The puzzle of telecom regulation

Revenues from telecom firms contribute to more than 90 per cent of the estimated ₹47,000 crore non-tax revenue of the government for 2017-18. The reduced turnover of these companies and their apparent need for a bailout threatens to derail the government’s fiscal arithmetic. Is there a way out?

The fundamental reason for their distress is not the market strategy of Reliance Jio, which is merely a symptom, but the transformation the industry is going through. In the early days different companies provided voice telephony, Internet service, and Internet content and applications. For instance, in India we had Airtel, Sify and Rediff.com.

Today, however, telephony, internet connectivity and Internet content and applications have become heavily vertically integrated, either through organic growth or arm’s length relationships. Successful business practices along these lines include carriers bundling Apple handsets, Netflix having strategic partnerships with carriers, AT&T providing preferential treatment of DirecTV content. Increasingly, the new model of value creation involves integrated eco-systems or “walled gardens”.

In this new world, value is being captured by the anchors of the value networks, such as Apple, Google, and Amazon. On the other hand, telecom and Internet connectivity providers such as AT&T in the US and Airtel in India are relatively less profitable, even though the content provided by the Internet companies cannot be consumed without the bandwidth provided by the connectivity provider. Hence connectivity providers are attempting to become anchors of their own value networks. For instance, in the US, AT&T recently acquired DirecTV to provide a video service aligned with its connectivity offering. In India, Reliance Jio is making the most aggressive attempts to create a value network centred on itself. The fact that it is a late entrant lends an extra urgency to its efforts.

There are two regulatory approaches possible, based on two views of the boundaries of the telecom-Internet eco-system. Either we can treat telecom firms and Internet companies as belonging to the same industry, or we can regard them as different.

If we regard them as belonging to one industry, then one must keep in mind some key differences between telecom and Internet companies. The former have geographical jurisdiction, use scarce resources such as radio spectrum, and are subject to a variety of national regulations, including laws on net neutrality.

On the other hand, Internet companies operate globally and are subject to light touch regulations, in most national jurisdictions. They are not subject to net neutrality regulations unless they attempt, like Facebook, to partner with telecom companies to create walled gardens. Here also, the regulation kicks into place because of the involvement of the latter.

The bias of search engines that arguably violates net neutrality does not, by and large, invoke regulatory censure. Although the European Commission has just imposed a heavy fine on Google, the US Federal Trade Commission (FTC) concluded that Google’s practice of favouring its own content in the presentation of search results did not violate US antitrust laws.

India is also silent on the vertical integration of different layers of the Internet. However, while telecom firms have left innovation to telecom product vendors, Internet content and applications companies have to innovate constantly to remain relevant.

If we aim to provide a level playing field between telecom firms and Internet companies, then we have to get rid of the current notion of net neutrality that censures the connectivity provider for directing Internet traffic but does not take a similarly scathing view of Internet behemoths who also influence internet traffic by controlling key elements of the value network such as devices or search engines.

We should also reduce the levies and payments telecom firms are charged for spectrum, keeping in mind that many of the big Internet companies hardly pay anything at all by way of taxes. The reduction in levies necessary to make them competitive can be minimised by allowing cash-rich internet companies to invest in telecom companies to create integrated value networks.

However, letting go of the principle of net neutrality can destroy competition on the Internet as new firms will find it difficult to compete in an environment of walled gardens. Hence, there is a strong case for the second regulatory approach: treating connectivity providers and Internet companies as belonging to separate industries.

If we take this view then the principle of net neutrality has to be strictly enforced – not just with respect to the connectivity providers, but also with respect to the walled gardens created by Internet companies. If we do not establish an even-handed approach to both telecom and internet companies, the former will always have an incentive to try to become like the latter, in terms of dominance in the applications layer.

Telecom firms, not being adept at innovation, will try to use the power of subscriber numbers to turn the tables, as Jio is doing. If this principle of net neutrality is established, then innovation in the Internet will be enhanced. Importantly, telecom firms will have no incentive to build market share too aggressively as they know they will not be allowed to use their subscriber base to build an applications suite which they can monetise. They will charge sustainable prices for service, reducing the resources needed for a bailout. Stronger data protection laws will also reduce the incentive of telecom and Internet companies to subsidise subscribers only to monetise their information through ads.

Perhaps both regulatory approaches discussed are extreme and difficult to adopt. What is the middle path that increases both the health of the sectors as well as is beneficial for end users?

Prasad and Sridhar are Professors at MDI Gurgaon and IIIT-B, respectively