The Economist, the Internet, Telecom and the Dow

In the 1980's I found that reading The Economist was more interesting than reading science fiction. I'm not proud of this and I am surprised at myself. But the real world is fascinating and I find The Economist to be a fairly sober publication.

But the Economist has had problems coming to terms with the Internet. It seems to abandon the free market advocacy that seems to characterize its reporting when it comes to the Internet. I suspect that the reason is simply that the reporters (or editors) confuse the businesses done using the Internet with the Internet itself. The Internet itself is not a business nor a marketplace or even a particular technology. It is simply a way of providing connectivity by simply packaging bits in uniform packets and then delivering them anywhere else in the world.

That's not very interesting. But then paper money isn't very interesting to most people; printing money is just a way to simplify business transactions by having a simple way to transport value. Printing money and carrying packets are interesting businesses in their own right. We don't confuse the business of printing money with using the money for financial transactions.

The July 20th cover story on the Telecom Crash (in particular, Too many debts, too few calls) draws no distinction between the business of providing commodity Internet connectivity with the business of providing telecommunications-based services. Of course The Economist is not alone in this fundamental error but "Crash" story is a useful foil for addressing this misunderstanding.

It is a tragic misunderstanding since the woes of the Telecom industry are seen as representing the state of the economy rather than the collapsing of a facade of a Potemkin industry. In 1900's there was a real telecommunications industry just like in the 1800's when there was a thriving business in transporting ice from frozen lakes to warmer climes. Just as refrigeration put an end to the need for buying ice, the Internet has put an end to the need to buy telecommunications services from others. We just need commodity connectivity.

The article has the patina of credibility including citing research from Andrew Odlyzko. The problem is in the interpretation:

• The article confuses commodity connectivity suppliers like Level 3 with value-added information services like WorldCom. WorldCom does have a transport business but the retail business seems to dominate the company and set its tone.
• There is indeed a lot of unused fiber capacity in the backbone but to say that the growth has not met expectations is to blame the victim. We are the victims. The service operations of these companies are being decimated by the limited access we have to this backbone. Even the "high speed broadband" offerings are providing only a small fraction of what is technologically possible and its asymmetricity is modeled after the television network, not the peer connectivity of the Internet. The failure to understand what the Internet really is deprives us of economic opportunity at a time when it is most vital. Giving a dead industry an exemption from antitrust so it can keep the future at bay is the way to maximize the damage to the economy. It is a tragic misunderstanding with real and immediate consequences.
• The so-called investments in infrastructure and capacity are lumped together. A hundred billion dollars (or euros) for the 3G network is a good example. This "investment" is premised on the assumption that we (the users) will pay a multiple of current rates and allow ourselves to be captive of their service providers. It is as if in 1964 ATT bet more money that it had on the expectation that we would all use pictures phones and all traffic would go via their satellites instead of terrestrial fiber and we would pay a premium price unrestrained by marketplace competition. One immediate consequence of the Internet is that we can take advantage of the most opportunistic path. An 802.11 connection to a fiber is far more cost effective and can seamlessly connect to anyplace else in the world including, when appropriate, cellular phones. In fact, the whole cellular phone system is premised on the assumptions of the radio technology from the early 1900's and, in turn, on the harmonic telegraph of the 1800's. Image what happens when the sliver of spectrum allocated to 802.11 is expanded to the rest of the spectrum. 3G isn't the first example of very unwise investments. Telecom has been viewed as a very capital intensive business and such large bets have become accepted. As long as telecom was an exclusive club no company seemed to be more foolish than another. The commodity connectivity of the Internet has opened the club and the old players must face the consequences of foolish "investments".
• To quote the article "The industry's hangover has two components: overcapacity and debt". They are not intertwined at all. As I've pointed out, the so-called overcapacity of the fiber is largely a result of actively thwarting the ability to create demand and value. The debt, again, has little to do with the fiber capacity. The hundred billion thrown into the 3G quagmire is gone. Well, maybe not. The spectrum auctions have had secondary consequences in minimizing the value of wireless connectivity. Perhaps the governments should return the money. But they can't since, due to the telecom debacle and the limitations on Internet connectivity, the economy is suffering.
• The article does note that the growth in voice traffic hasn't resulted in revenue growth. In fact, with effective Internet connectivity the voice telephony business is like the typewriter business. The whole industry is worth no more than a simple software program that can be written by a single high school student. But the proffered solution only compounds the problems. If we can create our own voice services why would we think that the current telecom companies have a special ability to create new services outside their core competence? The real damage occurs when they try because rather than investing in what we really need, commodity capacity so we can create value, they try to keep it all to themselves and frustrate the market by assuring that they are the sole provider. It's 1964 again but this time they really believe picture phone is the answer to their woes. Or managed services or VPNs or horoscopes.
• The article does note that "nobody knows what kind of services consumers really want". Yet, strangely, The Economist, a staunch advocate of the marketplace, doesn't see anything strange in this statement. But saying that the 3G sinkhole will be filled with revenues from text messaging is like trying to fund education from bake sales. (The bake sale is a traditional way to raise small amounts of money by selling baked good. They are fine social events but the amount of money raised is insignificant against the costs of actually running the schools.) The very notion that these companies are playing with gewgaws like text messaging and phones with built-in cameras is an extreme case of psychological dissonance. Even the post-bubble use of the Internet is far more exciting than these lame applications. And they are already free on the Internet. Free? Well, of course you pay for the Internet connectivity but a 100 character text message is less than a millionth the cost of a short videos stream. Of course, if the cell providers can force us to pay $.10 per message they will make out like bandits.
• The Internet Bubble? Much of the foolish speculation stemmed from the misunderstanding that considers telecom a viable industry. The history of computing is littered with vast over-promises. But the value delivered by the 1% of the capability that is actually provided has been large enough to drive the economy. This is even more true of the Internet. Amidst the telecom carnage the Internet continues to be useful and, even better, mundane. I am one of the many who can now publish to the world (whether people read what I write is another matter). But the Internet is taking value away from the old industries that provide us with the measures of the economy. This is certainly the case in telecom. But we need to be careful of how we look at value. After all a Hurricane provides boost to the economy as we employ people to repair the damage. How can we measure the value of enfranchising billions of people around the world to create new value? It is easier to focus on the measurable carnage in telecom.

The real problem is that the concept of the Internet doesn't make sense to those wedded to traditional economic models that presume that value is created only by anointed companies. Telecom is a most extreme case since the industry tries to maintain absolute control over the services built on their networks.

But the Internet has given us a chance to see what happens when we give everyone the ability to create new services. But common sense tells us that there is a limited supply of a resource. But computing and connectivity don't behave that way. Demand actually creates supply.

Perhaps the problem is that such statements border on madness to those who have stewarded The Economist through the last century. But these are just examples of the power of the stakeholder argument. The real madness, however, is in ceding our economy to companies whose time has come and gone. At this point the only way they can create value is by exercising a degree of control that is nothing less than an egregious violation of anti-trust.

The real damage done by violating the spirit of antitrust is not so much the increased cost to consumers as much as it is the distortion of the marketplace. It is impossible to make rational investments if the market is not rational.

The commodity connectivity business is thwarted by competitors who can use the profits from their service business to cover infrastructure costs thus making the narrower margins of the commodity business very unattractive. But, as we've seen, the service business is illusionary so society loses both because debts of the "value" businesses cannot be repaid while investors are denied the opportunity to invest in creating the infrastructure that is needed.

Connectivity is not intrinsically scarce but the legacy of the current telecommunications regulatorium is an artificial scarcity. Over the long term the market will roll past the current telecoms but until then we must come to terms with the new marketplace:

• The first step is understanding. The Internet has given us a new basic resource – connectivity. It must be provided by those with incentive to increase the capacity and whose business structure is based on selling a commodity rather than gorging itself on the ability to hold a service like caller-ID hostage and then charge us $6/month.
• We must recognize that traditional telecom companies are simply dead. The very idea that they can pay back debts when they have nothing to offer is foolish. Aiding and abetting such attempts requires a conspiracy to violate anti-trust. Limiting connectivity also happens to frustrate free speech. A trillion dollar write-off to save the world's economy is a very small price. But the current value of the telecom providers is already lower than that.
• We must address the realities of the new marketplace and assure the ability of connectivity. I expect we'll see a combination of private commodity suppliers of connectivity and municipal services since connectivity is a basic utility like water and electricity.

The first step is understanding and I hope the Economist can help lead the way.