INDUSTRY ANALYSIS
California Tele-Scheming

Last week California's Public Utilities Commission had an opportunity to undo some of the damage price controls have wreaked on the telecom sector. Instead it clung to a losing strategy that rewards sloth and punishes innovation.

The PUC approved a below-cost wholesale rate that SBC can charge competing carriers to lease its network. There are very few sectors where the government has so much control over operations, and this iron-fist management inflicts great damage. Forcing some companies to subsidize others removes incentives to innovate on the part of both parties, harming consumers in the long run.

For instance, SBC estimates that it costs $29.92 to provide its network to other carriers, yet the PUC is only allowing them to charge $16.53. As a result, the company says it may now have to scale back.

Competitors Aplenty

"SBC cannot continue to subsidize competitors without making difficult decisions to continue investment and jobs in the state," said Lora Watts, president of external affairs at SBC West. Perhaps Ms. Watts is thinking it would be better to shift her resources to Nevada, where the permitted rate is $34.04.

A cynic might say that SBC is overestimating what it costs to provide the service in order to drive up rates, but that raises the question of why the PUC is even in the business of setting prices. The marketplace, not regulators, should dictate the price. If SBC prices itself too high, competitors will turn to alternate, lower-cost methods of competing. And anyone who says the telecommunications market isn't competitive must have been hiding under a rock for the last five years.

Cable competes with landlines, which also compete with cellular and satellite. Consider that just this week Bank of America (NYSE: BAC) announced that it is replacing its desk phones with 180,000 Internet phones that connect its 5,800 offices and branches in 29 states. And BofA is not alone.

Other big corporations such as IBM (NYSE: IBM) and Boeing (NYSE: BA) have announced they are migrating to Internet telephony. The old business of landline telephony is starting to fade, forcing providers of voice and data services to innovate or die.

Verizon Innovation

One company working hard to innovate is Verizon. The company is "very committed from a resource standpoint," said Vice Chairman Larry Babbio. "We're hiring people," he said. "We already have planned to pass over a million homes this year. And we've said publicly we're going to pass at least two million next year."

Verizon's goals may well be met, but the way things are going right now, it won't be California consumers who benefit from Babbio's enthusiasm. The Federal Communications Commission (FCC) has said that new technologies are not subject to government price setting and conditions, but a judge at the California PUC recently ruled that Verizon must share its new network. This decision caused a collective "huh?" throughout the telecom community, as everyone knows that the FCC has been clear about not applying legacy regulations to new technologies.

For its part, the PUC is apparently making the case that Verizon must share its new network because of old interconnection contracts. (PUC officials did not return calls on this issue.) But that reasoning doesn't hold up when it comes to consumer welfare. Is Verizon supposed to wait to innovate until state regulators say it can?

Left Coast Luddites

As a result of the PUC's action, Verizon has halted its California installation of the new packet-switched system that, when connected with fiber optics, enables the delivery of one of the industry's most comprehensive suites of entertainment, communications and IP-based multimedia services.

"Verizon had planned to make California one of the first states in the country to have a significant deployment of this advanced technology," said Tim McCallion, Verizon's Pacific region president. But now, "Verizon has no choice but to halt this program because of a regulatory ruling that imposes conditions we cannot meet and that undermine the economics of this investment."

California might think of itself as a technology-friendly state, but the PUC's actions make the state seem rather Luddite. If new technology is to go forward, regulators must step out of the way and let business serve consumers. Imposing price controls and other restrictions slows innovation and makes California much less golden.