Using the Telecommunications Act to Regulate the Net

The Internet is a network of networks. It makes extensive use of traditional telecom infrastructure, notably leased lines from various telecom carriers for the “backbone,”¹⁷ and local exchange networks. It is not surprising, therefore, that telecom regulation, though focused largely on telephony, has affected the Net. Although the effect of this regulation has not (yet) been of great direct importance, it has been of considerable indirect importance and may become of more direct importance in the future if the Net becomes a closer substitute for traditional telecoms.

Background: recent
developments in
telecommunications regulation

Since 1979, the CRTC has taken a long series of steps moving toward more competition, albeit subject to (some) regulation; and deregulation of certain markets via selective forbearance, exemption, and the ending of regulation (see a summary in Stanbury, 1998b). This has been done on a market-by-market basis, e.g., first with private lines, then terminal attachment, then domestic long distance,¹⁸ then local exchange service, and finally Canada-overseas services.¹⁹

Rate re-structuring in Canada has been going on for over a decade. The amount of contribution levied per minute of long distance traffic has fallen, as has the total amount of this contribution transferred to subsidize local service. Local rates have been reduced for business lines in the largest cities, but have been increased in smaller ones. There has been some shifting of business and residential rates closer to their relative costs.

The introduction of competition and liberalization of the regulation of international services has been pushed by the World Trade Organization’s Basic Telecommunications Services Agreement, which went into effect on February 5, 1998. Competition on Canada-overseas routes²⁰ has been promoted only in the past few years by switched hubbing, which was “ratified” by the CRTC in the rehearing of Telecom Decision 97-10 in December 1997 (see CRTC, 1997g).

There has been a large drop in the price of long distance telephony²¹ over the past decade in Canada, particularly after resellers were allowed in the domestic market in 1990 and facilities-based competition was permitted in 1992. There has been a vast increase in the capacity of telephone “wires” by using fibre optic cables instead of microwave transmission or traditional copper wires. The cost of telephone switching has benefited from the huge drop in costs (per million instructions) of increasingly powerful microprocessors.

In addition, there has been a rapid growth in wireless local telephony (cellular) since it was introduced in 1984. The entry of Personal Communications Systems (PCS) (digital local wireless telephony) companies in 1997 has lowered the price significantly, as analog cellular suppliers face more competition.²² Improvements in wireless technology mean that it is possible to provide access to the Net via satellite.²³ At this point the market is limited by the cost of equipment and the tariff for service, but all this may change in the near future.

I turn now to a discussion of how CRTC telecom regulation has affected the Internet, directly and indirectly.

Bell Canada and the ISPs

A short-lived “battle” between Bell Canada and the ISPs (between November 1995 and August 1996)²⁴ illustrates the importance of the tariff local exchange carriers (LECs) charge for connecting ISPs to the local exchange network. It is said to constitute the largest single cost category for ISPs, and illustrates the possibility of a vertical squeeze by the incumbent monopoly LECs.²⁵

In November, 1995 Bell Sygma introduced “Sympatico,” an Internet access service sold by Bell Canada, in competition with ISPs. As at that time, the cable companies had not entered that market, it was made up of many small, independent operators. Most were steeped in the culture of the Net and failed to appreciate the key role the telcos play as a supplier.

The problem came about when Bell engineers discovered that some new Centrex customers (who were ISPs) were putting an unusually heavy load in the local network. The engineers said that the higher information service access line (ISAL) tariff should apply. The difference in Toronto was $22.60 to $39.00 per month versus $85.50 (Ian Angus, 1996c).

The ISPs were horrified when they learned of the price increase. They immediately spread the word over the Net and got organized, e.g., Responsible Internet Service Providers. The new groups very quickly began to target the CRTC²⁶ and Industry Canada. In the meantime, the issued moved up the hierarchy at Bell. Senior executives quickly moved to meet up with RIBC and other ISP groups, and consultant Ian Angus was brought in to mediate.

In the a few months, a “win-win” solution was found: the price ISPs paid for access to the local network was not increased, and Bell filed new tariffs (including the elimination of the ISAL tariff), which were approved by the CRTC in September 1996. Bell’s revenues were reduced because the ban on “undue discrimination” meant that existing customers on the ISAL tariff and (e.g., banks, universities, etc.) were able to use Centrex or ISP-Link at lower rates (Angus, 1996d).

Very limited regulation of ISPs

An ISP is needed by most persons who want access to the Net.²⁷ At present there are five types of ISPs: independent ISPs, which tend to be small, local businesses; Telesat Canada satellite service for one-way access²⁸; local telcos, i.e., one of the nine members of the Stentor alliance, which may bundle Net access with local and possibly long distance telephony²⁹; cable TV operators, e.g., Rogers “Wave” using coaxial cable; and subscription networks like America Online. Two other suppliers of Net access are in the wings: wireless operators, including MMDS,³⁰ and LMCS,³¹ and entrant LECs like MetroNet.³²

In a series of decisions, the CRTC decided to forbear from regulating the provision of end-user access to Internet services by telephone companies under s.34 of the Telecommunications Act. This forbearance was unconditional if the telco had split its rate base pursuant to Telecom Decision 95-21, as had Telus Communications, NB Tel, Telus Communications (Edmonton) and NewTel Communications.³³ In Telecom Order 97-471 regarding NBTel and Telus Communications, the Commission said that Internet access markets “exhibit all the characteristics of a highly competitive market” and that “barriers to entry … are very low.” Further, “all the underlying telecommunications transmission facilities are available at tariffed, non-discriminatory rates “and there are “adequate safeguards” against cross subsidies and predatory pricing.”

In Telecom Order 98-929, the CRTC (1998f, par 21) held that only internet access lines (IAL) provided by an LEC carrying PSTN  voice traffic are subject to contribution, and that if an IAL is used to carry any local or interexchange public switched telephone network (PSTN) voice traffic, then all traffic on that line is required to pay contribution. Internet protocol data traffic is exempt from paying contribution. The CRTC recognized that this ruling may need to be revisited in light of technological change.

The CRTC set out the information to be filed by ISPs with a telco or competitive LEC to support exemptions within a lighter regulatory regime (CRTC, 1998f, par. 31-33. ISPs which provide Internet access and PSTN. Voice (“real time” voice communication via the Internet where the conversion or carriage is performed by the ISP) at the same location will not be included in the lighter regime. Thus they still must file a technical audit to satisfy the CRTC that its use of the local carrier’s circuits warrants an exemption.

Bell’s TelecomLink Plan:
the importance of flat monthly rates for local service

Extensive use of the Net is encouraged by the traditional pricing structure for local exchange service in Canada, namely that it is a fixed amount per month for businesses or residences regardless of the volume of use. However, the amount of infrastructure in the local exchange territory (lines and switching capacity) depends on the average duration of calls and calling volumes during the day. While a typical local call is three minutes, people surfing the Net tie up a line for an average of 20 minutes, and some connections last for hours. Obviously, the pricing of access to the Net depends on the pricing of local service.

On May 31, 1995, Bell Canada proposed Local Measured Service (LMS) for business customers under the name “TelecomLink.”³⁴ The CRTC responded with Public Notice 95-33.³⁵ Almost immediately, an ad hoc group (Halt All Local Tolls or HALT) was established to oppose Bell’s move. (see Globe and Mail, June 2, 1995, p. B8). In the August 1995 issue of Telemanagement, editor Ian Angus (1995a) provided 20 arguments against Bell’s plan. Among other points, he said that administrative costs would be high; a sliding scale would be more consistent; local usage costs were declining; the plan was based on the wrong measurement; the rates were not cost-based; the usage rates were arbitrary; and very importantly for electronic commerce, Bell’s plan would impose a tax on transaction services.

On July 27, 1995, Bell responded to the interest group/customer pressure by modifying its plan to offer business customers a choice of flat rate service or a usage-sensitive pricing effective July 1, 1997 (see Globe and Mail, July 28, 1995, p. A2). Then, on December 21, 1995, Bell Canada submitted to the CRTC a two-phase plan for changes in local rates for business customers, under which they would still have the option of a flat monthly rate (Financial Post, December 22, 1995, p. 2). Later, Bell abandoned LMS (Ian Angus, 1997a).

The CRTC and internet telephony: the contribution issue

On May 1, 1997, the CRTC (1997a) decided that it would not be appropriate to extend to Net services the tax (called “contribution”) imposed on all long distance carriers and resellers, and which is paid to the suppliers of local exchange service. At the same time, the CRTC enunciated the following general policy position: “where the Internet network is used as the underlying transmission facility by a service provider to provide public switched inter-exchange voice or data service, the service provider is to register as a reseller and pay contribution” (CRTC, 1997a).

Subsequently, a new company, Shadow Tel Communications Inc., sought an exemption from contribution payments for a network used to supply voice and data communications services over a frame relay network with public access gateways to the PSTN. It argued that it was offering a “value-added” service and so should be exempt. The CRTC (1998a) disagreed, saying that Shadow Tel is “providing public switched interexchange voice services, albeit over the Internet.” Thus it had to register as a reseller and pay contribution (about four cents per minute).

As Intven et al. (1998, p. 9) point out, the CRTC did not attempt to define the key terms. Nor did it make a distinction between voice over the PSTN and the Net in terms of quality of service, in effect saying that the quality of service is irrelevant.

As noted in the section “Very Limited Regulation of Service Providers,” the CRTC (1998f) has created a streamlined contribution exemption for ISPs. However, in the rapidly evolving technology of communications and computers, the CRTC may not be able to maintain such traditional distinctions as telephone and computer (i.e., telephone-based long distance voice service versus PC-based Net voice services), voice and data (both are just a stream of bits when digitized), and circuit-switched (telcos are using the latter which is the Net protocol).

Intven et al. (1998, p. 7) note that the CRTC has established separate regulatory regimes for Net data transmission and Net applications which provide alternatives to long distance calls over the PSTN; the former being exempt from the contribution “tax,” and the latter not. This distinction, “in many respects … has been made in advance of a market” (Intven et al., 1998, p. 8). It could stifle or distort the evolution of certain new markets.

Imposing even a modified form of contribution tax on ISPs would likely generate a strong political backlash. Two sacred cows, on old and one new, would be in collision (subsidized cross-local service and “free” communications on the Net, at least at the margin).

Internet telephony: threat
and opportunity

The Internet permits the transmission anywhere in the world at very low cost of any file which can be digitized. Thus, the following are transmitted:

• e-mail (substitute for regular or “snail” mail, fax, and some voice calls),
• text or data file attachments (substitute for fax, courier, snail mail),
• graphics files,
• video files,
• sound files,
• data files in the form of computer software, e.g., Netscape Navigator, Adobe Acrobat, and
• executable files such as Java applets.

The Internet provides a substitute (albeit not a perfect substitute) for conventional long distance telecom carriers. Already e-mail attachments are substituting for fax and fax over the Net is substituting fax over the telephone network (see Blackwell, 1998c). Vast amounts of data are moving over the Net rather than through the telcos networks. And voice over the Net could become a serious threat to the telcos.

Telephony over the net

At present, the Internet protocol (packet-switching) is better for fax and data than for voice calls.³⁶ There are two alternatives for voice calls. First, Voice-over-IP, in which the Internet protocol is used for voice calls handled by an ISP. There is little saving for calls within North America, as contribution must be paid. But there is a greater advantage when the ISP is used as a gateway for international calls. Second, Voice-over-Internet, where the caller routes the call. While this technology is improving rapidly (see Savetz & Sears, 1996a, 1996b),³⁷ there are still two key disadvantages: the receiver and caller need the same software, and the receiver’s computer must be on when the call is made. See Ian Angus (1998a).

Internet phone calls in 1998 cost an average of US 6.5 cents per minute (Bloomberg, 1998, p. D11). Domestic long distance voice calls within the US and Canada are easily available at about 10 cents per minute, particularly off-peak.³⁸

The economic advantage of Internet-based telephony appears to have three parts: lower switching costs; lower transmission costs; and at this point, Internet based telephone carriers don’t pay access charges in the US (but they must pay “contribution” charges in Canada).

With respect to switching costs, the ITU estimates that it costs US 15 cents to switch a kilobyte of data using traditional means, but only four cents using the Internet packet switching method of transmission (Naik, 1997, p. B4).

With respect to transmission costs, the Internet protocol makes far more intensive use of the network leased lines plus parts of the PSTN:

With conventional [telephone] systems, calls are connected through a switch that makes a link between the caller’s and recipient’s phone lines. As long as the conversation continues, no one else can use the same lines. But with Internet telephony, something very different happens. Every spoken word is broken up into scores of “packets,” tagged with the destination address, and allowed to take whatever easy route they can find to the recipient’s phone.

Once the packets arrive—often in a split second—they are instantly reassembled in the original order and emerge as the same spoken word. This technique allows an Internet-based offering to use fiber-optic lines far more efficiently—and hence cheaply—than today’s standard phone method. (Naik, 1997, p. B4)

With respect to access charges, the traditional telcos are trying to convince the FCC that suppliers of telephony over the Net be required to pay access charges.

“The odds are high that the [FCC] will impose access charges,” said William Deatherage, an analyst at Bear Stearns & Co. BellSouth Corp. already is taking issue with the lack of access fees, which are levied to cover the regional Bells’ cost of completing long-distance companies’ calls and can add as much as 10 cents a minute to the price of a phone call. The Atlanta-based Baby Bell said it soon will begin charging Internet phone companies to complete their calls, just as it does long-distance providers. (Bloomberg, 1998, p. D11)

The price differential between international and domestic calls, particularly in North America, provides the greatest economic incentive for using the Net for telephony. For example, international calls outbound from the US cost an average of about US $1.00 per minute in 1997, while domestic long distance calls could easily be had for 10 cents per minute. Even if voice calls over the Net are inconvenient, and of lower quality, a price of a few cents per minute versus over $1 makes Internet telephony attractive.

How the Internet is shaking
up telecom

Ian Angus (1997c) identified four main ways in which the Internet is “shaking up telecom.” First, “Internet traffic transforms local traffic patterns.” The key problem is that while voice calls average three minutes, Internet connections average 20 minutes, but some people are online for hours at a time. This creates congestion in local networks. The local telcos face a Catch 22 situation. If they spend the money to expand/upgrade local networks they might get stuck with stranded investment after competition in local exchange services develops. If they don’t invest, they will lose Net traffic to rivals and new technologies, says Angus.

Second, “the Internet subverts global long distance.” The growth of the Net and its ability to handle data,³⁹ fax and voice (albeit in an rudimentary fashion and subject to notable limitations) means that “we now have two global networks, running over identical wires and connections to the same local access facilities, carrying identical content, with dramatically different cost structures. That can’t continue for long.” Exactly—that is why some new, rapidly growing long distance carriers are using the Net or the Internet protocol to lower their costs. That is why Sprint Corp. is transforming its network to handle all types of traffic, except that people will pay on the basis of the volume of bits they send or receive (see below).

Third, “the Internet is an alternative to the Intelligent Network.” The telcos claim that an intelligent network can deliver advanced services faster, more reliably and at lower prices than what customers can do for themselves (e.g., Centrex replacing a Post Branch Exchange (PBX)). But the Internet challenges this view. It focuses on delivering the bits while end-users could control routing, features and other things.

Fourth, “the Internet breaks down long-established categories for telecom policy, management and operation.” Local versus long distance has no meaning on the Net.⁴⁰ The width of the bit stream matters only in terms of the capacity of transmission paths, modems and storage devices. Broadcasting and telecom truly converge on the Net.⁴¹

Finally, Ian Angus (1997c) notes that “despite its phenomenal growth, the global Internet is still tiny, compared to the telephone network.” In September 1998, there were 148 million people on the Net, but over one billion people have access to a telephone.⁴² Further, the telcos provide most of the infrastructure for the Net (see Varian, 1998). The importance of the Net, however, seems to be much greater than its size.

Sprint’s new integrated on-demand
network

Net technology is influencing the telcos’ networks. For example, Sprint Corp. is about to change its telephone network in the US away from the “circuit-switch” design which holds a single channel open for the full duration of a call. Sprint proposes a closer integration of the telephone network and the Net.

Rather than use the traditional system of switching centres, Sprint’s new system employs components of the Internet age—high-speed switches, data-packet routers and optical fibre. It is scheduled to begin commercial operation later this year.

Sprint calls its system the “Integrated On-demand Network” or ION. The system would measure and bill for service based not on the number of minutes a person spends on the phone but on the number of digital bits the customer transmits in a given month. Usage would be measured by the little box that acts like an electric meter and is placed in a home or office. (Keller, 1998, p. A1)

Homes and businesses will be able to make voice calls, send faxes and e-mail, and download a video program simultaneously, using only an existing, single telephone line. Customers will be online all the time, and they will be using a modem which may be 100 times faster than dial-up access. People will only pay for what they use (i.e., per bit) and “unlimited bandwidth” is available on demand. Each user will have what amounts to an enhanced virtual private network. It is expected that the network cost of delivering a typical voice call will drop by over 70 percent.