What Google Fiber Says about Tech Policy: Fiber Rings Fit Deregulatory Hands

Google’s first lesson for building affordable, one Gbps fiber networks with private capital is crystal clear: If government wants private companies to build ultra high-speed networks, it should start by waiving regulations, fees, and bureaucracy.

Executive Summary

For three years now the Obama Administration and the Federal Communications Commission (FCC) have been pushing for national broadband connectivity as a way to strengthen our economy, spur innovation, and create new jobs across the country. They know that America requires more private investment to achieve their vision. But, despite their good intentions, their policies haven’t encouraged substantial private investment in communications infrastructure. That’s why the launch of Google Fiber is so critical to policymakers who are seeking to promote investment in next generation networks.

The Google Fiber deployment offers policymakers a rare opportunity to examine policies that successfully spurred new investment in America’s broadband infrastructure. Google’s intent was to “learn how to bring faster and better broadband access to more people.” Over the two years it planned, developed, and built its ultra high-speed fiber network, Google learned a number of valuable lessons for broadband deployment – lessons that policymakers can apply across America to meet our national broadband goals.

To my surprise, however, the policy response to the Google Fiber launch has been tepid. After reviewing Google’s deployment plans, I expected to hear the usual chorus of Rage Against the ISP from Public Knowledge, Free Press, and others from the left-of-center, so-called “public interest” community (PIC) who seek regulation of the Internet as a public utility. Instead, they responded to the launch with deafening silence.

Maybe they were stunned into silence. Google’s deployment is a real-world rejection of the public interest community’s regulatory agenda more powerful than any hypothetical. Google is building fiber in Kansas City because its officials were willing to waive regulatory barriers to entry that have discouraged broadband deployments in other cities. Google’s first lesson for building affordable, one Gbps fiber networks with private capital is crystal clear: If government wants private companies to build ultra high-speed networks, it should start by waiving regulations, fees, and bureaucracy.

That’s the policy template that worked for the residents of Kansas City. It could work for the rest of America too, but only if all broadband providers receive the same treatment. When private companies compete on a level playing field, consumers always win. When government regulations mandate a particular business model or favor a particular competitor, bureaucracy is the only winner – everyone else loses.

Maybe the silence of PIC advocates indicates they’ve had a change of heart. Although PIC has violently opposed the efforts of other broadband providers to eliminate similar regulatory barriers in the past, perhaps the success of Google Fiber has persuaded them that deregulatory policies fairly applied to all competitors are essential to meeting our nation’s shared goal of national broadband connectivity.

Google’s deployment certainly indicates the PIC would benefit from a change in their approach to policy. The Google Fiber business model contradicts virtually every element of the PIC’s current regulatory agenda.

PIC says restrictive regulations don’t discourage new investment. Google says it passed over proposals by cities in California due to restrictive regulations.

PIC says the government should limit the delivery of “specialized” IP-based video services by network operators. Google says specialized video services support fiber deployment.

PIC says that the provision of subsidized devices by network operators harms innovation and term contracts harm consumers. Google says bundling its own, vertically integrated computing devices with its fiber network services in exchange for a two-year contract commitment is part of the “Full Google Experience.”

PIC says the “open access” model is “easy” and viable even in competitive markets. Google says it abandoned its commitment to open access because it doesn’t think anyone else can deliver service as well as it can.

PIC says the “end-to-end” regulatory model, which severs all business relationships between “core” network infrastructure and “edge” elements of the network, promotes innovation and investment. Google says we should explore alternatives to the “end-to-end” model, including vertical integration among network operators and edge providers.

Every level of our government could benefit from a change in its policy approach as well. If we are serious about achieving affordable, ultra high-speed broadband connectivity for every American, we must question the traditional assumptions underlying our legacy regulatory approach. Google Fiber demonstrates that the problem isn’t deregulation, a lack of competition, or an unwillingness to invest in American infrastructure. It’s the imposition of burdensome bureaucracy, unnecessary costs, and political favoritism at all levels of government. Eliminating these regulatory barriers would drive investment in America’s infrastructure, spur innovation, create jobs, and grow the economy while helping to meet President Obama’s goal of connecting every American to broadband.

Google has shown the way. Is government willing to let other competitors in the marketplace follow the same path?

Introduction

The story begins two years ago, when Google announced its plans to build experimental, ultra high-speed broadband networks and operate them on an “open access” basis. Over 1,100 communities asked Google to build a network in their area, including several “desperate cities” willing to change their names and even swim with sharks. Google ultimately chose Kansas City as its broadband mecca.

So far, people in this prosperous city on the plains are embracing Google Fiber with enthusiasm. A little over a week after Google offered designated areas an opportunity to request service, 46 neighborhoods had qualified. Analysts estimate Google has already achieved approximately 4 percent market penetration. Google’s bet on an all-IP, fiber network appears poised for early success in Kansas City, which is something every tech geek should be pleased to see.

Like most new enterprises, it’s unclear whether Google Fiber will enjoy financial success in the long term. Many analysts are skeptical that Google’s business model can be replicated on a larger scale. Others believe it will deliver a “knock-out punch” to existing cable and telecom operators. Though I have my doubts, I’m content to let the market determine Google Fiber’s financial fate.

I’m more intrigued by the public policy implications of the Google Fiber business plan. Am I the only one who is baffled by the unusual response to Google’s announcement? After reviewing Google Fiber’s terms of service, I expected to hear the usual chorus of Rage Against the ISP from Public Knowledge, Free Press, and other PIC advocates who believe the Internet should be a public utility. I also expected the technology press would be critical of several elements of Google’s service. I was surprised on both counts.

Many in the tech press are offering gushing praise for Google’s new service. BGR says Google Fiber is a “ridiculously awesome value” for “lucky” Kansas City residents. CNET suggests that the Google Fiber business model offers the “rest of the broadband industry” a template for successful deployment of one Gbps networks: “Google is showing the cable companies and telecommunications providers how a broadband network should be built.”

The notion that other ISPs should mimic Google Fiber may explain why PIC advocates have been so deafeningly silent on the Kansas City deployment. The PIC narrative says that “the evil folks at cable companies and telecoms” are sabotaging fiber deployment in order to maintain their legacy businesses. Google doesn’t have a legacy network business, and its informal corporate motto is “don’t be evil.” So, according to the PIC narrative, Google’s business model shouldn’t look anything like those implemented by existing ISPs.

It turns out that Google’s business model validates a host of existing industry practices that PIC advocates seek to outlaw or regulate, and demonstrates that existing regulations are the biggest factor inhibiting the deployment of all-IP fiber networks by other service providers. Ironically, to the extent Google’s business model does differ significantly from those typical of other ISPs, it relies on an industry structure – vertical integration – PIC advocates vociferously oppose. As the following analysis of the “lessons learned” from Google Fiber demonstrates in detail, Google’s model contradicts virtually every element of the PIC regulatory agenda.

First Lesson Learned: Deregulation promotes private investment

The first lesson Google learned from its fiber project: If government wants private companies to build ultra high-speed networks, it should start by waiving regulations, fees, and bureaucracy.

It’s no accident that Google chose to deploy its broadband network in a city subject to deregulatory statewide video franchising laws (in Kansas and Missouri). (Federal law prohibits the provision of video programming services without a “franchise”.)

Franchises were historically granted by local county or municipal governments who gave virtual monopolies to cable providers in exchange for “universal service” commitments (i.e., commitments to build the cable network to every neighborhood irrespective of cost or demand). Although federal law has prohibited monopoly video franchises since 1992, when potential new entrants asked permission to build competitive cable networks, local franchising authorities often stonewalled their applications or demanded unreasonable concessions. When new entrants challenged the legality of these tactics, PIC advocates derided the potential competitors for attempting to enter the market.

In 2006, the FCC adopted an order prohibiting local franchising authorities from unreasonably refusing to award competitive franchises for video service. The FCC found that many local franchising regulations were “unreasonable barriers to entry” in the video market and were “discourage[ing] investment in the fiber-based infrastructure necessary for the provision of advanced broadband services.” The unreasonable regulations included excessive build-out mandates, the inclusion of non-video revenue in franchise “fees” (including advertising fees), and demands unrelated to the provision of video service. The FCC has since reported that 20 states have enacted statewide video franchising laws to streamline the delivery of video service.

PIC advocates opposed this deregulatory decision when it was made and continue to oppose it. When the FCC announced its decision, Harold Feld, then Senior Vice President of the Media Access Project, said preempting local franchise regulation would “deprive the public of the best way to guarantee that cable providers and competitors meet the needs of their local communities.” When states began implementing the decision through statewide franchising laws, Sascha Meinrath, Director of the New America Foundation’s Open Technology Institute, attacked such legislation for providing build-out waivers even when developments are “inaccessible using reasonable technical solutions.” Despite evidence of significant competitive entry in the video market since the FCC preempted unreasonable local franchising regulations, many PIC advocates still believe deregulation has had no positive impact.

This brief history of video franchising isn’t merely academic. Absent deregulation of local franchising in Kansas City, Google Fiber’s business model wouldn’t have been possible. When Time Warner Cable became the principal video service provider in the Kansas City market decades ago, its franchise required that it build its network to virtually every neighborhood, including areas that pose geographic challenges and neighborhoods where residents are less likely to subscribe. A monopolist can fund (i.e., cross-subsidize) uneconomic construction by raising prices in other neighborhoods. In a competitive market, however, cross-subsidization mandates typically inhibit entry. For example, New York City delayed Verizon’s FiOS deployment for nearly a year while the city negotiated a requirement that Verizon build its network in all five boroughs of the city.

In Kansas City, Google doesn’t have a build-out requirement. It will offer service only to neighborhoods that demonstrate their potential to cover the costs of construction. Google divided Kansas City into a number of small neighborhoods and then cherry picked the areas where it would be willing to offer service. It then set preregistration goals for these neighborhoods based on their size, density, and ease of construction. Eligible neighborhoods have six weeks to meet their preregistration goals. If they don’t, Google won’t construct its network in that area. In neighborhoods that are more expensive to build,Google says it wants to make sure that enough residents want its service before committing capital to network construction. There is “no need to dispatch crews and rip up asphalt in pursuit of a handful of potential customers when Google can laser in on the most eager concentrations of subscribers.”

Although it wasn’t required to obtain a municipal franchise, Google received stunning regulatory concessions and incentives from local governments, including free access to virtually everything the city owns or controls: rights of way, central office space, power, interconnections with anchor institutions, marketing and direct mail, and office space for Google employees. City officials also expedited the permitting process and assigned staff specifically to help Google. One county even offered to allow Google to hang its wires on parts of utility poles – for free – that are usually off-limits to communications companies.

The key element for Google was that Kansas City officials promised to stay out of the way. When Google’s vice president of access services, Milo Medin, was asked why Google chose Kansas City for its fiber deployment, he said, “We wanted to find a location where we could build quickly and efficiently.” In his testimony before Congress last year, Medin emphasized that “regulations – at the federal, state, and local levels – can be central factors in company decisions on investment and innovation.” Based on his experience with Google Fiber, he concluded that government regulation “often results in unreasonable fees, anti-investment terms and conditions, and long and unpredictable build-out timeframes” that “increase the cost and slow the pace of broadband network investment and deployment.”

Second Lesson Learned: Specialized Video Services Support Fiber Deployment

The second lesson Google learned from its fiber project: Specialized video services help support the costs of fiber deployment.

In its order preempting unreasonable local franchise regulations, the FCC found that broadband deployment and video entry are “inextricably linked,” because broadband providers require the revenue from video services to offset the costs of fiber deployment. The FCC affirmed this finding in its 2010 net neutrality order, which exempted “specialized services”, including Internet Protocol-based video offerings, from net neutrality regulations. The FCC recognized that specialized video services “may drive additional private investment in broadband networks and provide end users valued services” that support the open Internet.

The Google Fiber business model indicates the FCC was right – specialized video services do help support the costs of fiber deployment. When it initially announced its fiber project, Google did not intend to offer specialized video services at all. Little more than a year ago, Google remained focused only on Internet connectivity and still had no plans to provide video services; though it said it wanted to “hear from Kansas City residents what additional services they would find most valuable.” By the time it launched the project, Google had decided to center its highest subscription rate on a new, specialized video service (Google Fiber TV) that Google says is “designed for how you watch today and how you’ll watch tomorrow.” It appears that, after listening to Kansas City residents, Google learned that many consumers want their ISP to offer specialized video services.

PIC advocates generally oppose any form of specialized service based on IP, especially video services. Less than a week after Google launched its own, IP-based video service, Public Knowledge filed a petition at the FCC arguing that Comcast’s specialized Xfinity video service is discriminatory and illegal. Although the petition is based on conditions imposed on the Comcast/NBC-Universal merger, Public Knowledge says the service may violate the FCC’s net neutrality rules as well.

Third Lesson Learned: Equipment Subsidies Offer Benefits to Consumers

The third lesson Google learned from its fiber project: Equipment subsidies coupled with term contracts offer benefits to consumers.

The Google Fiber business model also embraces the standard communications industry practice of offering consumers subsidized equipment in exchange for term contracts. Consumers who opt for “The Full Google Experience” will get four devices, including a set-top box, a network box, a storage box, and a new tablet for use as a “remote control”, subject to a two-year contract.

Bundling branded set-top boxes and other devices is standard practice in the video industry, but Google’s approach is new in at least one respect: The tablet is a Google Nexus 7 running Google’s Android OS, a powerful computing device that is capable of far more than controlling a television set. Google is also offering the option of buying a “Chromebook” laptop for as little as $299 – slightly less than the amount of the “construction fee” Google is waiving for premium customers. By bundling its own, vertically integrated computing devices with its premium service, Google can leverage its fiber network to gain market share from the makers of other devices, software, and operating systems, including Apple and Microsoft.

Though I think it’s a savvy move that could have a long-lasting impact on the communications marketplace, I’m surprised that the PIC has said nothing about this new wrinkle on device bundling. On March 30, 2012, Public Knowledge released a paper asserting that subsidized video devices harm innovation. The paper says innovation suffers because it’s easier to attach devices provided by the video service provider, and most consumers “just find it simpler to settle for whatever device their cable company offers.” It also contends that the subsidized device model is unusual, and notes “no one rents their computer from their ISP.” I suppose that’s still true. Google isn’t renting the Nexus 7 – it’s giving it away (and subsidizing the Chromebook by waiving the construction fee).

Fourth Lesson Learned: Open Access Isn’t Viable in Competitive Markets

The fourth lesson Google learned from its fiber project: Open access isn’t a viable business model in competitive markets.

When Google originally announced its intention to build its fiber network and operate it on an “open access” basis, Susan Crawford said we would “learn how easy it is” to allow competitive access to fiber networks and how little such networks cost. What we actually learned from Google Fiber is that “open access” isn’t a viable business model in a competitive market. Once Google analyzed how fiber networks are financed, built, and operated, it abandoned its earlier commitment to open access and decided not to allow other ISPs on its network. According to Google Fiber project manager Kevin Lo, “We don’t think anybody else can deliver a gig the way we can.” Translation: Open access doesn’t make financial sense in a competitive environment.

It’s still possible that Google could open its network to other ISPs in the future, but I suspect that in short term, Google’s reversal will dampen, if not extinguish, the PIC dream of open access networks in competitive markets.

Fifth Lesson Learned: Vertical Integration Offers an Alternative to the End-to-End Principle

The fifth lesson Google learned from its fiber project: Vertical integration among “edge” and “infrastructure” providers offers an alternative to the “end-to-end” principle.

The elements of Google Fiber’s business model discussed so far affirm existing industry practice (and free market regulatory theory). In one respect, however, the Google model differs significantly from industry practice. Google is offering free Internet service, albeit limited to 5 Mbps, for seven years to customers who pay the “construction fee.” That speed is just fast enough to support Google’s primary advertising business, including the delivery of video advertisements, but just slow enough to avoid cannibalizing Google Fiber’s premium Internet and video services.

Even so, some analysts predict Google will lose money on its free service. So why would Google offer it? Because Google’s “core advertising business is so powerful, dominant and profitable that it can subsidize almost everything else the company does, using Free to get customers in new markets.” Chris Anderson, the author of “FREE: The Future of a Radical Price,” has asked whether that’s fair when Google’s competitors don’t have a similar golden goose. Google’s response: “If a company chooses to use its profits from one product to help provide another product to consumers at low cost, that’s generally a good thing” (in the absence of tying arrangements).

On its own, Google’s willingness to subsidize broadband access to promote its advertising services might be unremarkable. But, when combined with its provision of a “free” Nexus 7 table and a subsidized Chromebook, it suggests that Google is willing to explore alternatives to the pure end-to-end Internet religion (practiced by PIC advocates and tech evangelists) in favor of a vertically integrated approach. The end-to-end purist believes core network infrastructure should be economically severed from the “edge” of the network, i.e., that Internet access should be offered entirely separately from the services, devices, applications that use network infrastructure. Strict adherence to this principle would prohibit the subsidization of network architecture by profits derived from services (e.g., specialized video and advertising), devices, and applications. Google was thought to be an end-to-end purist, but, assuming that were once true, it appears the company’s views have shifted.

What if large Internet “edge” companies – Google, Apple, and Microsoft – were vertically integrated with the large infrastructure providers – Comcast, Verizon, and AT&T? If the government allowed that to happen, it’s possible that the enormous profits generated by the edge companies (Apple is one of the most valuable companies in the world) would be used to rapidly drive ultra high-speed network deployment rather than fill cash coffers in offshore banks. Google is sitting on $43 billion overseas. Apple has more than $81 billion and Microsoft has $54 billion. By comparison, Verizon currently has about $10 billion in cash, which is less than one quarter of Google’s overseas holdings.

The reality of the Internet economy is that the “edge” generates more revenue than the “core”. In 2011,Comcast produced $8.7 billion in revenue from the sale of high-speed Internet access service. Google produced $37.9 billion in revenue, 96 percent of which was derived from advertising services.

While Google and other edge companies are content to let massive profits sit overseas, America’s network owners are reinvesting their capital in America. AT&T and Verizon ranked first and second, respectively, among U.S.-based companies by their U.S. capital spending in 2011, with Comcast coming in eighth. Google and Apple were ranked 24th and 25th, respectively, with approximately $2 billion in U.S. capital spending each. In 2011, AT&T alone invested ten times that much capital ($20.1 billion) in America. If companies like Comcast, Verizon, and AT&T had access to edge company capital, it could create a new broadband boom.

I’m not sure the edge companies are interested in a vertical integration model, and I’m reasonably certain the current administration wouldn’t allow it. But, now that Google has dipped its toes in the water, it might be a discussion worth having.