallest companies the hardest.

VoIP providers were also required to enable wiretaps (CALEA), a ruling that was reasonable, but which was made unreasonable by the federal government’s unwillingness to certify systems as being compliant. VoIP companies were expected to pay $100,000 or more for a system that might or might not do what it was supposed to do. This hit the smallest companies the hardest.

In 2007, VoIP providers were required to register for a CPNI, another bureaucratic procedure that hit small innovators but provided little encumbrance to the monopolies.

VoIP, caged

The result of these rules is that today, the largest VoIP companies are massive companies, and the largest single VoIP provider in the U.S. is Comcast. As of September 30, 2010, Comcast had 8.4 million VoIP customers, almost half of the VoIP market all by itself (before counting the other cable companies).

The “digital phone” service offered by cable companies today is the result of FCC policies: it is a service that runs over the internet but whose features are restricted to mimic as closely as possible the phone service of the previous century. It competes with wireline voice services on price but, more importantly, it no longer allows its users to roam and therefore no longer competes with cellular service. The phone companies are now selling off their wireline voice services, have stopped investing in internet service, and are spending all of their money on cellular. They do not mind if VoIP competes with wireline phone services; they must be thrilled that it no longer competes with cellular service because “digital phone” cannot move.

Some providers are doing wonderful things with VoIP — the innovators are the smallest companies on whom the burden of regulation falls the hardest. M5 Networks, a business-only VoIP provider in New York City, provided hundreds of virtual phone numbers to real estate firm Coldwell Banker. Every advertisement that the realtor placed that week had a different phone number, so the realtor was able to track, in minute detail, the response rate of every ad. Of course, the FCC has left the rules for business VoIP services more liberal than those for residential. As a result, many of the most innovative local players offer business VoIP services only.

Digium, the business end of the Asterisk project, offers a wide open technology that can be used to do many things. I spoke to one developer several years ago, Professor Brian Capaouch, who set up an anti-raccoon device in his chimney using Asterisk. When a video camera sees a raccoon, it turns on a kitchen mixer that is broken — it’s missing a ball bearing and squeals like murder. The video camera also takes a still photo and e-mails it to the professor. The professor can “call in” to the camera and view the live image on his cell phone.

Capaouch told me that VoIP enabled a completely different kind of collaborative development. Because the calls were free, developers would open a party line and talk to each other for hours while working on code together.

Simple disruptions of the telco business model were also important. You could obtain a phone number in another city or another country and avoid international and long distance phone charges. In the same article cited above, I interviewed Greg Boehnlein who told me, “our operations manager is from London and he was spending $400 per month calling his parents. Now, with VoIP, he pays zero.”

Today, while experts can still do truly amazing things with VoIP, the services that residential consumers see are limited. They compete on price, not features, and deliver something very similar to traditional phone service. Most use phones instead of computer microphones for audio.

Business services are somewhat more sophisticated, but for the truly nifty things that VoIP can do, even a knowledgable business IT department usually needs to hire a consultant like M5 Networks to get elaborate things done. Many IT departments also pay consultants whose job is simply to get them the telephone services they need and make sure they’re not paying for anything they don’t need.

VoIP technology is widely deployed, even within the phone company, but it has been prevented from fundamentally changing the phone business, largely through the intervention of the FCC.

The Third Way is a phrase made popular by Tony Blair and Bill Clinton. It describes an attempt to navigate a path between socialism and the free market. Given the extent to which the Obama administration’s opponents attack so many things it proposes as “socialism”, it is courageous of the FCC to use this term. (To be fair, the FCC says it’s seeking a middle road between re-regulation of a utility and the unfettered free market.)

The FCC does not want to regulate the internet if the internet is defined as the websites and services that we use when we connect to the internet. The FCC wants to regulate the price that users pay to connect to the internet and to be able to police monopoly power at the access level. To this end, the FCC refuses to abandon the great mistake of 2002 in which the FCC first decided that the internet was comprised of both a telecommunications component and an information service.

The problem with this splitting of the internet atom is that the internet consists of interdependent services.

Take VoIP. You can use it to make a phone call. When you do so, which part is the telecommunications component? You can use VoIP by clicking on a customer service button on a website. When you do so, is VoIP now purely an information service? In either case, an ISP might affect your ability to use VoIP service by blocking ports (or using more complex procedures as Comcast did).

When is VoIP an information service and when is it a telecommunications component? If the ISP blocks VoIP with hardware, is it telecommunications, but if it routes traffic through a third party website to block VoIP, is that an information service that the FCC cannot regulate?

Commentators are cautiously optimistic today, just a few days after a major net backlash. The strength of the backlash against the FCC’s apparent attempt to abandon Obama campaign promises with regard to net neutrality made the FCC of Monday (Obama Abandons Internet Promise) seem very different from the FCC of today (Obama Abandons . . . maybe not so much . . .).

The FCC has more fears than ambitions

In his statement, Genachowski says the FCC will:

• Recognize the transmission component of broadband access service—and only this component—
  as a telecommunications service;
• Apply only a handful of provisions of Title II (Sections 201, 202, 208, 222, 254, and 255) that,
  prior to the Comcast decision, were widely believed to be within the Commission’s purview for
  broadband;
• Simultaneously renounce—that is, forbear from—application of the many sections of the
  Communications Act that are unnecessary and inappropriate for broadband access service; and
• Put in place up-front forbearance and meaningful boundaries to guard against regulatory
  overreach.

The goal of the FCC at this time is to make policy that won’t be overturned by the DC circuit court, and to make policy that won’t upset the monopolies. The FCC statement specifically says that the FCC will not create any new unbundling obligations for the large companies, and Genchowski specifically says that he wants to prevent “regulatory overreach.”

Commentators such as Yankee Group’s Carl Howe want the FCC to ensure that there’s a free and fair market. “Last time I looked, The U.S. was ranked anywhere from 19th to 21st in the world in terms of Internet speeds and costs,” Howe writes (h/t Benoit Felten). That needs to change.

The meaning of Title II in this case

Genachowski refers to six specific provisions of Title II that he wants to apply to the internet.

They are:

Section 201: fees must be “just and reasonable” — this has not harmed the large phone companies at all, but that may be because the law is not usually applied to large phone companies.

Section 202: nondiscriminiation.

Section 208: a complaint procedure that is expensive and rarely used.

Section 222: privacy rules designed to regulate large telephone companies.

Section 254: USF. The FCC is going to face considerable opposition if it seeks to apply USF fees to broadband. One way to gain support for this would be to lower the rates from 15 percent to about 1.5 percent. A broader revenue base should enable lower FCC fees.

A second problem is that this rule, like all of the others the FCC is considering, would impose a heavy compliance burden on small businesses. Many ISPs and WISPs are literally mom and pop operations. They have a lawyer they can call but none on staff. They have a bookkeeping function but not an accounting function. They can handle questions about costs but have trouble with questions about depreciation.

Section 255: Access for those with disabilities. The FCC is concerned about this issue and will hold a hearing on it (.pdf) on May 13, 2010. Vint Cerf was part of a round 1 stimulus proposal seeking $70 million for broadband for the deaf and hard of hearing (personally, I think broadband for those lacking sight would be a more impressive achievement).

Conclusion: questions remain

1) Is the FCC serious about supporting competition? As David Isenberg wrote, “we’ll see.” The FCC just lost a major legal battle to NBC-Comcast. Will it be willing to fight such a battle again?

2) Will the burden of complying with new rules fall on small businesses but not on large businesses? Madison River paid the fine, but Comcast-NBC sued the FCC and won. In this way (and many others) FCC regulations restrict only what small companies can do.

2a) Will broadband providers have to justify their prices every year or only if the FCC audits them? Will the FCC ever investigate deceptive advertising or falsified charges? Would it investigate small companies only or would it actually investigate Verizon’s phantom data fee or its fee for not using long distance service?

3) How will the USF apply to broadband. There will be no cash for broadband without a tax on broadband. Implementing it in a fair way will be difficult.

4) What does the FCC intend to do about people with disabilities? What about the enforcement of non-discriminiation rules?

All of these questions explain what David Isenberg and others mean when they say, “we’ll see.”

” Reading AT&T’s announcement that the nationwide rollout of its femtocell product–called the Microcell 3G–is about to begin called into sharp relief the level at which I expect to get screwed by the phone company. About halfway through decoding the PR doublespeak, I had an epiphany. It was if I suddenly saw the words on the page for the very first time. “

Here’s a list of whom Forbes expects to win.

My comments, based on what we know at this time, are here.

“Of course the lesson learned is that in the Internet age, the harder a company works to stifle criticism, the more attention that criticism gets. The better path is perhaps to listen to what your customers are saying about your business practices, and change them where possible if you value your customers,” Bode writes.

The legal documents are here:

http://www.boingboing.net/2010/02/23/magicjack-legal-docu.html

Imagine my surprise — and pleasure — when MagicJack called me to discuss the problem. After some back and forth, the MagicJack representative recommend that I purchase a powered USB hub.

I purchased the StarTech ST4200USB 4 Port USB 2.0 Hub from Newegg for $28.99 plus $14.55 shipping and handling for a total of $43.54.

That’s a lot of money to support a service that costs $20 per year, but the net price remains far below what my phone bill would be without MagicJack.

Today, we had a hiccup in service, but I went to the MagicJack website, downloaded the latest update, and the problem was solved.

The problem, however, demonstrated why MagicJack gets such poor ratings for technical service. The error message said that I needed to plug MagicJack into a USB jack, but the actual problem was that the update had failed.

Since service failed shortly after (but not immediately after) an automatic update, this was not too difficult a diagnosis, but I would not recommend this product to anyone who does not know how to troubleshoot their own PC and internet connection. Given a certain level of technical proficiency, MagicJack can save you a lot of money.

The company is preparing to add femtocell to its service line. If you have a cell phone, check it out.

Time and time again, regulators have implicitly endorsed poor service by refusing to fine telcos at a level that would provide a disincentive for harm to consumers. Verizon got away with this activity for years and is paying less than a month’s profit per customer.