Federal Communications Commission

Office of Plans and Policy

1919 M Street NW

Washington, DC 20554

OPP Working Paper Series

29 Digital Tornado: 

The Internet and

Telecommunications

Policy

March 1997

Note: The graphics associated with this document are not included in this WordPerfect version. An electronic copy

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http://www.fcc.gov/Bureaus/OPP/working_papers/oppwp29.pdf

Kevin Werbach*

*The analysis and conclusions of this Working Paper are those of the author, and do not necessarily represent the

views of other Commission staff, individual FCC Commissioners, or the Commission.
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487-4650.
Digital Tornado: The Internet and

Telecommunications Policy

Kevin Werbach*

Counsel for New Technology Policy

<kwerbach@fcc.gov>

Office of Plans and Policy

Federal Communications Commission

Washington, DC 20554

March 1997

OPP Working Paper No. 29

* Many people at the FCC provided advice, comments, and other assistance in the development of

this working paper. In particular, I would like to thank Robert Pepper, Elliot Maxwell, Greg

Rosston, Richard Metzger, David Sieradzki, and Karen Rose for reviewing earlier drafts, and

Chairman Reed Hundt for his leadership on Internet issues. The analysis and coclusions of this paper

do not necessarily represent the view of other FCC staff or the Commission.
CONTENTS

Executive Summary i

A. Background .................................................... i

B. Summary of Contents ............................................ iii

C. The Government Role ............................................ v

I. Introduction -- The Endless Spiral of Connectivity .......................... 1

A. How the Internet is Unique ........................................ 1

B. The Feedback Loop .............................................. 3

C. Threats to the Continued Spiral ..................................... 7

D. How Government Should Act ...................................... 8

II. What is the Internet? ................................................. 10

A. General Description ............................................. 10

B. An Extremely Brief History of the Net ............................... 13

C. How the Internet Works .......................................... 17

1. Basic Characteristics ....................................... 17

2. Addressing .............................................. 18

3. Services Provided Over the Internet ........................... 19

4. Governance and Management ............................... 20

D. Development of the Internet Market ................................ 21

1. The Internet Today ........................................ 21

2. Internet Trends ........................................... 22

III. Category Difficulties ................................................. 26

A. FCC Authority Generally ........................................ 26

B. Telephony .................................................... 30

1. Legal Framework ........................................ 30

a. Carrier Obligations. .................................. 30

b. Basic vs. Enhanced Services ......................... 312.

Implications ............................................. 33

a. Section 251 Interconnection Obligations .................. 33

b. Section 254 Universal Service Obligations ................ 35

c. Internet Telephony .................................. 36

C. Broadcasting and Cable .......................................... 41

D. Relationship to Content .......................................... 43

E. Administrative Issues ........................................... 45

F. Toward a Rational Approach ...................................... 46

IV. Pricing and Usage ................................................. 48

A. Current Pricing Structure ........................................ 48

B. Network Economics ............................................ 52

C. Implications for Local Exchange Carriers ............................ 54

1. Pricing Issues ............................................ 56
2. Switch Congestion ........................................ 58

3. Responses to Switch Congestion .............................. 61

a. Pricing Changes .................................... 62

b. Technical Solutions .................................. 66

4. State Tariffing Issues ...................................... 71

5. Competitive Dynamics ..................................... 71

V. Availability of Bandwidth ............................................. 73

A. Deployment and Pricing of High-Speed Access Technologies ............. 74

B. The ISDN Case Study ........................................... 76

C. Universal Service and Advanced Access Technologies .................. 78

VI. Conclusion ......................................................... 82

A. The Internet and Competition in Telecommunications ................... 82

B. The Right Side of History ........................................ 84

Appendix A: Internet Architecture Diagram
DIAGRAMS

Figure 1 The Internet Spiral ............................................. 4

Figure 2 Conceptual Overview of the Internet ............................... 11

Figure 3 NSFNET Architecture .......................................... 14

Figure 4 Internet Growth Projections ..................................... 23

Figure 5 What is the Correct Analogy? .................................... 27

Figure 6 Internet vs. Conventional Telephony ............................... 37

Figure 7 Current Dial-Up Internet Access Pricing ............................ 49

Figure 8 Typical Dial-Up Internet Architecture .............................. 55

Figure 9 LEC Internet Usage Studies ..................................... 59

Figure 10 Some Solutions to Switch Congestion .............................. 68

Figure 11 Major End-User Internet Access Technologies ....................... 75

Internet Architecture ................................... Appendix A
 Telecommunications Act of 1996, Pub. L. No. 104-104, 110 Stat. 56, to be codified at 47 U.S.C. §§ 151 et. seq 1

(1996 Act), at § 230(b)(2). Hereinafter, all citations to the 1996 Act will be to the 1996 Act as codified in the

United States Code.

A Framework for Global Electronic Commerce, available on the World Wide Web at 2

<http://www.whitehouse.gov>. 

i

Executive Summary

A. Background

The Internet, from its roots a quarter-century ago as a military and academic research tool,

has become a global resource for millions of people. As it continues to grow, the Internet will

generate tremendous benefits for the economy and society. At the same time, the Internet poses

significant and difficult questions for policy makers. This working paper examines some of

these emerging issues at the intersection of technology, law, economics, and public policy. 

The United States federal government has long been involved in the development of the

Internet. Through research grants, and by virtue of its status as the largest institutional user of

computer services in the country, the federal government played a central role in bringing what

we now call the Internet into being. Just as important, the federal government has consistently

acted to keep the Internet free of unnecessary regulation and government influence. As the

Internet has matured and has grown to support a wide variety of commercial activity, the federal

government has transitioned important technical and management functions to the private sector. 

In the area of telecommunications policy, the Federal Communications Commission (FCC) has

explicitly refused to regulate most online information services under the rules that apply to

telephone companies. 

Limited government intervention is a major reason why the Internet has grown so rapidly

in the United States. The federal government's efforts to avoid burdening the Internet with

regulation should be looked upon as a major success, and should be continued. The

Telecommunications Act of 1996 (1996 Act) adopts such a position. The 1996 Act states that it

is the policy of the United States "to preserve the vibrant and competitive free market that

presently exists for the Internet and other interactive computer services, unfettered by Federal or

State regulation," and the FCC has a responsibility to implement that statute. The draft 1

"Framework for Global Electronic Commerce" developed by the White House with the

involvement of more than a dozen federal agencies, similarly emphasizes the need to avoid

unnecessary government interference with the Internet.2

This working paper addresses three overlapping telecommunications policy areas that

relate to the Internet: law, economics, and public policy. Legal questions arise from the

difficulty in applying existing regulatory classifications to Internet-based services. Economic
ii

questions arise from the effects of Internet usage on the telecommunications infrastructure, and

the effects of the telecommunications infrastructure on the Internet. Public policy questions

arise from the need to maximize the public benefits that the Internet brings to society. 

The Internet is a fluid, complex entity. It was designed to route around obstacles, such as

failures at central points of the network, and it may respond in unexpected ways to pressures

placed on it. It has developed largely without any central plan, especially in the past several

years as the U.S. government has reduced its management role. It overcomes any boundaries

that can be drawn, whether rooted in size, geography, or law. Because the Internet represents an

ever-growing interconnected network, no one entity can control or speak for the entire system. 

The technology of the Internet allows new types of services to be layered on top of existing

protocols, often without the involvement or even the knowledge of network providers that

transmit those services. Numerous users can share physical facilities, and the mix of traffic

through any point changes constantly through the actions of a distributed network of thousands

of routers. 

The chaotic nature of the Internet may be troubling for governments, which tend to value

stability and certainty. However, the uncertainty of the Internet is a strength, not a weakness. 

With decentralization comes flexibility, and with flexibility comes dynamism. Order may

emerge from the complex interactions of many uncoordinated entities, without the need for

cumbersome and rigid centralized hierarchies. Because it is not tied to traditional models or

regulatory environments, the Internet holds the potential to dramatically change the

communications landscape. The Internet creates new forms of competition, valuable services for

end users, and benefits to the economy. Government policy approaches toward the Internet

should therefore start from two basic principles: avoid unnecessary regulation, and question the

applicability of traditional rules.

Beyond these overarching themes, some more specific policy goals can be identified. For

the FCC in particular, these include the following.

Promote competition in voice, video, and interactive services.

In passing the 1996 Act, Congress expressed its intent to implement a "pro-competitive

deregulatory national communications policy." The Internet provides both a space for

innovative new services, as well as potential competition for existing communications

technologies. The FCC's role will be to ensure that the playing field is level, and that

efficiency and market forces drive competition. 

Facilitate network investment and technological innovation.

The Internet encourages the deployment of new technologies that will benefit consumers

and produce jobs. The Commission should not attempt to pick winners, but should allow

the marketplace to decide whether specific technologies become successful. By

eliminating regulatory roadblocks and other disincentives to investment, the FCC should

encourage both incumbents and new entrants to develop innovative solutions that transcend

the capabilities of the existing network.
iii

Allow all citizens to benefit from advanced technologies.

The communications revolution should benefit all Americans. In an age of new and

exciting forms of interactive communications, the FCC should ensure that entities such as

schools and libraries are not left behind. However, the mechanisms used to achieve this

goal should be consistent with the FCC's broader policies of competition and deregulation. 

B. Summary of Contents

This working paper reviews some of the major Internet-related issues that have already

come before the Commission, as well as those that may come before the FCC in the near future. 

This paper is not intended to be a comprehensive overview of every Internet topic that has

implications for the FCC. I have focused on issues where I believe the Internet raises the most

immediate questions for telecommunications policy, and especially those that have already been

raised in FCC proceedings. Beyond those discussed in this paper, there are several other topics

of great importance to the development of the Internet that may have implications for the FCC. 

These include: Internet governance (such as the allocation of domain names), intellectual

property, network reliability, privacy, spectrum policy, standards, and security. By omitting

these issues, I do not suggest that they are of less importance to the government or the private

sector. The underlying policy recommendations of this paper are applicable to all Internet issues

that come before a government agency such as the FCC, although specific subjects may require

individualized consideration. 

Because this paper is about the role of the FCC, it focuses almost entirely on the United

States. The FCC's decisions depend on the specific legal and economic structures that govern

the communications industry in this country. Likewise, the United States experiences more

acutely many of the challenges the Internet generates, because this country has by far the largest

percentage of the Internet's infrastructure and traffic. The Internet, however, is a global

network. The essential characteristics that make the Internet so valuable, and also so difficult to

understand in the context of traditional telecommunications policy, are relevant worldwide. 

Some Internet issues may best be addressed in international fora, and this paper does not suggest

that all the issues described should be resolved by the United States government alone. 

With these caveats in mind, the paper seeks to develop a consistent public policy approach

for issues involving the Internet and telecommunications policy.

Section I provides a framework for understanding the dynamism of the Internet, and the

fundamental forces that propel it. This section propounds the notion of the Internet as feedback

loop, a constantly expanding spiral that creates the conditions for its further growth. The Internet

spiral is driven by four factors. First, "deep convergence," which represents the impact of digital

technology in breaking down barriers between different services and networks. Second, the

interaction of Moore's Law (progressively higher computing power at a given cost) with
iv

Metcalfe's Law (progressively more value to being connected to a network), combined with

increasing network bandwidth, leads to plummeting costs and soaring performance for the

Internet's underlying facilities. Third, through "the magnetism of money and minds," the market

rewards innovation by attracting both the people and the financing necessary for further

innovation. Fourth, unfettered competition pressures companies to take advantage of market

opportunities and to utilize more efficient technologies. 

Envisioning the Internet as a feedback loop leads to three recommendations for

government policy. First, government should seek scalability, not just stability. Government

policy should be forward-looking, recognizing that the Internet will continue to grow and

evolve, and should not attempt to impose on the Internet the familiar limitations of traditional

communications technologies. Second, government should swim with the current. In other

words, government should harness the tremendous potential of the Internet to help achieve

public policy goals. The challenge is to meet the exploding demand for bandwidth, not to

restrain it. Third, government should promote the Network, not networks. Rather than focusing

on individual companies or industries, government should create a climate that maximizes social

welfare.

Section II identifies the salient characteristics of the Internet. To understand how the

Internet affects and is affected by regulatory decisions, it is important to understand how

services are provided over the Internet, and to distinguish the Internet from other

communications technologies. This section also provides a brief history of the Internet, to place

the analysis of the current Internet in a proper context.

Section III examines whether existing FCC regulatory and statutory requirements should

apply to services provided over the Internet. The Commission has not yet confronted most of

these legal questions directly, although it has expressed reservations about applying traditional

rules to the Internet. However, the continued growth of the Internet and the development of

new, hybrid services make it likely that the FCC will need to resolve some of these issues. The

FCC's current division between "basic" and "enhanced" services, and the statutory definitions of

entities such as "telecommunications carriers" and "broadcasters," provide only limited guidance. 

The paper recommends that government exercise caution in imposing pre-existing statutory and

regulatory classifications on Internet-based services. The FCC should begin by identifying

Internet services that clearly lie outside the scope of traditional regulatory requirements, so as to

minimize market uncertainty while it confronts the more difficult categorization issues.

Section IV looks at the economics of Internet usage. The growth of the Internet pressures

not only the current regulatory regime, but also the physical networks that carry Internet traffic. 

The FCC oversees the most of the underlying communications facilities upon which the Internet

depends, including the public switched telephone network. FCC decisions on the pricing of

traditional telecommunications services significantly impact the Internet, even as the growth in

Internet usage itself affects the voice network. The debate in this context should focus on the

future of the network. The FCC should strive to give companies market-efficient incentives to

build high-capacity, high-performance networks that are optimized for data transport. This
v

approach will allow the operation of the market and technological development to resolve

difficulties such as congestion and limited bandwidth. 

Section V considers the extent to which users can take advantage of the Internet. The FCC

has for decades promoted "universal service" in telecommunications, and the emergence of the

Internet requires a reassessment of how that responsibility should be interpreted today. The

value of the Internet largely depends on the level of bandwidth that can be delivered to end

users. Many different technologies are being developed to permit higher-speed connections than

are currently affordable for most consumers. In addition, certain institutions, such as schools

and libraries, as well as users who would otherwise be unable to access the Internet, should be

able to benefit from the Global Information Infrastructure. 

Section VI concludes by linking the Internet-specific issues with the FCC's overarching

efforts to facilitate competition in all communications markets. Competition is a theme that runs

throughout this paper. The technological shifts associated with the Internet dovetail with the

communications industry's transition from regulated monopolies to a world of overlapping

competitive firms. In the end, successfully opening the communications sector to competition

will likely be the greatest contribution that government can make to the development of the

Internet. 

C. The Government Role

This working paper is intended to explore issues and to facilitate discussion, not to propose

specific government actions. Many proponents of the Internet's development are wary of any

government actions directed toward the Internet. Government, however, has been intimately

involved with the Internet since the network's beginnings. Government decisions -- such as the

FCC's directive that Internet service providers not be subject to interstate access charges, and the

widespread requirement by state regulators that local calls be available at flat monthly rates --

continue to shape Internet development. Moreover, policy decisions are best made with

knowledge and comprehension of their potential implications. 

The goal of this paper, therefore, is to promote greater understanding, on the part of both

government and the private sector, of the unique policy issues the Internet raises for the FCC and

similar agencies. The discussion of a topic is not a suggestion that government regulation in that

area is necessary or desirable. On the contrary, a fundamental position of this paper is that

government should work to avoid unnecessary interference with the Internet's development.

Government may influence the evolution of the Internet in many ways, including directly

regulating, participating in technical standards development, providing funding, restricting anticompetitive behavior by dominant firms, facilitating industry cooperation otherwise prohibited

by antitrust laws, promoting new technologies, encouraging cooperation between private parties,

representing the United States in international intergovernmental bodies, and large-scale

purchasing of services. The FCC and other government entities may also play a useful role

simply by raising the profile of issues and stimulating debate. A better understanding of the
vi

relationship between the Internet and telecommunications policy will facilitate intelligent

decision-making about when and to what extent any of these government actions are appropriate.
1

I. Introduction: The Endless Spiral of Connectivity

 Government officials, pundits, and market researchers often compare the Internet to

established communications technologies such as telephony and broadcasting. These efforts are

understandable. "Traditional" technologies have well-defined usage characteristics, growth

patterns, and market behavior. Moreover, the Internet physically "piggybacks" on other

networks, in particular the wireline telephone infrastructure. 

Drawing analogies between the Internet and traditional media makes it easier to decide

whether existing bodies of law or regulation apply to new Internet-based services. Thus, for

example, the debate over the constitutionality of the Communications Decency Act (CDA),

which seeks to restrict the transmission of indecent material over the Internet, has often boiled

down to a conflict of analogies. Opponents of the CDA have compared the Internet to a

telephone network, while supporters often describe the Internet as similar to broadcasting. 

Because telephone carriers are generally not legally responsible for the content routed over their

networks, but broadcasters may be subject to fines for transmitting inappropriate material, the

choice of analogy can predetermine the legal outcome. 

Although such analogies are appealing, most break down upon closer analysis of the

unique characteristics of the Internet. The Internet is substitutable for all existing media. In

other words, the Internet potentially poses a competitive threat for every provider of telephony,

broadcasting, and data communications services. At the same time, Internet-related businesses

are substantial customers of existing telephony, broadcasting, and data companies. The Internet

creates alternate distribution channels for pre-existing content, but more importantly, it permits

delivery of new and hybrid forms of content. The Internet is one of many applications that

utilize the existing telephone network. However, from another perspective, the telephone,

broadcasting, and cable networks are simply nodes of the larger network that is the Internet.

Thus, the Internet is fundamentally different from other communications technologies. In

most cases, simply mapping the rules that apply to other services onto the Internet will produce

outcomes that are confusing, perverse, or worse. Any attempt to understand the relationship

between the Internet and telecommunications policy must therefore begin with the distinguishing

aspects of the Internet.

A. How the Internet is Unique

The distinctiveness of the Internet derives in large part from its technical architecture,

which is described in greater detail in Section II. The Internet functions as a series of layers, as

increasingly complex and specific components are superimposed on but independent from other
 Tony Rutkowski, former Executive Director of the Internet Society, has written a more detailed discussion of the 3

implications of Internet architecture for the development of the network. See Anthony M. Rutkowski, "Internet as

Fractal: Technology, Architecture, and Evolution," in The Internet as Paradigm (Aspen Institute 1997).

See Amir Atai & James Gordon, Impacts of Internet Traffic on LEC Networks and Switching Systems (Bellcore 4

1996); Vadim Antonov, ATM: Another Technological Mirage, available on the World Wide Web at

<http://www.pluris.com/ip_vs_atm/>.

2

components. The technical protocols that form the foundation of the Internet are open and 3

flexible, so that virtually any form of network can connect to and share data with other networks

through the Internet. As a result, the services provided through the Internet (such as the World

Wide Web) are decoupled from the underlying infrastructure to a much greater extent than with

other media. Moreover, new services (such as Internet telephony) can be introduced without

necessitating changes in transmission protocols, or in the thousands of routers spread throughout

the network. 

The architecture of the Internet also breaks down traditional geographic notions, such as

the discrete locations of senders and receivers. The Internet uses a connectionless, "adaptive"

routing system, which means that a dedicated end-to-end channel need not be established for

each communication. Instead, traffic is split into "packets" that are routed dynamically between

multiple points based on the most efficient route at any given moment. Many different

communications can share the same physical facilities simultaneously. In addition, any "host"

computer connected directly to the Internet can communicate with any other host. 

A further distinguishing characteristic of the Internet is its fractal nature. Fractals are

derived from the branch of mathematics known as chaos or complexity theory. Fractals exhibit

"self-similarity"; in other words, a roughly similar pattern emerges at any chosen level of detail. 

Internet traffic patterns most clearly demonstrate the Internet's fractal tendencies. For traditional

communications networks (including the telephone network), engineers have over many years

developed sophisticated statistical models to predict aggregate usage patterns. Researchers have

shown that usage of the Internet follows not the traditional "poisson" pattern, but rather a fractal

distribution. In other words, the frequency of Internet connections, the distribution between 4

short and long calls, and the pattern of data transmitted through a point in the network tend to

look similarly chaotic regardless of the time scale.

The fractal nature of the Internet confounds regulatory and economic models established

for other technologies. However, as chaos theorists have shown, fractals have valuable

attributes. In a fractal entity, order emerges from below rather than being dictated from above. 

The fact that the Internet does not have an easily-identifiable hierarchy or any clear

organizational structure does not mean that all behavior is random. Many small, uncoordinated

interactions may produce an aggregate whole that is remarkably persistent and adaptable. 

Finally, the Internet has thus far not been regulated to the same extent as other media. The

Communications Act of 1934 (Communications Act), which created the Federal

Communications Commission to oversee telephony and radio broadcasting, is more than sixty
 For a thorough explication of various metaphors for the Internet, including the now well-worn notion of the 5

"Information Superhighway" coined by Vice President Albert Gore, see Mark Stefik, Internet Dreams:

Archetypes, Myths, and Metaphors (1996).

For an extended discussion of the significance for feedback loops and control mechanisms as they relate to 6

new technologies, see Kevin Kelly, Out of Control: The New Biology of Machines, Social Systems, and the

Economic World (1994). 

See infra section (IV)(B). 7

3

years old. By contrast, Internet service providers, and other companies in the Internet industry,

have never been required to gain regulatory approval for their actions. 

B. The Feedback Loop

If the Internet is not like any other established communications technology, what then is it? 

On one level, the Internet is whatever anyone wants it to be. It is plastic, decentralized, and

constantly evolving network. Any simple concept to describe the Internet will necessarily be

incomplete and misleading. Such templates are useful, however, to promote greater 5

understanding of aspects of the Internet that may not otherwise be obvious. 

For purposes of this paper, I believe it is valuable to understand the Internet as a feedback

loop. A feedback loop occurs when the output of a system is directed back into the system as an

input. Because the system constantly produces fuel for its own further expansion, a feedback

loop can generate explosive growth. As the system expands, it produces more of the conditions 6

that allow it to expand further. All networks are feedback loops, because they increase in value

as more people are connected. The Internet, however, is driven by a particularly powerful set of 7

self-reinforcing conditions.

 The tornado metaphor has been used by Paul Saffo, Eric Schmidt, and others to describe the Internet. 8

See Digitization and Competition (Computer Systems Policy Project 1996). 9

5

Figure 1 describes some of the interrelated factors that build upon each other to foster the

growth of the Internet. Some "supply" factors (such as the availability of higher-capacity

networks) permit an expansion of demand (for example, by allowing bandwidth-intensive

services such as high-resolution video transmission). Like a digital tornado, the vortex

continues, as the new level of demand creates the need for additional capacity, and so forth.8

The Internet feedback loop is a fundamentally positive force, because it means that more and

more services will be available at lower and lower prices. So long as effective self-correcting

mechanisms exist, the Internet will overcome obstacles to its future growth.

Understanding the underpinnings of the Internet feedback loop is necessary to craft policies

that facilitate, and do not hinder, its continuation. There are four primary factors that support

the growth of the Internet:

Digitalization and "Deep Convergence"

As described above, the Internet exhibits characteristics of several media that had

previously been distinct. Networks carry three types of information -- voice, video, and data --

and those categories are further subdivided into areas such as pre-recorded vs. live or real-time

presentation, and still vs. moving images. Historically, these different forms of information

have used different delivery vehicles. The telephone network delivered voice, private corporate

networks delivered data, and broadcast networks delivered video. Each service was tightly

coupled to a specific form of infrastructure -- the telephone network used copper wires to reach

subscribers, broadcast television used the airwaves, cable television used coaxial cable, and so

forth. 

"Convergence" means that those lines are blurring. However, convergence is often

understood in a shallow manner, as simply the opportunity for owners of one type of delivery

system to compete with another type of delivery system, or as the opportunity for content

owners to deliver their content using different technologies. In reality, convergence is

something far more fundamental. "Deep convergence" is driven by a powerful technological

trend -- digitalization. Digitalization means that all of the formerly distinct content types are

reduced to a stream of binary ones and zeroes, which can be carried by any delivery platform.9

In practical terms, this means not only that specific boundaries -- between a telephone network

and a cable system, for example -- are blurred, but also that the very exercise of drawing any

such boundaries must be fundamentally reconsidered or abandoned. 

Digitalization has been occurring for decades. The long-distance telephone network in the

United States is now almost entirely comprised of digital switches and fiber optic transmission

links. These digital facilities, however, have been optimized to transport a single service --

voice. The Internet, by contrast, can transmit any form of data. Internet protocols are
See, e.g., George Gilder, "The Bandwidth Tidal Wave," Forbes ASAP, December 5, 1994. 10

6

sufficiently flexible to overcome the boundaries between voice and other services. Innovators

can develop new services and immediately load them onto the existing Internet infrastructure. 

Convergence creates new markets, and new efficiencies, because particular services are no

longer locked into specific forms of infrastructure. 

Moore's Law and Metcalfe's Law

As George Gilder has most clearly articulated, the two technological "laws" that most

impact the growth of the Internet are Moore's Law and Metcalfe's Law. Moore's Law holds 10

that the maximum processing power of a microchip, at a given price, doubles roughly every

eighteen months. In other words, computers become faster at an explosive rate, or conversely,

the price of a given level of computing power decreases at that same dramatic rate. Metcalfe's

Law says that the value of a network is equivalent to the square of the number of nodes. In other

words, as networks grow, the utility of being connected to the network not only grows, but does

so exponentially.

Moore's Law and Metcalfe's Law intersect on the Internet. Both the computers through

which users access the Internet, and the routers that transmit data within the Internet, are subject

to the price/performance curve described by Moore's Law. At the same time, advances in data

transmission technology have expanded the capacity of the Internet's backbone networks. As the

bandwidth available through the network continues to grow, Moore's Law states that the price of

obtaining a given level of bandwidth continues to drop, while Metcalfe's Law dictates that the

value of a connection increases exponentially. The ratio of the cost of Internet access to the

value it provides plummets over time. And as it plummets, connectivity and higher-bandwidth

connections become that much more important, generating more usage and more capital to

upgrade the network.

The Magnetism of Money and Minds

Moore's Law and Metcalfe's Law describe the technological forces that push the growth of

the Internet, but there are also business forces that exert a powerful influence. In a capitalist

economy, the "invisible hand" of the market dynamically redirects capital where it is most highly

valued, without any direct outside intervention. Companies that demonstrate superior potential

for generating future revenues more easily attract investment, and for public companies, see their

stock prices rise. Other companies in the same industry sector often see increases in their stock

prices as well, as investors seek to repeat the pattern of the first company and to capitalize on

economic trends. 

As money flows into a "hot" sector, so do talented people seeking to obtain some of that

money by founding or working at a company in that sector. The presence of so many top minds

further attracts capital, reflecting a synergistic process I call "the magnetism of money and
7

minds." This trend promotes the availability of financing to spur the future growth of the

Internet.

Competition

Competition enables both the dynamic allocation of capital and talent, as well as the

constant innovation in technology that leads to deep convergence and falling prices. In a

competitive market, companies must constantly invest and innovate, or risk losing out to

competitors. Intel CEO Andy Grove has observed that in the computer industry there are only

two kinds of companies: the quick and the dead. Even those companies with strong positions

must always look over their shoulder, because customer loyalty vanishes in the face of superior

alternatives. 

The benefits of competition are evident in the computer industry, where companies must

constantly improve their products to remain successful. Competition in the Internet context

means that many different providers of hardware, software, and services vie for customers. In a

competitive market, providers that can offer superior service or prices are more likely to

succeed. Technological innovations that lower costs or allow new service options will be

valuable to providers and consumers alike.

C. Threats to the Continued Spiral

If the Internet truly operates like a feedback loop, why is government intervention

necessary? 

There are many ways the Internet spiral could be derailed. Any of the underlying drivers

of Internet growth could be undermined. Moving toward proprietary standards or closed

networks would reduce the degree to which new services could leverage the existing

infrastructure. The absence of competition in the Internet service provider market, or the

telecommunications infrastructure market, could reduce incentives for innovation. Excessive or

misguided government intervention could distort the operation of the marketplace, and lead

companies to expend valuable resources manipulating the regulatory process.

Insufficient government involvement may also, however, have negative consequences. 

Some issues may require a degree of central coordination, even if only to establish the initial

terms of a distributed, locally-controlled system. A "tragedy of the commons" situation may

arise when all players find it in their own self-interest to consume limited common resources. 

The end result, in the absence of collective action, may be an outcome that no one favors. In

addition, the failure of the federal government to identify Internet-related areas that should not

be subject to regulation leaves open opportunities for state, local, or international bodies to

regulate excessively and/or inconsistently. 
8

D. How Government Should Act

The novel aspects of the Internet require government policies that are sensitive to both the

challenges and the opportunities of cyberspace. Three principles should guide such government

decision-making:

Scalability, not just Stability

Rather than seeking to restrain the growth of the Internet, government should encourage it. 

As long as the underpinnings of the network support further expansion, and self-correcting

mechanisms can operate freely, the Internet should be able to overcome obstacles to further

development. Additional capital and innovation will be drawn to any challenge due to the

prospect of high returns. In addition, a focus on scalability directs the attention of policy makers

to the future of the network, rather than its current configuration. Given the rapid rate at which

the Internet is changing, such a forward-looking perspective is essential. The "growth" of the

Internet means more than an increase in the number of users. It also means that the network will

evolve and change, becoming an ever more ubiquitous part of society. 

Nevertheless, stability remains important. The Internet must achieve a sufficient level of

reliability to gain the trust of consumers and businesses. However, even such stability requires

an architecture that is built to scale upward. Otherwise, periods of calm will inevitably be

followed by crashes as the Internet continues to grow.

Swim with the Current

The economic and technological pressures that drive the growth of the Internet should not

be obstacles for government. Rather, government should identify ways to use those pressures to

support the goals that government hopes to achieve. In telecommunications, this means using

the pricing signals of the market to create incentives for efficiency. In a competitive market,

prices are based on costs, and the firm that can provide a service for the lowest cost is likely to

succeed. Such competitive pressures operate far more effectively, with lower administrative

costs, than direct government mandates. 

Similarly, government should look for mechanisms that use the Internet itself to rectify

problems and create opportunities for future growth. For example, new access technologies may

reduce network congestion, as long as companies have proper incentives to deploy those

technologies. Filtering systems may address concerns about inappropriate content. Competition

from Internet services may pressure monopolies or outdated regulatory structures. Government

agencies should also use the Internet themselves to receive and disseminate information to the

public. 
9

The Network, not networks

The Internet is a network, but so are AT&T, TCI, and NBC. The FCC's goal should not be

to foster the development of any one of those networks individually, but to maximize the public

benefits that flow from the Network that encompasses all of those networks and many more. 

With the growth of competition and the elimination of traditional regulatory, technological, and

economic boundaries, networks are more likely than ever to be interdependent, and a policy that

benefits one network may have a detrimental effect on others. For example, a mandate that

Internet service providers be entitled to connect to the telephone network for free might

stimulate Internet use, but telephone companies might be forced to increase their rates or offer

lower quality service to recover the increased cost of supporting such connections.

Although government should support the growth of the Internet, this support need not

involve explicit subsidies that are not independently justified as a matter of public policy and

economics. Instead, government should create a truly level playing field, where competition is

maximized and regulation minimized. 
 For example, the Internet is not just electronic mail or the World Wide Web; both are services or applications 11

that run over the Internet infrastructure. The Internet is not America Online; AOL is just one of the many

networks interconnected with the global Internet. Finally, the Internet is not the information superhighway; that

term describes a broader concept of the current and future networks that could deliver communications,

entertainment, education, health care, and other services to users.

 IP defines the structure of data, or "packets," transmitted over the Internet. The higher-level "transmission 12

control protocol" (TCP) and "user-defined protocol" (UDP) control the routing and transmission of these packets

across the network. Most Internet services use TCP, and thus the Internet is often referred to as a "TCP/IP"

network.

 Because of the focus of this paper, and the limits of the US government's jurisdiction, most of the discussion in 13

this section focuses on the portion of the Internet within the United States. The Internet outside the United States

operates for the most part based on the same general model, although the topology of the networks varies in

different regions and countries.

10

II. WHAT IS THE INTERNET?

Although the Internet has been the subject of tremendous media, corporate, and public

interest in recent years, most people have only a vague notion of how the Internet actually

works. It is often easier to identify what the Internet is not than to explain in non-technical

terms what the Internet is. This uncertainty presents a significant challenge for policy-makers, 11

and especially for governmental entities such as the FCC that must clearly define the scope of

their actions. 

A. General Description

The Internet is an interconnected global computer network of tens of thousands of packetswitched networks using the Internet protocol (IP).12

The Internet is a network of networks. For purposes of understanding how the Internet 13

works, three basic types of entities can be identified: end users, Internet service providers, and

backbone providers. Figure 2 shows the general relationships between these entities; a more

detailed Internet architecture diagram is provided as Appendix A. End users access and send

information either through individual connections or through organizations such as universities

and businesses. End users in this context include both those who use the Internet primarily to

receive information, and content creators who use the

 Dedicated Internet service providers, which offer a connection to the Internet but no proprietary content, are 14

distinguished from online service providers (such as America Online) that provide access to proprietary content

and also allow their users to access the Internet. Such distinctions are blurring, however, as online service

providers such as the Microsoft Network move their content to the Internet, and as dedicated Internet service

providers begin to offer some local content. For purposes of this paper, all of these providers are labeled as

"ISPs," because all of them, as a component of their service, connect end users to the Internet.

 These divisions in the voice world are, of course, largely a result of historical and regulatory events, such as the 15

breakup of AT&T into a competitive long-distance carrier and seven regional Bell operating companies. As

competition develops, such arbitrary divisions will almost certainly collapse.

 47 U.S.C. § 230. 16

12

Internet to distribute information to other end users. Internet service providers (ISPs), such as

Netcom, PSI, and America Online, connect those end users to Internet backbone networks.14

Backbone providers, such as MCI, UUNet, and Sprint, route traffic between ISPs, and

interconnect with other backbone providers. 

This tripartite division highlights the different functionalities involved in providing

Internet connectivity. The actual architecture of the Internet is far more complex. Backbone

providers typically also serve as ISPs; for example, MCI offers dial-up and dedicated Internet

access to end users, but also connects other ISPs to its nationwide backbone. End users such as

large businesses may connect directly to backbone networks, or to access points where backbone

networks exchange traffic. ISPs and backbone providers typically have multiple points of

interconnection, and the inter-relationships between these providers are changing over time. It is

important to remember that the Internet has no "center" and that individual transmissions may be

routed through multiple different providers due to a number of factors.

End users may access the Internet though several different types of connections, and unlike

the voice network, divisions between "local service" providers and "long-distance" providers are

not always clear. Most residential and small business users have dial-up connections, which 15

use analog modems to send data over the plain old telephone service (POTS) lines of local

exchange carriers (LECs) to ISPs. Larger users often have dedicated connections using highspeed ISDN, frame relay or T-1 lines, between a local area network at the customer's premises

and the Internet. Although the vast majority of Internet access today originates over telephone

lines, other types of communications companies, such as cable companies, terrestrial wireless,

and satellite providers, are also beginning to enter the Internet access market. 

At present, there is no generally-applicable federal statutory definition of the Internet. The

1996 Act, in the limited context of offensive material transmitted interactive computer networks,

defined the Internet as "the international computer network of both Federal and non-Federal

interoperable packet switched data networks."16

B. An Extremely Brief History of the Net
 For a somewhat more detailed history of the Internet, see Katie Hafner & Matthew Lyon, Where Wizards Stay 17

Up Late: The Origins of the Internet (1996). See also Jack Rickard, "Internet Architecture," available on the

World Wide Web at <http://www.boardwatch.com/isp/archit.htm>, and Henry Edward Hardy, "A Short History of

the Net," in Gary Welz, The Internet World Guide to Multimedia on the Internet, available on the World Wide

Web at <http://found.cs.nyu.edu/found.a/CAT/misc/welz/internetmm/02history/history1.html>. 

 The original thirteen sites were: Merit, the National Center for Atmospheric Research, the Cornell Theory 18

Center, the National Center for Supercomputing Applications, the Pittsburgh Supercomputer Center, the San

Diego Supercomputer Center, the John Von Neumann Center, BARRNet, MIDnet, Westnet, NorthWestNet,

SEQUINET, and SURANET.

13

The roots of the current Internet can be traced to ARPANET, a network developed in the

late 1960s with funding from the Advanced Research Projects Administration (ARPA) of the

United States Department of Defense. ARPANET linked together computers at major 17

universities and defense contractors, allowing researchers at those institutions to exchange data. 

As ARPANET grew during the 1970s and early 1980s, several similar networks were

established, primarily between universities. The TCP/IP protocol was adopted as a standard to

allow these networks, comprised of many different types of computers, to interconnect. 

In the mid-1980s, the National Science Foundation (NSF) funded the establishment of

NSFNET, a TCP/IP network that initially connected six NSF-funded national supercomputing

centers at a data rate of 56 kilobits per second (kbps). NSF subsequently awarded a contract to a

partnership of Merit (one of the existing research networks), IBM, MCI, and the State of

Michigan to upgrade NSFNET to T-1 speed (1.544 megabits per second (Mbps)), and to

interconnect several additional research networks. The new NSFNET "backbone," completed in

1988, initially connected thirteen regional networks. As shown in Figure 3, individual sites 18

such as universities could connect to one of these regional networks, which then connected to

NSFNET, so that the entire network was linked together in a hierarchical structure. Connections

to the federally-subsidized NSFNET were generally free for the regional networks, but the

regional networks generally charged smaller networks a flat monthly fee for their connections.

 Although the precise origin of the term is unclear, the word "Internet" became commonly used in the early 19

1980s to refer to the interconnection of multiple networks to form a virtual "inter-network." 

 Jeffrey K. MacKie-Mason & Hal Varian, Some Economics of the Internet, available on the World Wide Web at 20

<http://www-personal.umich.edu/~jmm/papers.html>.

 In addition, the NSFNET contractors established in 1991 a for-profit subsidiary of Advanced Network and 21

Services (ANS), the non-profit company they had created to operate the NSFNET backbone. This subsidiary,

ANS CO+RE Systems, was set up specifically to handle commercial traffic.

 The number of Internet sites or "domains" identified with the ".com" suffix designating commercial sites has 22

exceeded the number of education sites represented by the ".edu" suffix since mid-1994. See Anthony M.

Rutkowski, Internet Trends, available on the World Wide Web at

<http://www.genmagic.com/internet/trends/sld001.htm>.

 In addition to the three "official" NAPs, Metropolitan Fiber Systems (MFS) operates several "metropolitan area 23

ethernets" (MAEs), which in effect are unofficial NAPs, and a few other legacy exchange points from the period

before the closure of NSFNET. For simplicity, all such exchange points are referred to throughout this paper as

"NAPs."

15

The military portion of ARPANET was integrated into the Defense Data Network in the

early 1980s, and the civilian ARPANET was taken out of service in 1990, but by that time

NSFNET had supplanted ARPANET as a national backbone for an "Internet" of worldwide

interconnected networks. In the late 1980s and early 1990s, NSFNET usage grew 19

dramatically, jumping from 85 million packets in January 1988 to 37 billion packets in

September 1993. The capacity of the NSFNET backbone was upgraded to handle this 20

additional demand, eventually reaching T-3 (45 Mbps) speed. 

In 1992, the NSF announced its intention to phase out federal support for the Internet

backbone, and encouraged commercial entities to set up private backbones. Alternative

backbones had already begun to develop because NSFNET's "acceptable use" policy, rooted in

its academic and military background, ostensibly did not allow for the transport of commercial

data. In the 1990s, the Internet has expanded decisively beyond universities and scientific sites 21

to include businesses and individual users connecting through commercial ISPs and consumer

online services.22

Federal support for the NSFNET backbone ended on April 30, 1995. The NSF has,

however, continued to provide funding to facilitate the transition of the Internet to a privatelyoperated network. The NSF supported the development of three priority Network Access Points

(NAPs), in Northern California, Chicago, and New York, at which backbone providers could

exchange traffic with each other, as well as a "routing arbiter" to facilitate traffic routing at 23

these NAPs. The NSF funded the vBNS (Very High-Speed Backbone Network Service), a noncommercial research-oriented backbone operating at 155 megabits per second. The NSF

provides transitional funding to the regional research and educational networks, as these

networks are now required to pay commercial backbone providers rather than receiving free

interconnection to NSFNET. Finally, the NSF also remains involved in certain Internet
See "Clinton Announces Moves for Improving Access to the Internet," Wall Street Journal, October 11, 1996, at 24

B5; "Internet 2 Project General Information," available on the World Wide Web at

<http://www.internet2.edu/about_i2/>. 

 A "host" is a computer directly connected to the Internet. Although this figure gives a good indication of the 25

size of the Internet, is does not accurately reflect the actual number of Internet users. For example, America

Online, with approximately eight million members as of early 1997, has only has a handful of "host" computers

through which those users receive their Internet connectivity.

16

management functions, through activities such as its cooperative agreement with SAIC Network

Solutions Inc. to manage aspects of Internet domain name registration. 

Since the termination of federal funding for the NSFNET backbone, the Internet has

continued to evolve. Many of the largest private backbone providers have negotiated bilateral

"peering" arrangements to exchange traffic with each other, in addition to multilateral exchange

points such as the NAPs. Several new companies have built nationwide backbones. Despite this

increase in capacity, usage has increased even faster, leading to concerns about congestion. The

research and education community, with the support of the White House and several federal

agencies, recently announced the "Internet II" or "next-generation Internet" initiative to establish

a new high-speed Internet backbone dedicated to non-commercial uses.24

Another important trend in recent years has been the growth of "intranets" and other

corporate applications. Intranets are internal corporate networks that use the TCP/IP protocol of

the Internet. These networks are either completely separate from the public Internet, or are

connected through "firewalls" that allow corporate users to access the Internet but prevent

outside users from accessing information on the corporate network. Corporate users are often

ignored in discussions about the number of households with Internet access. However, these

users represent a substantial portion of Internet traffic. In addition, intranets generate a

tremendous amount of revenue, because companies tend to be willing to pay more than

individual users in order to receive a level of service that they value.

Perhaps surprisingly, the Internet’s growth rate has actually been quite stable for some

time, with the number of hosts roughly doubling every year. The rate appears to have 25

accelerated in recent years only because the numbers have gotten so large, and the Internet has

entered into popular consciousness. 

C. How the Internet Works 

1. Basic Characteristics

Just as hundreds of millions of people who make telephone calls every day have little

conception of how their voice travels almost instantaneously to a distant location, most Internet

users have only a vague understanding of how the Internet operates. The fundamental

operational characteristics of the Internet are that it is a distributed, interoperable, packetswitched network. 
 In some cases, centralized networks use regional servers to "cache" frequently accessed data, or otherwise 26

involve some degree of distributed operation. 

 Some newer technologies, such as asynchronous transfer mode (ATM) switching, allow for the creation of 27

"virtual circuits" through the Internet, which allow traffic to follow a defines route through the network. 

However, information is still transmitted in the form of packets.

 In actuality, much of the PSTN, especially for long-distance traffic, uses digital multiplexing to increase 28

transmission capacity. Thus, beyond the truly dedicated connection along the subscriber loop to the local switch,

the "circuit" tied up for a voice call is a set of time slices or frequency assignments in multiplexing systems that

send multiple calls over the same wires and fiber optic circuits.

17

A distributed network has no one central repository of information or control, but is

comprised of an interconnected web of "host" computers, each of which can be accessed from

virtually any point on the network. Thus, an Internet user can obtain information from a host

computer in another state or another country just as easily as obtaining information from across

the street, and there is hierarchy through which the information must flow or be monitored. 

Instead, routers throughout the network regulate the flow of data at each connection point. By

contrast, in a centralized network, all users connect to single location. The distributed nature of 26

the Internet gives it robust survivability characteristics, because there is no one point of failure

for the network, but it makes measurement and governance difficult.

An interoperable network uses open protocols so that many different types of networks

and facilities can be transparently linked together, and allows multiple services to be provided to

different users over the same network. The Internet can run over virtually any type of facility

that can transmit data, including copper and fiber optic circuits of telephone companies, coaxial

cable of cable companies, and various types of wireless connections. The Internet also

interconnects users of thousands of different local and regional networks, using many different

types of computers. The interoperability of the Internet is made possible by the TCP/IP

protocol, which defines a common structure for Internet data and for the routing of that data

through the network.

A packet-switched network means that data transmitted over the network is split up into

small chunks, or "packets." Unlike "circuit-switched" networks such as the public switched

telephone network (PSTN), a packet-switched network is "connectionless." In other words, a 27

dedicated end-to-end transmission path does (or circuit) not need to be opened for each

transmission. Rather, each router calculates the best routing for a packet at a particular 28

moment in time, given current traffic patterns, and sends the packet to the next router. Thus,

even two packets from the same message may not travel the same physical path through the

network. This mechanism is referred to as "dynamic routing." When packets arrive at the

destination point, they must be reassembled, and packets that do not arrive for whatever reason

must generally be re-sent. This system allows network resources to be used more efficiently, as 

many different communications can be routed simultaneously over the same transmission

facilities. On the other hand, the inability of the sending computer under such a "best effort"
 In a "best effort" delivery system, routers are designed to "drop" packets when traffic reaches a certain level. 29

These dropped packets must be resent, which to the end user is manifested in the form of delay in receiving the

transmission.

 "Streaming" voice and video applications are those in which the data available to the receiving user is updated 30

as data packets are received, rather than waiting until an entire image or sound file is downloaded to the

recipient's computer. 

 TCP/IP packets are not uniform in size, in part because routers along the route can add additional header 31

information to indicate the routing of a particular packet. As of early 1994, the average packet size was

approximately 240 bytes, including headers, and was steadily increasing. See Some Economics of the Internet at

4. Some other packet-switching technologies, such as ATM, use fixed-size packets, which facilitates more rapid

and reliable delivery of data under certain conditions.

 In technical terms, the address blocks are separate bytes of a 32 bit address. The growth of the Internet has 32

raised concerns that this number space will eventually be exhausted. As a result, the next version of the Internet's

underlying protocol, referred to as IP version 6 or simply IPv6, includes a much larger 128 bit address space.

 Every "top-level" domain name, such as "whitehouse.gov," must be associated with a primary and a secondary 33

name server.

 NSI was subsequently acquired by SAIC, a privately-held defense contractor. 34

18

routing system to ensure that sufficient bandwidth will be available between the two points 29

creates difficulties for services that require constant transmission rates, such as streaming video

and voice applications.30

2. Addressing

When an end user sends information over the Internet, the data is first broken up into

packets. Each of these packets includes a header which indicates the point from which the data 31

originates and the point to which it is being sent, as well as other information. TCP/IP defines

locations on the Internet through the use of "IP numbers." IP numbers include four address

blocks consisting of numbers between 0 and 256, separated by periods (e.g. 165.135.0.254).32

Internet users generally do not need to specify the IP number of the destination site, because IP

numbers can be represented by alphanumeric "domain names" such as "fcc.gov" or "ibm.com." 

"Domain name servers" throughout the network contain tables that cross reference these domain

names with their underlying IP numbers. Thus, for example, when an Internet user sends email 33

to someone at "microsoft.com," the network will convert the destination into its corresponding

IP number and use that for routing purposes. 

Some top-level domains (such as ".uk" for Britain) are country-specific; others (such as

".com") are "generic" and have no geographical designation. The domain name system was

originally run by the United States Department of Defense, through private contractors. In 1993,

responsibility for non-governmental registration of generic domains was transferred to the NSF. 

The NSF established a cooperative agreement with Network Solutions Inc. (NSI), under which

NSI handles registration under these domains. NSI currently charges $50 per year to register a 34

domain name; a portion of this money goes to NSI to recover their administrative costs, and a

portion goes into an "Internet intellectual infrastructure fund." The cooperative agreement is
 The significance of this point of "network economics" is discussed in greater detail below in Section IV. 35

 The Web was originally developed at CERN, the European laboratory for particle physics research, to enable 36

researchers around the world to more easily share research. 

19

scheduled to end in mid-1998. Country-specific domains outside the United States are generally

handled by registration entities within those countries.

The existing registration process for generic top-level domains has generated substantial

controversy. Some parties have objected to what they consider to be NSI's monopoly control

over a valuable resource, especially since an entity in the United States is responsible for

assigning addresses with international ramifications. There have been several lawsuits raising

intellectual property questions, as domain names may overlap with existing trademark rights

throughout the world. Several proposals have been made to expand the space of generic toplevel domains. The International Ad Hoc Committee (IAHC), comprised of representatives

from the Internet Society, International Telecommunications Union (ITU), the World

Intellectual Property Organization (WIPO), and other groups, has issued a wide-ranging

proposal to restructure generic top-level domain name system. However, the authority and

ability of the IAHC to implement such changes remains unclear. 

3. Services Provided Over the Internet

The actual services provided to end users through the Internet are defined not through the

routing mechanisms of TCP/IP, but depend instead on higher-level application protocols, such as

hypertext transport protocol (HTTP); file transfer protocol (FTP); network news transport

protocol (NNTP), and simple mail transfer protocol (SMTP). Because these protocols are not

embedded in the Internet itself, a new application-layer protocol can be operated over the

Internet through as little as one server computer that transmits the data in the proper format, and

one client computer that can receive and interpret the data. The utility of a service to users,

however, increases as the number of servers that provide that service increases.35

By the late 1980s, the primary Internet services included electronic mail or "email," Telnet,

FTP, and Usenet news. Email, which is probably the most widely-used Internet service, allows

users to send text-based messages to each other using a common addressing system. Telnet

allows Internet users to "log into" other proprietary networks, such as library card catalogs,

through the Internet, and to retrieve data as though they were directly accessing those networks. 

FTP allows users to "download" files from a remote host computer onto their own system. 

Usenet "newsgroups" enable users to post and review messages on specific topics. 

Despite the continued popularity of some of these services, in particular news and email,

the service that has catalyzed the recent explosion in Internet usage is the World Wide Web.36

The Web has two primary features that make it a powerful, "full service" method of accessing

information through the Internet. First, Web clients, or "browsers," can combine text and

graphical material, and can incorporate all of the other major Internet services such as FTP,
20

email, and news into one standard interface. Second, the Web incorporates a "hypertext" system

that allows individual Web "pages" to provide direct "links" to other Web pages, files, and other

types of information. Thus, full-scale user interfaces and complex services such as online

shopping, continuously-updated news information, and interactive games can be provided

through the Internet over a non-proprietary system. The Web thus forms the foundation for

virtually all of the new Internet-based services that are now being developed. 

4. Governance and Management

There is no one entity or organization that governs the Internet. Each facilities-based

network provider that is interconnected with the global Internet controls operational aspects of

their own network. With the demise of the NSFNET backbone, no one can even be sure about

the exact amount of traffic that passes across the Internet, because each backbone provider can

only account for their own traffic and there is no central mechanism for these providers to

aggregate their data. Nonetheless, the Internet could not function as a pure anarchy. Certain

functions, such as domain name routing and the definition of the TCP/IP protocol, must be

coordinated, or traffic would never be able to pass seamlessly between different networks. With

tens of thousands of different networks involved, it would be impossible to ensure technical

compatibility if each network had to coordinate such issues with all others. 

These coordinating functions have traditionally been performed not by government

agencies, but by an array of quasi-governmental, intergovernmental, and non-governmental

bodies. The United States government, in many cases, has handed over responsibilities to these

bodies through contractual or other arrangements. In other cases, entities have simply emerged

to address areas of need. 

The broadest of these organizations is the Internet Society (ISOC), a non-profit

professional society founded in 1992. ISOC organizes working groups and conferences, and

coordinates some of the efforts of other Internet administrative bodies. Internet standards and

protocols are developed primarily by the Internet Engineering Task Force (IETF), an open

international body mostly comprised of volunteers. The work of the IETF is coordinated by the

Internet Engineering Steering Group (IESG), and the Internet Architecture Board (IAB), which

are affiliated with ISOC. The Internet Assigned Numbers Authority (IANA) handles Internet

addressing matters under a contract between the Department of Defense and the Information

Sciences Institute at the University of Southern California. 

The legal authority of any of these bodies is unclear. Most of the underlying architecture

of the Internet was developed under the auspices, directly or indirectly, of the United States

government. The government has not, however, defined whether it retains authority over

Internet management functions, or whether these responsibilities have been delegated to the

private sector. The degree to which any existing body can lay claim to representing "the Internet

community" is also unclear. Membership in the existing Internet governance entities is drawn

primarily from the research and technical communities, although commercial activity is far more

important to the Internet today than it was when most of these groups were established. 
 Network Wizards Internet Domain Survey, January 1997. 37

See "US on-line population reaches 47 million - Intelliquest survey results," Internet IT Informer, February 19, 38

1997, available on the World Wide Web at <http://www.mmp.co.uk/mmp/informer/netnews/HTM/219n1e.htm>.

See Julia Angwin, "Internet Usage Doubles in a Year," San Francisco Chronicle, March 13, 1997, at B1. 39

 Network Wizards Internet Domain Survey, January 1997, available on the World Wide Web at 40

<http://www.nw.com/zone/WWW/top.html>.

Boardwatch Directory of Internet Service Providers (Fall 1996). 41

See "Market Size," CyberAtlas, available on the World Wide Web at 42

<http://www.cyberatlas.com/market.html>.

21

D. Development of the Internet Market

1. The Internet Today

As of January 1997 there were over sixteen million host computers on the Internet, more

than ten times the number of hosts in January 1992. Several studies have produced different 37

estimates of the number of people with Internet access, but the numbers are clearly substantial

and growing. A recent Intelliquest study pegged the number of subscribers in the United States

at 47 million, and Nielsen Media Research concluded that 50.6 million adults in the United 38

States and Canada accessed the Internet at least once during December 1996 -- compared to 18.7

million in spring 1996. Although the United States is still home to the largest proportion of 39

Internet users and traffic, more than 175 countries are now connected to the Internet.40

According to a study by Hambrecht & Quist, the Internet market exceeded one billion

dollars in 1995, and is expected to grow to some 23 billion dollars in the year 2000. This market

is comprised of several segments, including network services (such as ISPs); hardware (such as

routers, modems, and computers); software (such as server software and other applications);

enabling services (such as directory and tracking services); expertise (such as system integrators

and business consultants); and content providers (including online entertainment, information,

and shopping). The Internet access or "network services" portion of the market is of particular

interest to the FCC, because it is this aspect of the Internet that impacts most directly on

telecommunications facilities regulated by the Commission. There are now some 3,000 Internet

access providers in the United States, ranging from small start-ups to established players such 41

as Netcom and AT&T to consumer online services such as America Online. 

2. Internet Trends

Perhaps the most confident prediction that can be made about the Internet is that it will

continue to grow. The Internet roughly doubled in users during 1995, and this trend appears to

be continuing. Figure 4 shows one projection of the growth in residential and business users 42
 Paul Taylor, "Internet Users 'Likely to Reach 500m by 2000,'" Financial Times, May 13, 1996, at 4. 43

22

over the remainder of the decade. Estimates suggest as many as half a billion people will use the

Internet by the year 2000.43

As the Internet grows, methods of accessing the Internet will also expand and fuel further

growth. Today, most users access the Internet through either universities, corporate sites,

dedicated ISPs, or consumer online services. Telephone companies, whose financial resources

and network facilities dwarf those of most existing ISPs, have only just begun to provide

Internet access to businesses and residential customers. Cable companies are also testing

Internet access services over their coaxial cable networks, and satellite providers have begun to

roll out Internet access services. Several different forms of wireless Internet access are also

being deployed. 

 Several manufacturers are beginning to deploy 56kbps modems. See "U.S. Robotics Launches the New Battle -- 44

56kbps Modems," Boardwatch, January 1997. This technology provides higher downstream transmission rates,

but requires ISPs to have digital connections to the local exchange network. The throughput of these modems

under real-world conditions will depend on the nature of each user's connection, and will usually be lower than 56

kbps. In addition, current FCC technical rules governing line power may limit the maximum connection speed of

these modems to 53kbps. 

 MCI, for example, currently plans to upgrade its backbone to OC-48 speed (2.5 Gbps) by 1998. 45

 Of course, widespread penetration of new, higher-bandwidth services may take far longer than some breathless 46

commentators predict today. See Jonathan Weber, "Internet Video: Idea Whose Time Will Come ... Slowly," Los

Angeles Times, May 13, 1996, at B8. Although policy-makers and regulators should be aware of the possibilities

that the Internet created, concrete actions should not be taken based on mere speculation about the potential

impact of a service. 

24

At the same time as these new access technologies are being developed, new Internet

clients are also entering the marketplace. Low-cost Internet devices such as WebTV and its

competitors allow users to access Internet services through an ordinary television for a unit cost

of approximately $300, far less than most personal computers. Various other devices, including

"network computers" (NCs) for business users, and Internet-capable video game stations,

promise to reduce the up-front costs of Internet access far below what it is now. These clients

promise to expand greatly the range of potential Internet users. Moreover, as Internet

connectivity becomes embedded into ordinary devices (much as computer chips now form the

brains of everything from automobiles to microwave ovens), the Internet "market" will expand

even more.

Bandwidth will continue to increase to meet this new demand, both within the Internet

backbones and out to individual users. There is a tremendous level of pent-up demand for

bandwidth in the user community today. Most users today are limited to the maximum speed of

analog phone lines, which appears to be close to the 28.8 or 33.6 kbps supported by current

analog modems, but new technologies promise tremendous gains in the bandwidth available to

the home. In addition, the backbone circuits of the Internet are now being upgraded to OC-12 44

(622 Mbps) speeds, with far greater speeds on the horizon. With more bandwidth will come 45

more services, such as full-motion video applications. Virtually every one of the challenges

identified in this paper will become more acute as bandwidth and usage increase, and as the

current limitations of the Internet are overcome. Thus, even though some of the questions that

the Internet poses are of limited practical significance today, policy-makers should not wait to

consider the implications of the Internet.46

Throughout the history of the Internet, seemingly insurmountable obstacles have been

overcome. Few people would have expected a network designed for several dozen educational

and research institutions to scale to a commercial, educational, and entertainment conduit for

tens of millions of users, especially with no means of central coordination and administration. 

Governments should recognize that the Internet is different from traditional media such as

telephony and broadcasting, although lessons can be learned from experience in dealing with

those technologies. At the same time, the Internet has always been, and will continue to be
25

influenced by the decisions of large institutions and governments. The challenge will be to

ensure that those decisions reinforce the traditional strengths of the Internet, and tap into the

Internet's own capability for reinvention and problem-solving.
 47 U.S.C. §230(b)(1). 47

26

III. CATEGORY DIFFICULTIES

The FCC has never directly exercised regulatory jurisdiction over Internet-based services. 

However, the rapid development of the Internet raises the question of whether the language of

the Communications Act of 1934 (as amended by the Telecommunications Act of 1996), or

existing FCC regulations, cover particular services offered over the Internet. 

Governments act by drawing lines, such as the jurisdictional lines that identify which

governmental entity has authority over some activity, or the service classifications that

differentiate which body of law should be applied in a particular case. Governments

traditionally determine the treatment of new services by drawing analogies to existing services. 

For example, the FCC regulates long-distance telephony, but does not regulate dial-up remote

access to corporate data networks. ISPs almost exclusively receive calls from their subscribers,

but so do retailers taking catalog orders or radio stations holding call-in promotions. Figure 5

shows some how dial-up access to the Internet resembles, but differs from, other types of

connections. 

There are reasons to believe that a simple process of drawing analogies to familiar services

will not be appropriate for the Internet. The Internet is simultaneously local, national, and

global, and is almost infinitely plastic in terms of the services it can support. As a result, it

confounds any attempt at classification. Failure to consider such category difficulties is,

however, itself a form of line drawing. As long as some communications services are subject to

regulatory constraints, legal boundaries will be necessary. New approaches may therefore be

necessary to avoid inefficient or burdensome results from existing legal and regulatory

categories.

A. FCC Authority Generally

The Communications Act provides little direct guidance as to whether the Commission has

authority to regulate Internet-based services. Section 223 concerns access by minors to obscene,

harassing, and indecent material over the Internet and other interactive computer networks, and

sections 254, 706, and 714 address mechanisms to promote the availability of advanced

telecommunications services, possibly including Internet access. Section 230 states a policy goal

"to preserve the vibrant and competitive free market that presently exists for the Internet and

other interactive computer services, unfettered by Federal or State regulation." None of these 47

sections, however, specifically addresses the FCC's jurisdiction.

 Similar language was introduced in the subsequent FCC Modernization Act of 1996, but this legislation was not 48

adopted before the 104th Congress recessed. 

 47 U.S.C. §151. 49

 47 U.S.C. §160. 50

See United States v. Southwestern Cable Co., 392 U.S. 157 (1968). 51

28

In fact, nothing in the Act expressly limits the FCC's authority to regulate services and

facilities connected with the Internet, to the extent that they are covered by more general

language in any section of the Act. Although some early versions of the bill that became the

1996 Act contained language prohibiting "economic regulation" or "content or other regulation"

of the Internet by the FCC, such language does not appear in the final version of the Act.48

Moreover, it is not clear what such a prohibition would mean even if it were adopted. The

Communications Act directs the FCC to regulate "interstate and foreign commerce in

communication by wire and radio," and the FCC and state public utility commissions 49

indisputably regulate the rates and conditions under which ISPs purchase services and facilities

from telephone companies. Would a prohibition on FCC "regulation" of the Internet invalidate

limits on the rates LECs can charge to ISPs? Would such language prevent the FCC from

mandating discounted Internet access for schools and libraries? Such language would likely

result in confusion at best.

Given the absence of clear statutory guidance, the Commission must determine whether or

not it has the authority or the obligation to exercise regulatory jurisdiction over specific Internetbased activities. The Commission may also decide whether to forebear from regulating certain

Internet-based services. Forbearance allows the Commission to decline to adopt rules that would

otherwise be required by statute. Under section 401 of the 1996 Act, the Commission must

forbear if regulation would not be necessary to prevent anticompetitive practices and to protect

consumers, and forbearance would be consistent with the public interest. Finally, the 50

Commission could consider whether to preempt state regulation of Internet services that would

be inconsistent with achievement of federal goals. 

The Commission has struggled with such questions before as new technologies emerged. 

For example, prior to the passage of federal legislation in the 1980s, the Communications Act

had no provisions that would directly cover cable television. The Commission concluded that,

because of the competitive implications of cable for the regulated broadcasting industry,

jurisdiction over cable television was "reasonably ancillary" to the Commission’s established

authority. Section 303 of the Communications Act of 1934 states broadly that: 51

the commission from time to time, as public convenience, interest, or necessity

requires shall ... [m]ake such rules and regulations and prescribe such restrictions and
 47 U.S.C. §303(r). 52

29

conditions, not inconsistent with law, as may be necessary to carry out the provisions

of this Act....52

This language gives the Commission broad authority to use its expertise to address novel

situations. The Internet, however, is not cable television, and the FCC today is moving rapidly

to deregulate existing services rather than to expand the scope of its regulatory ambit. 

Nonetheless, it would be difficult to claim that the Internet does not, at some level, involve

interstate communications, or that the Internet will not at some point (if it does not already) have

a significant competitive impact on existing providers of regulated communications services. 

Moreover, the only way to wholly exclude the Internet from regulation would be to develop a

precise definition of what is and is not an "Internet" service, now and in the future, which is

exactly what the Internet makes it difficult to do. 

The FCC's theoretical jurisdiction over the Internet is quite expansive, because the Internet

relies on communications facilities and services over which the FCC has longstanding and broad

authority. Such a conclusion, however, provides little or no guidance in answering the question

about how the Commission should act towards Internet-based services and companies. For

example, the Commission's existing framework for "enhanced services" provided through the

telephone network, developed in the Computer II proceeding, states that the FCC has authority

to regulate these services, but that regulation would not serve the public interest. 

Those who oppose "regulation of the Internet," generally do not wish to make the Internet

a zone in which all government authority, such as prohibitions on theft and fraud, or guarantees

of property rights, cease to exist. Rather, the debate is about whether new legal constructs are

needed to address Internet-based transactions, and whether existing constructs meant for

different situations should be applied to the Internet. In other words, would a particular type of

service, offered by a particular type of company, be subject to particular requirements and

prohibitions? 

The Commission can and should greatly limit the extent to which its actions interfere with

the functioning of the Internet services market. Communications regulation has traditionally

been justified by the presence of dominant firms, by overwhelming public interest imperatives,

or by the inherent invasiveness of broadcast media. Most of these justifications simply do not

exist in the Internet realm. 
 Common carriers are also subject to regulation by the state public utilities commissions of each state in which 53

they provide service.

 47 U.S.C. §153(43). 54

 47 U.S.C. §153(44). 55

 47 U.S.C. §153(46). 56

 Internet Relay Chat (IRC) is a service that allows multiple Internet users to conduct a real-time "chat" by typing 57

statements into a computer. Other participants in the "chat" see these utterances as they are typed.

 Internet telephony is discussed in greater detail in section (III)(B)(2)(c). 58

30

B. Telephony

1. Legal Framework

a. Carrier Obligations

Title II of the Act generally regulates the activities of two overlapping classes of entities:

communications common carriers and telecommunications service providers. Under the 1934

Act, common carriers (such as telephone companies) must be certificated and file tariffs setting

forth a schedule of their charges in order to provide service to the public. Common carriers are 53

prohibited from unreasonably denying requested services, or from unreasonably discriminating

in their terms and conditions of service, and are subject to various other requirements and fees. 

The 1996 Act adds a related category, "telecommunications" service, defined as follows:

The term "telecommunications" mean the transmission, between or among points specified

by the user, of information of the user's choosing, without change in the form or content of

the information as sent and received.54

The term "telecommunications carrier" means any provider of telecommunications

services.... A telecommunications carrier shall be treated as a common carrier under this

act only to the extent that it is engaged in providing telecommunications services....55

The term "telecommunications service" means the offering of telecommunications for a fee

directly to the public, or to such classes of users as to be effectively available to the public,

regardless of the facilities used.56

To what degree do Internet-based services meet the three-pronged definition of

"telecommunications?" For example, the sender of an email message selects the person to

receive the information and chooses the information to be transmitted, with no alteration (other

than protocol conversion and other administrative overheads of the network) of the information

sent and received. Real-time "Internet relay chat" and "Internet telephony" are even easier to 57 58
 A similar debate about the application of existing communications regulation to the Internet is taking place in 59

Europe. European regulators have argued that services provided over the Internet that constitute "like services" to

traditionally-regulated media such as telephony and broadcasting are subject to the rules and regulations that

govern those areas. This analysis generally distinguishes Internet-based services such as electronic mail from

services such as Internet telephone, which is "real time," and therefore a "like service" to conventional telephony. 

Efforts to apply existing regulatory frameworks to the Internet have also created some confusion in Europe. For

example, a dispute recently arose in Great Britain between the Independent Television Commission, which

regulates video services, and Oftel, which oversees phone communications, over who has jurisdiction over the

Internet. See "Warning as ITC tries to muscle in on Internet," London Telegraph, April 1, 1996, at 29.

 Usenet newsgroups are topic-specific discussion groups. Users "post" messages to the group, which can then be 60

read by all subscribers to the group. Unlike email, which is sent to a user's mailbox, Usenet news requires users to

connect to a "news server" and select the particular newsgroup they wish to view. There are now more than

10,000 Usenet newsgroups in operation.

See Computer II Final Order, 77 FCC2d 384 (1980). For a discussion of the history of the basic/enhanced 61

distinction and its applicability to Internet access, see Robert Cannon, "What is the 'Enhanced Service Provider'

Status of Internet Service Providers?" FCBA News , February 1997.

 "Enhanced services" are defined in section 64.702(a) of the FCC's rules. See 47 C.F.R. 64.702(a) 62

31

fit within the statutory definition. If some Internet services fall within the definition of

"telecommunications," however, who are the "carriers" that should be subject to regulation?59

Would it be possible to regulate some services and not others, such as Usenet newsgroups,60

which do not seem to satisfy the three-pronged test? 

Ultimately, such micro-level exercises in statutory interpretation can lead to results that

appear strange or worse. Common sense suggests that Congress did not intend to treat any

company that facilitates the transmission of email as a local telephone company, subject to the

full panoply of public-utility-derived regulation that applies to such companies. Nonetheless, the

language of the statute cannot be ignored. 

b. Basic vs. Enhanced Services

Beginning with the Computer II proceeding in the 1970s, the Commission has

distinguished between "basic" and "enhanced" communications services. Basic services are 61

standard voice transmission offerings, while enhanced services are defined as: 

...services, offered over common carrier transmission facilities used in interstate

communications, which employ computer processing applications that act on the format,

content, code, protocol or similar aspects of the subscriber's transmitted information;

provide the subscriber additional, different, or restructured information; or involve

subscriber interaction with stored information.62

Specific enhanced services include protocol processing, alarm monitoring, voice messaging, and

electronic publishing, as well as the provision of access to data networks such as commercial

online services and the Internet. 
 BOCs have incentives to disadvantage competing ESPs that must interconnect with them to provide service. 63

Therefore, the Computer III rules require the BOCs to comply with accounting safeguards to ensure they do not

cross-subsidize their enhanced services with revenues from their regulated basic services. In addition, BOCs must

file open network architecture (ONA) plans detailing how they will offer competing ESPs comparable network

features and functions to those used by the BOC's own enhanced services, or comparable efficient interconnection

(CEI) plans for specific enhanced services they offer. BOCs must also make new features and functions available

upon a reasonable request from an independent ESP, through a process overseen by the information industry

liaison committee (IILC), an industry group.

Computer II Final Order, 77 FCC2d at 420. 64

Id. 65

Application of AT&T for Authority under Section 214 of the Communications Act of 1934, as amended, to 66

Install and Operate Packet Switches at Specified Telephone Company Locations in the United States, 94 FCC2d

48, 55-57 (1983); Independent Data Communications Manufacturer's Association, Petition for Declaratory Ruling

that AT&T's InterSpan Frame Relay Service is a Basic Service, Memorandum Opinion and Order, DA 95-2190

(released October 18, 1995).

See, e.g., Bell Atlantic Offer of Comparable Efficient Interconnection to Providers of Internet Access Services,

67

Order, CCBPol 96-09 (released June 6, 1996).

32

The basic/enhanced framework has two primary purposes. First, it defines a class of

enhanced service providers (ESPs), that use the telephone network but are not subject to

regulation under Title II of the Communications Act. Although the FCC may have jurisdiction

to regulate ESPs, such regulation would be unnecessary and harmful to the development of the

competitive enhanced services industry. Second, it provides a framework to ensure that when

incumbent LECs (in particular the regional Bell Operating Companies (BOCs)) offer enhanced

services, they do not use their control over bottleneck basic services to disadvantage competing

ESPs. The 1996 Act incorporates something similar to the basic/enhanced dichotomy in its 63

distinction between telecommunications and "information" services.

The Internet in its current form did not exist at the time the FCC created the

basic/enhanced distinction. However, in Computer II and in subsequent orders, the Commission

has addressed the implications of packet-switching technologies for this framework. In

Computer II, the Commission described basic communications services as providing "pure

transmission capability over a communications path that is virtually transparent in terms of its

interaction with customer-supplied information." The use of packet switching and error control 64

techniques "that facilitate the economical, reliable movement of [such] information [do] not alter

the nature of the basic service." Thus, for example, in subsequent decisions the Commission 65

has determined that packet-switched networks following X.25 protocols, and frame relay service

offerings, provide a basic transport service.66

Although some underlying packet-switched transport functions are considered to be basic

services, Internet access has always been treated as an enhanced service. ISPs have never been

subject to regulation by the FCC under Title II of the Communications Act. In addition, BOCs

have been required to file comparable efficient interconnection (CEI) plans when they

themselves offer Internet access, to ensure that they do not disadvantage competing ISPs. ISPs 67

engage in various information processing functions, such as authentication, email storage and
 47 U.S.C. §251-52. All LECs are required to interconnect with other telecommunications carriers on request, 68

but only incumbent LECs are subject to the unbundling, resale, and pricing requirements of the 1996 Act.

Implementation of the Local Competition Provisions of the Telecommunications Act of 1996, CC Docket No. 69

96-98, FCC 96-325 (released August 8, 1996) (Local Competition Order), petition for review pending sub nom.

and partial stay granted, Iowa Utilities Board et. al v. FCC, No. 96-3321 and consolidated cases (8th Cir., Oct.

15, 1996), at 493-95, ¶¶ 992-95.

Id. at ¶ 995. 70

 47 U.S.C. §251(c)(3). 71

33

retrieval, Web page hosting, and domain name server lookups. Many ISPs, especially online

services such as America Online, offer access to local content through databases, message

boards, and chat areas. These functions involve substantial computer processing and interaction

with customer-supplied information, and therefore fall squarely within the definition of

enhanced services.

2. Implications

The legal and regulatory categories described above have significant consequences. 

Because of the unique characteristics of the Internet, as described in this paper, such general

frameworks may produce unintended results when applied to Internet-based services.

Discussions of the status of ISPs or specific Internet services should not be based solely on

abstract legal analysis, but rather should take into account the real-world implications of such

decisions.

a. Section 251 Interconnection Obligations

Sections 251 and 252 of the 1996 Act mandate that incumbent LECs take various steps to

open their local networks to competition. Under these sections, incumbent LECs must make

interconnection, unbundled network elements, and wholesale services available to such new

entrants at reasonable rates. However, under the terms of section 251, these services are 68

available only to "requesting telecommunications carriers." In the Local Competition Order,

which implemented section 251, the Commission concluded that providers fell within this

definition only to the extent that they provided telecommunications directly to the public. Thus,

companies that provide both information and telecommunications services are able to request

interconnection, unbundled network elements, and resale under section 251, but companies that

provide information services only are not. The Commission did not state more specifically 69

how it would define the two categories for this purpose, although it did conclude that companies

that provided both telecommunications and information services should be considered

telecommunications service providers in this context. 

70

Because, under Section 251(c)(3), LECs must permit purchasers of their unbundled

network elements to combine such elements in order to provide a telecommunications service,71

Internet access providers may be able to design their networks more efficiently and economically
 47 U.S.C. §251(a). 72

See, e.g., Brock Meeks, "ISPs Prepare 'Doomsday Defense,'" MSNBC, December 21, 1996, available on the 73

World Wide Web at <http://www.msnbc.com/news/47762.asp>.

See Carol Wilson, "MFS Pushes DSL into Mass Market," Inter@ctive Week, December 16, 1996. 74

Local Competition Order at 149, ¶ 292. 75

34

by using unbundled elements in this manner. In order to do so, however, such companies must

overcome the "telecommunications carrier" restriction in the Act. One means of doing so would

be to classify themselves as providers of telecommunications service, and thus be subject to the

requirement that they interconnect with all other carriers and potentially other regulatory 72

provisions governing telecommunications carriers. Some ISPs are already considering this

course. 

73

Alternatively, Internet access providers could enter into an arrangement with a

telecommunications carrier, such as an IXC, which could purchase the unbundled elements and

in effect resell them to the ISP. MFS Worldcom, which provides telecommunications service

but owns a major ISP, UUNet, is already exploring this latter course, purchasing unbundled

loops and using them to offer high-speed ISDN and xDSL Internet access to corporate customers

through UUNet. The FCC's Local Competition order expressly stated that incumbent LECs 74

could not restrict the services that competitors could provide over unbundled network elements.75

Other possible mechanisms under which Internet access providers could make use of the

unbundling provisions of the 1996 Act would likely require additional action by the FCC to

clarify the legal framework. For example, ISPs could negotiate directly with LECs to lease

network elements they needed to offer high-speed data services, outside of the framework of

section 251. Such arrangements could be embodied in experimental or contract tariffs, subject

to Commission approval. Because section 251 would always be available as a fallback that the

ISPs could use to gain access to similar facilities, as described in the previous paragraph, the

FCC would not need to scrutinize closely the rates LECs charged under such arrangements. At

this time, however, there is no legal basis for LECs and ISPs to negotiate such agreements

outside of section 251. 

Another theoretically possible route would be through the Commission's open network

architecture (ONA) process, which was designed prior to the passage of the 1996 Act to give

enhanced service providers access to elements of local networks. However, ONA has been

criticized by many ESPs as being cumbersome an ineffective for achieving true network

unbundling. ONA was also designed facilitate unbundling of software functionality within LEC

switches, rather than physical network elements. 

The interconnection provisions of the 1996 Act also require that pricing for "transport and

termination of traffic" between telecommunications carriers be based on reciprocal
 47 U.S.C. § 252(d)(2). 76

Federal-State Joint Board on Universal Service, Recommended Decision, FCC 96J-3, CC Docket No. 96-45, at 77

398 ¶¶790-91 (Universal Service Joint Board Recommended Decision).

Id. at 237-38, ¶¶462-65. 78

35

compensation. In other words, when a user on one carrier's network makes a local call to a 76

user on a second carrier's network, the first carrier must pay the second carrier for terminating

that call. Reciprocal compensation arrangements operate on the assumption that traffic between

two networks will be relatively balanced, because on average users receive about as many calls

as they make. In the case of an Internet service provider, this assumption breaks down. ISPs

exclusively receive calls from their subscribers over LEC networks. Therefore, if an ISP were

considered a telecommunications carrier under section 251, LECs would presumably be required

to pay that ISP for terminating traffic on the ISP's network. This result would represent the

opposite of the current flow of funds, in which ISPs pay LECs for connecting to the LEC

network to receive calls. 

b. Section 254 Universal Service Obligations

Under section 254, all "telecommunications carriers" that provide "interstate

telecommunications services" must contribute to mechanisms established to preserve and

advance universal service. The Commission may require "any other provider of interstate

telecommunications" to also contribute to such mechanisms, "if the public interest so requires." 

Thus, to the extent that, as discussed above, Internet access providers or others are considered to

be both "telecommunications carriers" and providers of "interstate telecommunications services,"

the Act requires these entities to participate in whatever federal universal service funding

mechanism the Commission ultimately adopts. 

Pursuant to section 254, the Commission convened a federal-state joint board to

recommend an explicit and nondiscriminatory funding mechanism for universal service. In its

recommendations, the joint board concluded that information and enhanced service providers not

be required to contribute to the universal service funding mechanism. The joint board also 77

concluded that Internet access services provided to schools and libraries should be entitled to

universal service subsidies under section 254(h).78

The joint board recommendations, however, leave open several questions. As with the

interconnection rules, the precise definition of "telecommunications" and "information" services

as applied to various types of Internet-based service providers remains unclear. The decision

that information service providers are not required to contribute to universal service funding, but

can receive universal service subsidies under section 254(h) raises issues of competitive equity

when such companies are competing with traditional telecommunications carriers to provide

connectivity to schools and libraries. Finally, although as the joint board concluded, it would be

unreasonable to require ISPs to segregate their revenues between "content" and "conduit"
See, e.g., Douglas Lavin, "Small Phone Company Plans to Slash International Rates With Internet Link," Wall 79

Street Journal (November 10, 1995) at B7A.

See, e.g., Fred Langan, "Internet Phone Calls -- Without Computers," Christian Science Monitor, August 21, 80

1996; Mike Mills, "Phone Service Via Internet May Slash Rates," Washington Post, August 11, 1996, at A1; Bill

Frezza, "Internet Phone: The Ultimate Bypass," Network Computing, July 1, 1996.

36

services, the universal service framework is designed only to subsidize connections, not

proprietary content. 

c. Internet Telephony

Several companies now offer software that allows for real-time voice conversations over

the Internet (Internet telephony or "voice on the Net" (VON)). These services work by 79

converting voices into data which can be compressed and split into packets, which are sent over

the Internet like any other packets and reassembled as audio output on the at the receiving end. 

Most Internet telephony software today requires both users to use computers that are connected

to the Internet at the time of the call, but some recently announced services will allow the

receiving party, or even both parties, to use an ordinary POTS telephone. 

80

 

 Conversation with the author, December 30, 1996. 81

 Section 223(c)(6) of the Act, as amended by the 1996 Act, states that "Nothing in this section shall be construed 82

to treat interactive computer services as common carriers or telecommunications carriers." This language,

however, applies only to interactive computer services in the context of restrictions on access by minors to

indecent and obscene materials, and only states that the defenses in this section of the Act do not mean that these

entities are to be treated as common carriers or telecommunications carriers. This section would not appear to be

inconsistent with a finding that Internet access providers are "telecommunications carriers" because the services

they provide fall within the definitions set forth in section 153 of the Act.

 Portugal, for example, has reportedly banned Internet telephony. On the other hand, the Telecom Finland has 83

announced that it will soon begin offering Internet telephony itself. See "Telecom Finland to Unveil Phone

Service for Internet," Wall Street Journal, December 9, 1996, at B7

See generally John Simons, "Wrestling Over the Future," US News and World Report, April 15, 1996, at 53. 84

38

Internet telephony consultant Jeff Pulver estimates that approximately 55,000 - 60,000

people now use Internet telephony products on a weekly basis, although usage has been

increasing rapidly and a much larger number of people have access to Internet telephony

software. Netscape and Microsoft, the manufacturers of the leading Web browser software, 81

have released versions of their software that incorporate Internet telephony.

The FCC has not attempted to regulate the companies that provide the software and

hardware for Internet telephony, or the access providers that transmit their data, as common

carriers or telecommunications service providers. In March 1996, America's Carriers 82

Telecommunication Association (ACTA), a trade association primarily comprised of small and

medium-size interexchange carriers, filed a petition with the FCC asking the Commission to

regulate Internet telephony. ACTA argues that providers of software that enables real-time

voice communications over the Internet should be treated as common carriers and subject to the

regulatory requirements of Title II. The Commission has sought comment on ACTA's request. 

Other countries are considering similar issues.83

The ACTA petition raises the fundamental question of whether a service provided over the

Internet that appears functionally similar to a traditionally-regulated service should be subject to

existing regulatory requirements. The petition argues that VON providers should be 84

considered as fundamentally analogous to switchless long-distance resellers, and thus should pay

the same rates to LECs for use of local networks to originate and terminate interstate calls. 

Under this analysis, shown in Figure 6, the current pricing structure allows VON providers to

charge an effective usage charge of zero, while long-distance carriers must pass on roughly six

cents per minute in access charges for every interstate call.

ACTA's view, however, oversimplifies the comparison between VON and long-distance

voice telephony. There are many differences, beginning with quality of service. Current

Internet telephony products do not provide comparable sound quality to traditional long-distance

service. Most existing systems require both parties to be connected to the Internet through a

personal computer at the time of the call, and the sound quality of Internet telephony products
39

tends to be appreciably worse than circuit-switched voice telephony. At this time, Internet

telephony is in most cases not a comparable substitute for long-distance voice service. 

However, distinctions in quality and ease of use should not be the sole basis for regulatory

decisions. Cellular telephony typically provides poorer sound quality than wireline service, but

this fact does not affect the classification of cellular as a telecommunications service. Moreover,

service providers are working to improve sound quality and ease of use, and several providers

have begun to deploy "gateways" that allow Internet telephony conversations to be terminated or

even originated on an ordinary telephone. When such gateways are used, however, the pricing

structure changes. Gateway providers must pay for hardware at points of presence to route voice

traffic between the Internet and the voice network, and must also pay local exchange carriers to

terminate or originate calls over voice lines. Thus, gateway providers plan to charge per-minute

rates for their Internet telephony services, rather than the "free" calling available through current

computer-computer Internet telephony products.

Even these current products, however, do not really provide for "free" calling. Service

providers and users still must pay for their connections to the local phone network, and for their

connections to the Internet. If these services are priced in an inefficient manner, the issue is not

one related to Internet telephony, but is a broader question about the pricing for Internet access

and enhanced services that use local exchange networks. The issue of pricing for Internet access

is discussed in detail in the following section. The fact that some Internet packets now encode

voice rather than data does not alter the fundamental economics and technical characteristics of

network traffic. If anything, a shift toward usage of the Internet for voice telephony might result

in usage patterns that looked more like those of circuit-switched voice calling. The issue of how

exactly Internet telephony affects network usage, and how pricing affects usage of Internet

telephony, is not at all settled. Local calling throughout virtually all of the United States is

priced on a flat-rated basis, yet people do not tend to stay on the phone all day. 

Internet telephony is also technically different from long-distance voice calling. A circuitswitched voice call uses an entire 56 kbps channel for every call. By contrast, Internet telephony

uses digital compression techniques that can encode voice transmissions in as little as 4 kbps. 

Internet telephony is also packet switched, which means that it does not tie up a call path for the

portion of the call carried over the packet-switched Internet. Of course, when a packet-switched

Internet telephony call is originated through a modem over a dial-up circuit-switched connection

to an ISP, the potential efficiency benefits of packet-switched voice transmission may not be

realized. In some cases, the long-distance and international voice transmission networks, which

are in most cases digital today, may actually do a better job of compression than Internet

telephony products. All of these possibilities, however, reinforce the notion that the cost

comparison between Internet and circuit-switched voice telephony is not obvious, and is highly

contingent on network arrangements that are evolving rapidly.

Finally, as a practical and policy matter, regulation of Internet telephony would be

problematic. It would be virtually impossible, for example, for the FCC to regulate as carriers

those companies that merely sell software to end users, or to require the ISPs segregate voice
See, e.g., Alan Cane and Tim Jackson, "Net Telephony Anxieties Intensify," Financial Times, April 22, 1996, at 85

19.

See Jean Field, "ISP Fights Nebraska Regulation of IPhone," Wired News, February 11, 1997, available on the 86

World Wide Web at <http://www.wired.com/news/politics/story/986.html>; Scott Bauer, "Telephone Service Via

Internet Must End," Associated Press, January 2, 1997.

See Rebecca Sykes, "Internet Telephony Group Seeks FCC Action," InfoWorld Electric, January 30, 1997; Nick 87

Wingfield, "FCC Pressed on Net Phones," C|Net News, January 30, 1997, available on the World Wide Web at

<http://www.news.com/News/Item/0,4,7513,00.html?dtn.head>.

See Joint Opposition of Netscape Communications Corporation, Voxware, Inc. and Insoft Inc., RM No. 8775 88

(May 8, 1996).

40

and data packets passing through their networks for regulatory purposes. Rather, VON software

could more appropriately be compared to unregulated customer premises equipment (CPE), like

telephone handsets, which facilitate calling but do not themselves carry calls from one party to

another. Moreover, although ACTA claims that Internet telephony unfairly deprives

interexchange carriers of revenues, others argue that these services provide valuable competition

to incumbent carriers. The existing systems of access charges and international accounting 85

rates, to which long-distance carriers are subject, are both inefficient artifacts of monopoly

regulatory regimes. If circuit-switched long-distance carriers are paying excessive and

inefficient rates as a result, the best answer is to reform those rates rather than attempting to

impose them on other parties.

The FCC should consider whether to exercise its preemption authority in connection with

Internet telephony. ACTA has submitted a petition, similar to its FCC filing, to the Florida

Public Service Commission. In addition, the Nebraska Public Service Commission staff recently

concluded that an Internet telephony gateways service operated by a Nebraska ISP was required

to obtain a license as a telecommunications carrier. If federal rules governing Internet 86

telephony are problematic, state regulations seem even harder to justify. As discussed below in

section D, there is a good argument that Internet services should be treated as inherently

interstate. The possibility that fifty separate state Commissions could choose to regulate

providers of Internet telephony services within their state (however that would be defined),

already may be exerting a chilling influence on the Internet telephony market. Netscape, in its 87

comments on the ACTA petition, argued that the Commission should assert exclusive federal

jurisdiction and preempt states from regulating Internet telephony. 

88

C. Broadcasting and Cable 

The provision of real-time, or "streaming" audio and video services over the Internet raises

the question of whether some Internet-based services qualify as "broadcasting" subject to Title

III of the Communications Act. "Broadcasting" is defined in the Act as:
 47 U.S.C. §153(6). 89

 47 U.S.C. §522(20). 90

41

(153)(6) Broadcasting. -- The term "broadcasting" means the dissemination of radio

communications intended to be received by the public, directly or by the intermediary of

relay stations.89

"Internet radio" services exist today that transmit continuous, real-time audio over the Internet. 

Many other sites now offer a selection of real-time audio clips that users can choose to listen to,

such as news, weather forecasts, and music. Users must access theses sites, generally through a

World Wide Web browser, and must have the proper software and hardware to receive and play

streaming audio. Although analog modem bandwidth is largely insufficient to support real-time

video transmissions over the Internet, such services are already available for users with higherbandwidth connections. For example, software known as CU-See Me has been available for

some time that allows real-time video conferencing over the Internet, and a other products such

as VDOLive will allow real time simultaneous video and audio conferencing. Live video of

several events has been broadcast over the MBONE, a service that allows certain users with

high-speed connections to receive real-time video feeds through the Internet.

The Commission has never considered whether any of the rules that relate to radio and

television broadcasters should also apply to analogous Internet-based services. The vast

majority of Internet traffic today travels over wire facilities, rather than the radio spectrum. As a

policy matter, however, a continuous, live, generally-available music broadcast over the Internet

may appear similar to a traditional radio broadcast, and the same arguments may be made about

streaming video applications. The Commission will need to consider the underlying policy

principles that, in the language of the Act and in FCC decisions, have formed the basis for

regulation of the television and radio broadcast industries. One significant different may be the

fact that radio and television broadcasts are subject to the inherent scarcity of the usable

electromagnetic spectrum, whereas such transmissions over the Internet are simply a different

type of data packets, indistinguishable at any moment from other types of traffic passing through

the network. 

Similar issues arise in the context of cable television regulations under Title VI of the

Communications Act. The Act defines "video programming" as "programming provided by, or

generally considered comparable to programming provided by, a television broadcast station."90

A "cable service" means "the one-way transmission to subscriber of ... video programming." A

"cable system" is "a facility, consisting of a set of closed transmission paths ... that is designed to

provide cable service," but not "a facility that serves only to retransmit the signals of one or

more television broadcast stations; ... a facility that serves subscribers without using any public

right-of-way; ... [or] a facility of a common carrier" that does not provide video programming
 47 U.S.C. §522. 91

42

directly to subscribers (except solely to provide interactive on-demand services) or serve as an

open video system under section 653 of the Act.91

To what extent is real-time video transmitted over the Internet "comparable" to broadcast

television? The technology of the current Internet limits video transmission, even for users with

relatively high-speed access, to relatively low-quality images. Most Internet users today are able

to connect to the network at only 14.4 kbps or 28.8 kbps, which supports only rudimentary video

images that can easily be distinguished from broadcast television images. These limitations are

not permanent, however. As compression technology develops and end-user access speeds

increases, Internet video applications will provide service that increasingly resembles the quality

of television broadcast stations. In addition, the number of entities providing real-time video

over the Internet is today relatively small, but is certain to increase rapidly over time as

bandwidth increases. It seems inevitable that, at some point, consumers will be able to view

images that are virtually indistinguishable in quality and equally varied in selection to those

provided by television broadcasters. At what point will the threshold of "comparability" be

crossed?

A determination about whether Internet-based video applications constitute "video

programming" under the Act would not necessarily mean that these services would legally be

treated as cable systems. Section 602(7)(B) of the Act states that facilities that do not use any

public right-of-way are not considered cable systems. The Internet uses public right-of-way to

the extent that it runs over the existing telephone network, and in the future over existing cable

company facilities. The provision of video services over the Internet, however, generally

requires no additional use of public right-of-way beyond that necessary to provide basic Internet

connectivity, or to provide existing telephony or cable services. An additional definitional issue

is the extent to which Internet video services provided by common carriers such as telephone

companies are considered "interactive on-demand services," and therefore not treated as cable

systems, since many Internet-based video concepts require the user to select a specific "program"

to view. An Internet-based video service might be considered an "open video system," since the

Internet itself is an inherently open platform that allows capacity to be shared among all entities

with broadcast capabilities. Finally, certain providers of Internet-based video services could be

classified as "multichannel video programming distributors" (MVPDs) under 602(11) of the Act. 

MVPDs are entities that "make[] available for purchase, by subscribers or customers, multiple

channels of video programming."

Policy-makers must consider the policy rationales behind Title VI of the Act, and whether

they apply to Internet-based video delivery systems with the same force. It does appear,

however, that at some point the Internet may have significant competitive effects. A recent

survey suggested that 61% of Internet users watch less television in order to spend more time
Broadcasting & Cable, November 5, 1995, at 113. See also "The Internet May be Cutting into TV's Audience," 92

New York Times News Service, January 31, 1997.

Annual Assessment of the Status of Competition in the Market for the Delivery of Video Programming, CS 93

Docket No. 95-61, FCC 95-491 (released December 11, 1995) at para. 127. ("Being an open network, the Internet

has the potential to affect the video marketplace, perhaps significantly. However, it appears too early to assess its

impact.")

 47 U.S.C. §223. 94

 47 U.S.C. §223(e)(5). 95

43

online. The FCC's 1995 Cable Competition Report notes the possibility that the Internet will 92

affect the video marketplace, "perhaps significantly," but concludes that it is too early to assess

the impact of the Internet on this market. At some point, if the Internet continues to grow and 93

greater bandwidth is widely available to end users, the Internet may have even more significant

competitive effects on the video marketplace. Moreover, with the deployment of Internet access

over cable facilities and digital cable set-top boxes, however, the Internet may exert an influence

over the cable market not only as a competitor, but as a component of cable service as well. 

The fact that the Internet may affect competition in the video marketplace is not itself a

justification for additional regulation. If the Internet enhances competition, it may in fact justify

reducing regulation on all video service providers. Moreover, existing regulations for

broadcasters and cable operators were never designed with Internet services in mind, and could

produce strange results if applied blindly to companies that enable streaming audio or video

transmissions over the Internet. 

D. Relationship to Content

The FCC has made no effort to regulate the content of services transmitted over the

Internet. Nonetheless, the Commission does address content-related issues in broadcasting (such

as indecency and educational programming) and to a limited extent in telephony (principally

relating to dial-a-porn services). 

The 1996 Act also more directly addresses Internet content with its so-called

"Communications Decency Act" provisions. These provisions criminalize the knowing

transmission using the Internet or other interactive computer services of indecent material to

children under the age of 18. The statute further states that "[i]t is a defense to a prosecution" to 94

show that a person has "requir[ed] use of a verified credit card, debit account, adult access code,

or adult personal identification number" or otherwise "has taken, in good faith, reasonable,

effective, and appropriate actions under the circumstances to restrict or prevent access by

minors" to indecent material. Although the primary focus of this section of the Act is on 95

criminal liability, the Act provides that the Commission may describe additional measures

"which are reasonable, effective, and appropriate to restrict access to prohibited
 47 U.S.C. §223(e)(6). 96

 47 U.S.C. §223(e)(6). 97

 Steven Titch, "Controlling the Internet," Telephony 230:7 (February 12, 1996) at 52. 98

44

communications." At the same time, however, the Act places substantial limits on the 96

Commission's authority in this area: 

Nothing in this section authorizes the Commission to enforce, or is intended to

provide the Commission with the authority to approve, sanction, or permit, the use of

such measures. The Commission shall have no enforcement authority over the failure

to utilize such measures. The Commission shall not endorse specific products

relating to such measures.97

The Commission has not taken any action in response to this section of the Act, and enforcement

of these provisions is currently enjoined by a federal court, pending appeal to the Supreme

Court. 

In most cases, the Commission's existing content rules would apply to Internet services

only to the extent that the Commission treated these services as broadcasting. Some activities

now conducted over the Internet would likely be prohibited if transmitted over television or

radio networks. For example, existing rules proscribe broadcasting of advertisements for

cigarettes and gambling services, but such companies have created sites on Web. 

The decentralized nature of the Internet may doom any attempt to regulate content in order

to prevent access to undesirable material. Many different kinds of entities and individual 98

provide services through the Internet, and limited assumptions about providers or recipients of

information may prove unworkable. Creators of online content may have differing levels of

control over how the material they send or make available over interactive computer networks

such as the Internet can be accessed. Finally, the Internet is international in scope, while the

jurisdiction of governments that may seek to regulate Internet content is limited to a single

nation, creating both legal and practical difficulties. If content is hosted on a server outside the

United States, where the information provided is perfectly legal, can U.S. law be extended to the

provider of that content? 

In general, the FCC should seek to avoid regulation of Internet content. The legal

rationales for FCC regulation of content in other media -- such as scarcity of transmission

capacity and invasiveness -- do not necessarily apply to the Internet. Moreover, the Internet

provides new mechanisms to solve the very problems it creates. Several companies now provide

filtering software that allows users -- such as parents -- to block access to inappropriate Internet
See Amy Harmon, "Firms Unveil Rating Standard for the Internet," Los Angeles Times, May 10, 1996, at A1. 99

45

sites. Government regulation of content raises important constitutional issues involving 99

freedom of speech, and thus should not be undertaken lightly.

E. Administrative Issues

Unlike the voice network, which has evolved under the federal-state framework of the

Communications Act of 1934, the Internet has no built-in jurisdictional divisions. More

important, because the Internet is a dynamically routed, packet-switched network, only the

origination point of an Internet connection can be identified with clarity. Users generally do not

open Internet connections to "call" a discrete recipient, but access various Internet sites during

the course of a single connection. A voice call originates and terminates at two discrete points,

and therefore calls can readily be assigned into jurisdictional categories such as local,

intraLATA toll, interLATA intrastate, interLATA interstate, intraLATA interstate, and

international. The requirement that users dial ten digits instead of seven for calls outside their

area code provides some indication of the categorization of a particular call. Similarly, a cable

system has a defined boundary, and a broadcast signal, although propagating indefinitely, must

have a defined origination point.

For an Internet connection, by contrast, the user may have no idea where the sites he is

viewing are located. One Internet "call" may connect the user to information both across the

street and on the other side of the world. Furthermore, dynamic routing means that packets may

take different routes across the Internet to reach the same site, so even the location of the site the

user is contacting does not provide sufficient information to identify the routing of the call for

jurisdictional purposes. Internet routers have also not been designed to record sufficient data

about packets to support jurisdictional segregation of traffic. 

Any regulatory system that applies different rules to different types of Internet services

would require, however, some method of identifying and/or segregating Internet traffic. For

example, if Internet telephony is subject to Title II of the Communications Act, but basic

Internet data connectivity is not, some system would be required to determine whether or not

Internet access providers are carrying telephony traffic. Internet protocols currently do not

differentiate between different types of packets in a manner that would allow this type of

monitoring, and the overhead of such a system could be considerable. Moreover, the definition

of what constitutes an "Internet phone call" is not obvious, and changing technology may render

any "bright lines" obsolete very rapidly. 

Internet connections may be also used for many different purposes. Some uses of the

Internet -- such as voice telephony -- may fall more clearly within a plausible reading of the

Communications Act. However, service providers that carry such services may not even know

what type of data packets are passing through their networks at any given moment. 
See, e.g., "France Proposes Net Standards," Web Review, April 29, 1996, available on the World Wide Web at 100

<http://webreview.com/96/04/29/news/france.html> (describing a memorandum from the French

Telecommunications Minister acknowledging that any regulation of the Internet must be international in scope).

46

These characteristics pose difficulties for virtually every type of regulation. For example,

jurisdictional divisions are the basis not only of the regulatory status of companies themselves,

but also the decisions as to which rates regulated telephone companies can charge to unregulated

entities. Federal, state, and local governments use such distinctions as the basis for deciding

whether they have franchising or taxation authority over companies. The problem is magnified

because the Internet is international. Different countries may have completely different laws

governing issues such as acceptable content, intellectual property, and privacy, and virtually any

company that touches the global Internet could arguably be subject to all of them. Moreover,

any domestic regulatory regime must consider the treatment traffic that originates outside the

United States and therefore the jurisdiction of the FCC.100

F. Toward a Rational Approach

The primary goal of this paper is to identify issues, not to offer specific policy

recommendations. It is important to remember that, despite the tremendous attention given to

the Internet in the past few years, it remains orders of magnitude smaller in terms of usage and

revenues than the voice telephone network in the United States. Many of the questions raised

here will answer themselves as service providers fine-tune their business models and as the

communications industry evolves. Once competition is sufficiently well-developed, regulation

may become largely unnecessary. At some point, companies will be disciplined more strongly

by market forces than by the dictates of regulators. Nonetheless, some thoughts about how to

address the categorization challenges raised in this section are appropriate.

So long as some services are regulated, a line-drawing process must take place. When

Internet services are involved, this line drawing will be inherently messy and imprecise. 

However, even the premise that Internet services should not be regulated requires a precise

assessment of what constitutes an "Internet" service. With the increasing prevalence of hybrid

services, joint ventures, and alternative technologies, such distinctions will always be difficult. 

No matter how sophisticated the regulator, companies in the marketplace will devise clever

means of avoiding regulatory restrictions. No matter how well-intentioned the regulator,

government intervention in the private sector can have unexpected and unfortunate

consequences. 

Thus, government should apply blunt instruments that achieve underlying goals, rather

than struggling for an elegant or precise solution that will cover every case. Wherever possible,

market forces should be harnessed to take the place of direct regulatory intervention. Although

new services like Internet telephony and streaming video may create legal headaches, these

developments are positive ones that government should encourage. Such new technologies are

valuable both because of the new options they represent for consumers, but also because of the

potential competitive pressure they may exert on incumbent providers. 
47

The first task of government policy towards these new Internet-based services should

therefore be to identify those areas where regulation is clearly not appropriate. By

distinguishing these "easy cases," government can provide greater certainty to the private sector

that regulation will not be extended to the theoretical boundaries of statutory authority. For

example, when a company such as Vocaltec sells retail software that allows end users to make

voice phone calls through the Internet, and nothing more, it makes little sense to classify that

company as a telecommunications carrier subject to federal and state regulation. Such software

providers merely enable end users to utilize a functionality through the network, much like

companies that sell fax machines. They do not themselves transport telecommunications traffic. 

Similarly, an ISP should not be classified as a telecommunications carrier simply because some

of its users choose to use Internet telephony software to engage in voice calls. By stating that

such companies are not subject to the Communications Act, the FCC could eliminate fear and

uncertainty, while still leaving room to analyze the harder questions. 

 The next step should be to identify relatively simple and flexible structures that achieve

underlying policy goals. The initial assumption ought to be that new Internet-based services

should not be subject to the regulatory constraints of traditional services. Government policy

should be sensitive to the fact that technology is changing rapidly, and that the Internet

landscape a few years in the future may look very different than it does today. Market forces

may lead to the creation of differentiated classes of service, with users paying higher rates for

higher quality, thus de facto distinguishing between different types of service offerings, without

any intervention by the government.

The analytical process must work in both directions. Government should think not only

about the regulatory treatment of new services, but about the implications of those new services

for the regulatory treatment of existing services. If a competitive imbalance exists because a

new technology is not subject to the same regulatory constraints as a competing older

technology, the answer should be reduced regulation of the older technology. Of course, such

deregulation should be dependent on the existence of sufficient competition to police the actions

of incumbents. The ultimate objective, however, should be less regulation for all, rather than

more regulation for some.
 The trend for ISP pricing has been to move towards unlimited usage for a flat monthly rate, especially since 101

AT&T began offering unlimited Internet access for $19.95 per month in early 1996. America Online, which

provides Internet access along with proprietary content to eight million subscribers, is now offering an unlimited

usage $19.95 per-month pricing plan.

 Users in rural areas may be able to reach an ISP POP through a local call. See infra section (V)(C). 102

 Of course, this paradigm may change as new competitors enter both the local exchange and interexchange 103

marketplace, especially as integrated providers increasingly offer both local and long-distance services.

48

IV. PRICING AND USAGE

The FCC does not regulate the prices charged by ISPs or Internet backbone providers. 

However, the vast majority of users connect to the Internet over facilities of existing

telecommunications carriers. Those telecommunications carriers are subject to varying levels of

regulation at both the federal and the state level. Thus, regulatory decisions exercise a profound

influence over the economics of the Internet market. Economics will drive the development of

both the Internet and of other communications technologies. Consequently, the pricing structure

for Internet access, and its interrelationship to the public switched telephone network, are of

central importance.

A. Current Internet Access Pricing

To access the Internet, a user must pay an ISP, and any applicable charges to connect to

that ISP. Most ISPs charge a flat, monthly fee, although some assess a per-hour charge above a

certain monthly threshold. The vast majority of users reach their ISPs today through the 101

telephone network. The phone call to reach an ISP is usually a considered a local call, because

the ISP has established a point of presence (POP) in that local calling area. Local telephone 102

service for residential users is typically a flat, monthly fee (in contrast to long-distance service

which is typically billed by the minute). 

Thus, in the typical scenario for dial-up Internet access, as shown in Figure 7, an Internet

user "sees" a monthly telephone connection charge, a monthly charge from the ISP, and a usage

charge of zero. By contrast, a subscriber making a long-distance telephone call today sees a

monthly local connection charge from a LEC, plus a usage charge from an interexchange carrier

(IXC) for each minute of long-distance calling.103

MTS and WATS Market Structure, Memorandum Opinion and Order, 97 FCC 2d 682, 711-22, ¶¶ 75-90 (1983) 104

(Access Charge Reconsideration Order). In the Access Charge Reconsideration Order, we initially exempted

several other types of entities, such as WATS resellers, from the requirement that they pay interstate access

charges. The exemptions for those other entities were subsequently lifted. WATS-Related and Other Amendments

of Part 69 of the Commission's Rules, Second Report and Order, CC Docket No. 86-1, FCC 86-377 (released

August 26, 1986).

Local Competition Order at ¶718. 105

See Access Charge Reform, Notice of Proposed Rulemaking, Third Report and Order, and Notice of Inquiry, 106

FCC 96-488 (released December 24, 1996) (Access Reform Notice).

Access Charge Reconsideration Order, 97 FCC 2d at 715, ¶ 83 ("Other users who employ exchange service for 107

jurisdictionally interstate communications, including ... enhanced service providers ... would experience severe

rate impacts were we immediately to assess carrier access charges upon them.").

50

There are three fundamental reasons why most Internet users do not pay usage charges: (1)

residential local service tends to be flat-rated, and ISPs have located their POPs to maximize the

number of subscribers who can reach them with a local call; (2) Internet backbone providers

tend to charge non time-sensitive rates to each other and to ISPs; and (3) ISPs typically connect

to LECs through business lines that have no usage charges for receiving calls. 

Because Internet access is understood to be an enhanced service under FCC rules, ISPs are

treated as end users, rather than carriers, for purposes of the FCC's interstate access charge rules. 

This distinction, created when the FCC established the access charge system in 1983, is often

referred to as the "ESP exemption." Thus, when ISPs purchase lines from LECs, the ISPs buy 104

those lines under the same tariffs that any business customer would use -- typically voice grade

measured business lines (1MBs) or 23 channel ISDN primary rate interface (PRI). Although

these services generally involve a per-minute usage charge in addition to a monthly fee, the

usage charge is assessed only for outbound calls. ISPs, however, exclusively use these lines to

receive calls from their customers, and thus effectively pay flat monthly rates.

By contrast, IXCs that interconnect with LECs are considered carriers, and thus are

required to pay interstate access charges for the services they purchase. Most of the access

charges that carriers pay are usage-sensitive in both directions. Thus, IXCs are assessed perminute charges for both originating and terminating calls. As the Commission concluded in the

Local Competition Order, the rate levels of access charges appear to significantly exceed the

incremental cost of providing these services. The Commission in December 1996 launched a 105

comprehensive proceeding to reform access charges in a manner consistent with economic

efficiency and the development of local competition.106

The FCC's originally explained its decision to treat ESPs as users rather than carriers as a

temporary response to concerns about "rate shocks" if ESPs were immediately forced to pay

access charges. In 1987, the FCC proposed to require ESPs to pay interstate access charges, 107

on the theory that ESPs used LEC networks in the same manner as IXCs, but this proposal was
Amendments of Part 69 of the Commission's Rules Relating to Enhanced Service Providers, Notice of Proposed 108

Rulemaking, 2 FCC Rcd 4305 (1987) (ESP Exemption NPRM); Amendments of Part 69 of the Commission's Rules

Relating to Enhanced Service Providers, Order, 3 FCC Rcd 2631 (1988) (ESP Exemption Order). We also sought

comment on possible modifications to the ESP exemption in the context of the implementation of our open

network architecture (ONA) rules. Amendments to Part 69 of the Commission's Rules Relating to the Creation of

Access Charge Subelements for Open Network Architecture and Policy and Rules Concerning Rates for Dominant

Carriers,6 FCC Rcd 4524, 4534-35 (1991).

ESP Exemption Order at 2633, ¶ 20. 109

 47 C.F.R. § 69.704(a). 110

Access Reform Notice at ¶¶ 282-90. 111

Id. at ¶ 288. 112

See id. at ¶¶ 311-18. 113

51

withdrawn after intense opposition. In closing the 1987 docket, however, the FCC explained 108

that "this is not an appropriate time to assess interstate access charges on the enhanced services

industry," implying that it still viewed the treatment of ESPs as a temporary accommodation. 109

In the FCC rules, however, there is no "exemption" or "waiver;" only carriers are subject to

access charges, and ESPs are defined separately from carriers.110

 The Access Reform NPRM took up the question of whether enhanced service providers

should be subject to access charges as currently constituted, and tentatively concluded that they

should not. The Commission argued that, given the inefficiencies of the existing access 111

charge system, "[w]e see no reason to extend this regime to an additional class of users,

especially given the potentially detrimental effects on the growth of the still-evolving

information services industry." At the same time, the Commission issued a Notice of Inquiry 112

(NOI) seeking comment more broadly on actions relating to Internet and interstate information

service providers. 

113
See, e.g. Lee McKnight & Joseph Bailey, Internet Economics (forthcoming 1997); Jeff MacKie-Mason & Hal 114

Varian, Pricing the Internet, in Public Access to the Internet (Kahin & Keller, eds. 1994); Alok Gupta, Dale Stahl,

and Andrew Whinston, "Pricing Services on the Internet," available on the World Wide Web at

<http://cism.bus.utexas.edu/alok/pricing.html>.

 Nicholas Economides, "The Economics of Networks," International Journal of Industrial Organization 14:2 115

(March 1996).

See, e.g., Amy Friedlander, Natural Monopoly and Universal Service: Telephones and Telegraphs in the U.S. 116

Communications Infrastructure 1837-1940, at 54 (CNRI 1995).

 John Simons, "Stress, Strain and Growing Pains: As Usage Soars, the Net Could Face Brownouts," US News 117

and World Report, May 6, 1996. This article quotes Bob Metcalfe, the developer of Ethernet and founder of

3Com Corp., as stating, "The Internet is about to collapse" from excessive usage. See also Jeff Pelline and Jon

Swartz, "Internet Gridlock is Getting Worse," San Francisco Chronicle, April 16, 1996.

52

B. Network Economics

In recent years, there has been extensive academic literature on the economics of the

Internet. Much of the economic debate concerns the implications of various pricing models 114

for Internet usage. Pricing generates incentives that affect usage patterns, and that also affect the

manner in which service providers construct their networks. The FCC and state commissions,

through their regulatory authority over the rates charged by local phone companies and other

mechanisms, exercise great influence over the pricing of Internet access. Therefore, the

underlying economics of the Internet, and of networks generally, are of great importance for any

discussion of the relationship of the FCC to the Internet.

The value of networks to each user increases as additional users are connected. For 115

example, electronic mail is a much more useful service when it can reach fifty million people

worldwide than when it can only be used to send messages to a few hundred people on a single

company's network. The same logic applies to the voice telephone network, and is an important

underpinning of the FCC's public policy goal of universal service.116

However, this increasing value also can lead to congestion. Network congestion is an

example of the "tragedy of the commons:" each user may find it beneficial to increase his or her

usage, but the sum total of all usage may overwhelm the capacity of the network. With the

number of users and host computers connected to the Internet roughly doubling each year, and

traffic on the Internet increasing at an even greater rate, the potential for congestion is increasing

rapidly. The growth of the Internet, and evidence of performance degradation, has led some

observers to predict that the network will soon collapse, although so far the Internet has defied 117

all predictions of its impending doom.

Two types of Internet-related congestion should be distinguished: congestion of the

Internet backbones, and congestion of the public switched telephone network when used to

access the Internet. These categories are often conflated, and from an end user standpoint the

point of congestion matters less than the delays created by the congestion. However, there are

two fundamental differences. First, prices that carriers charge for use of local exchange facilities
 For a more detailed explanation of Internet congestion, see Vadim Antonov, "ATM: Another Technological 118

Mirage," available on the World Wide Web at <http://www.pluris.com/ip_vs_atm/>.

 For comparison, the NSFNET was upgraded from 56 kbps to 1.544 Mbps (T-1), and then to 45 Mbps (T-3) 119

before it was replaced by the commercial backbones. 

 "The Interminablenet," The Economist, February 3, 1996, at 70-71. 120

 Michael Shapiro, "Trio Targets Gridlock," Web Review News, May 9, 1996, available on the World Wide Web 121

at <http://webreview.com/96/05/09/news/network.html>.

 These protocols generally work by reducing duplication in sending high-bandwidth data to multiple recipients, 122

or by allowing users to "reserve" (and pay for) a guarantees level of bandwidth for a specific use. See Joe

McGarvey, "Beyond Bandwidth: Solving Net Traffic Jams," Inter@ctive Week, April 22, 1996, at 58.

53

are regulated, while those that Internet backbone providers charge are not. This regulatory

distinction is based on the reality that today there is generally only one LEC that an ISP can use

in a given area, while there are many competing Internet backbone providers. Second, the PSTN

generally uses circuit switching, while the Internet is packet switched. The congestion patterns

and pricing issues for the PSTN, which carriers both voice and Internet traffic, are therefore

different than those in the Internet backbone world.

Congestion of the Internet backbones results largely from the shared, decentralized nature

of the Internet. Because the Internet interconnects thousands of different networks, each of

which only controls the traffic passing over its own portion of the network, there is no

centralized mechanism to ensure that usage at one point on the network does not create

congestion at another point. Because the Internet is a packet-switched network, additional

usage, up to a certain point, only adds additional delay for packets to reach their destination,

rather than preventing a transmission circuit from being opened. This delay may not cause

difficulties for some services such as email, but could be fatal for real-time services such as

video conferencing and Internet telephony. At a certain point, moreover, routers may be

overwhelmed by congestion, causing localized temporary disruptions known as "brownouts."118

Backbone providers have responded to this congestion by increasing capacity. Most of the

largest backbones now operate at 155 Mbps (OC-3) speeds, and MCI has upgraded its backbone

to OC-12 (622 Mbps) speed. Backbone providers are also developing pricing structures, 119

technical solutions, and business arrangements to provide more robust and reliable service for

applications that require it, and for users willing to pay higher fees. Some network providers,

such as the @Home cable Internet service, are relying on "caching" multiple copies of

frequently-accessed documents to ease the congestion burden. In addition, hardware vendors 120

are working to improve the speed and interoperability of their Internet routers and switches. 

121

Congestion on Internet facilities may also be alleviated by the development and

implementation of technical protocols, such as HTTP version 1.1, IP version 6, IP multicasting,

and RSVP, that facilitate more coordinated and efficient use of bandwidth. These 122

technologies may allow for more differentiated levels of service quality, with associated
 There is a significant economics literature on priority-sensitive pricing models for the Internet. 123

 For simplicity, this description leaves out many other functions of ISPs, such as user authentication and domain 124

name queries. 

54

differentiation in pricing. The pricing of backbone services may affect end user charges for 123

Internet access, even if ISPs continue to pay flat rates to LECs. 

Internet backbone congestion raises many serious technical, economic, and coordination

issues. Higher-bandwidth access to the Internet will be meaningless if backbone networks

cannot provide sufficient end-to-end transmission speeds. Moreover, the expansion of

bandwidth available to end users will only increase the congestion pressure on the rest of the

Internet. However, Internet backbone providers are not regulated by the FCC in the same

manner as LECs. This paper concentrates primarily on the congestion and pricing issues that

affect the public switched telephone network, because it is in that area that decisions by the FCC

and other regulatory entities will have the greatest significance.

C. Implications for Local Exchange Carriers

Most residential subscribers reach their ISPs through dial-up connections to LEC networks. 

Figure 8 shows the typical scenario for a dial-up user. A modem at the customer premises is

connected to a local loop, which is connected to a switch at a LEC central office. ISPs also

purchase connections to the LEC network. In most cases, ISPs either buy analog lines under

business user tariffs (referred to as "1MBs") or 23-channel primary rate ISDN (PRI) service. 

When a call comes into an ISP, it is received through a modem bank or a remote access server,

and the data is sent out through routers over the packet-switched Internet. Both subscribers 124

and ISPs share usage of LEC switches with other customers. 

See, e.g., "Access Charge Reform: What's Past is Prologue and Pretty Scary," Communications Today,

125

February 5, 1996 (quoting former FCC Common Carrier Bureau Chief Albert Halperin as stating that the ESP

exemption "is one of the significant weaknesses in the existing [access charge] plan.")

See ESP Exemption NPRM. 126

 The CCLC was established to recover costs that could not be recovered due to caps on the flat end user 127

subscriber line charge (SLC). The Commission is currently considering whether to retain the current CCLC in the

context of its Universal Service proceeding.

56

1. Pricing Issues

Ever since 1983, when the FCC first decided that ESPs would not be subject to interstate

access charges, parties have challenged the "ESP exemption" as an inefficient temporary subsidy

that unfairly deprives LECs of revenues. The FCC has itself come close to endorsing this 125

view in the past, most notably in the infamous "modem tax" proposal in 1987. Nonetheless, 126

the current pricing structure for enhanced services has stayed in place for fourteen years. The

telecommunications landscape has changed tremendously in that time, with the emergence of the

Internet being among the most significant developments. The Access Reform NPRM proposes

to leave the current pricing structure for ISPs in place for now. In the companion NOI, the

Commission seeks comment on, among other issues, how these changes should affect the pricing

structure applicable to ISPs.

Access charges are designed to recover the LECs' interstate revenue requirements for the

underlying facilities. These revenue requirements were derived from rate-of-return, accounting

cost mechanisms designed to recover the embedded costs of monopoly LECs. Since 1990, large

LECs have been subject to price cap regulation of their access services, which has allowed rate

levels to diverge to some degree from embedded costs, but LEC access charges are still not

based on any calculation of forward-looking cost. Another aspect of the revenue requirement

that distorts rate levels is the fact that the jurisdictional separations system apportions costs

between the interstate and intrastate jurisdictions in a manner that does not accurately reflect

cost-causation. Finally, the interstate access charge regime includes various forms of costshifting and averaging. For example, the carrier common line charge (CCLC) is a per-minute

charge that is assessed on all LEC access customers, but it recovers costs associated with end

user subscriber lines.127

IXCs, ISPs, and others have long argued that access charges are substantially higher than

they would be in a competitive market, and the Commission essentially adopted this view in the 

Access Reform and Local Competition proceedings. The argument for requiring ESPs to pay

access charges has generally been premised on the notion that ESPs impose similar costs on the

network to providers of interstate voice telephony, and that ESPs should therefore pay the same

rates for these services. For example, the FCC's 1987 proposal stated that:

Enhanced service providers, like facilities-based interexchange carriers and resellers, use

the local network to provide interstate services. To the extent that they are exempt from
ESP Exemption NPRM at 4306, para. 7. 128

 Commercial Internet Exchange, White Paper: A Telecommunications Policy Framework for Internet Service 129

Providers (March 1995) (CIX White Paper).

 This pricing structure is not, however, followed in the cellular telephone industry today. 130

 The company could choose to reverse the charges with an 800 or 888 toll-free number, but this would be a 131

voluntary action on the part of the company in order to increase convenience for its customers.

57

access charges, the other users of exchange access pay a disproportionate share of the costs

of the local exchange that access charges are designed to cover.128

ESPs have rejected this analysis, and have claimed that they do not need or use many of the

features and functions of the network that IXCs require to set up voice calls. In addition, ESPs

have argued that imposition of interstate access charges would cause tremendous damage to the

enhanced services industry with the corresponding benefit of only a tiny reduction in charges to

other users. ESPs, and particularly the Internet access industry, have also emphasized the public

interest benefits of spurring growth in Internet access and other enhanced services. According to

a March 1995 white paper by the Commercial Internet Exchange (CIX), a trade association of

ISPs, "ESPs have enjoyed this status because of the public policy need to foster an on-line

nation." 

129

The development of Internet telephony provides an additional argument that at least some

enhanced services use LEC networks in a manner similar to IXCs. Voice telephony over the

Internet may operate as a direct substitute for telephony service provided by IXCs over their

voice networks. Today, however, Internet telephony does not provide the same quality and

convenience as traditional voice telephony. Commercial Internet telephony products are also a

relatively new phenomenon, and as a result of these factors the number of users of Internet

telephony is minuscule compared to users of the voice network. These characteristics may

change in the future, especially if Internet telephony continues to be available at significantly

cheaper rates than conventional telephony. As discussed in the previous section, the architecture

of Internet telephony services differs from circuit-switched voice telephony in ways other than

quality and ease of use. The real questions concern the economic implications of Internet

services that use the public switched network.

The current pricing structure of wireline service in the United States operates on the

principle of "sender pays" for transactions between users and carriers. The fact that a 130

subscriber only pays for making phone calls, not for receiving them, does not mean that the LEC

does not incur costs for the subscriber to receive a call; it only means that those costs are

recovered indirectly through the rates users pay for outbound calls and monthly service This

rule generally holds true even if the subscriber is a member of a distinct user category with a

different cost causation pattern. For example, a customer service center operated by a computer

company receives many times more calls from customers than it originates, but the call usage is

charged -- if at all -- to the customers. The 1996 Act essentially adopts a "sender pays" rule 131
 LEC switch and network architecture is actually somewhat more complex than described here, but the basic 132

principles set forth still hold true. 

 Amir Atai & James Gordon, Impacts of Internet Traffic on LEC Networks and Switching Systems (Bellcore 133

1996); letter from Joseph J. Mulieri, Bell Atlantic, to James D. Schlichting, FCC (June 28, 1996); letter from

Kenneth Rust, NYNEX, to James Schlichting, FCC (July 10, 1996); letter from Glenn Brown, US West, to James

Schlichting, FCC (June 28, 1996); letter from Alan Ciamporcero, Pacific Telesis, to James Schlichting, FCC (July

2, 1996).

58

for interconnection between carriers in the form of "transport and termination" charges;

originating telecommunications carriers must pay whenever they hand off local traffic to another

carrier. 

2. Switch Congestion

Several LECs and others now argue that the current pricing structure for Internet access

contributes to the congestion of LEC networks. Switch congestion can arise at three points in

LEC networks -- the switch at which the ISP connects to the LEC (the terminating switch), the

interoffice switching and transport network, and the originating end user switch. The point of

greatest congestion is the switch serving the ISP, because many different users call into the ISP

simultaneously. 

LECs have engineered and sized their networks based on assumptions about voice traffic. 

In particular, several decades of data collection and research by AT&T, Bellcore, and others has

shown that an average voice call lasts 3-5 minutes, and that the distribution between long and

short calls follows a well-established curve. Because very few people stay on the line for very

long periods of time, there is no need for LEC switches to support all users of the switch being

connected simultaneously. Instead, LEC switches are generally divided into "line units" or "line

concentrators" with concentration ratios of typically between 4:1 and 8:1 (see Figure 8). In other

words, there are between four and eight users for every call path going through the switch. Call

blockage on the voice network tends to be negligible because a significant percentage of users

are unlikely to be connected simultaneously.132

The distribution of Internet calls differs significantly from voice calls. In particular,

Internet users tend to stay on the line substantially longer than voice users. As shown in Figure

9, several LECs and Bellcore have submitted studies to the Commission documenting the

difference between Internet and voice usage patterns. ISPs, although challenging the 133

methodologies and conclusions of the studies, generally acknowledge that Internet calls tend to

be longer than voice calls.

 

 Lee L. Selwyn & Joseph W. Laszlo, The Effects of Internet Use on the Nation's Telephone Network (January 134

22, 1997) (ETI Study).

Id. at 19-22. 135

Id. at 27. 136

60

Because LEC networks have not been designed for these longer usage patterns, heavy

Internet usage can result in switches being unable to handle the load ("switch congestion").

Internet connections tie up a end-to-end call path through the PSTN for the duration of the call. 

When the average hold time of calls through a switch increases significantly, the likelihood of all

available call paths through the switch being in simultaneous use also goes up. If a particular

line unit has an 8:1 concentration ratio, only one eighth of the subscriber lines into that line unit

need to be connected at one time in order to block all further calls.

Because of the relatively short average duration of voice calls, the primary limiting factor

on the capacity of current digital switched for voice calls is the computer processing power

required to set up additional calls. Computer processing power can be expanded relatively easily

and cheaply, because modern switch central processing units are designed as modular systems

that can be upgraded with additional memory and processing capacity. On the other hand, LECs

argue, Internet usage puts pressure not on the call setup capacity of the switch, but on the

number of transmission paths that are concurrently open through the switch.

ISPs dispute the extent to which switch congestion currently represents a serious problem. 

A study by Economics and Technology, Inc. (ETI), commissioned by the Internet Access

Coalition, argues that the growth of Internet traffic poses no threat to the integrity of the voice

network. According to the study, incidents of congestion have been localized, are easily 134

corrected, and are primarily attributable to inadequate planning and inefficient engineering by

the LECs. The ETI study also concludes that LECs received approximately $1.4 billion of 135

revenue from additional residential subscriber lines used for online access in 1995, and that this

number far exceeds even the LECs' own estimates of the costs of network upgrades to ameliorate

congestion. Other opponents of imposing usage charges on ISPs point to the fact that LEC 136

state business line tariffs are designed to recover the costs LECs incur for usage of their network,

and that if flat-rated charges are compensatory for local service it is illogical to argue that they

are non-compensatory for Internet access. Long voice calls, these advocates claim, impose the

same costs on the network as long Internet connections, but LECs are still able to provide local

service at flat monthly rates. 

The Network Reliability and Interoperability Council, an industry group that tracks

reliability of the public switched telephone network and makes recommendations to the FCC,

has stated that Internet usage has not yet resulted in any outages above the NRIC's outage
See "Hundt asks Network Reliability and Interoperability Council to Monitor Impact of Internet Growth on 137

Public Networks," FCC News Release, November 1, 1997. Additional information about the Network Reliability

and Interoperability Council is available on the World Wide Web at <http://www.fcc.gov/nric/>.

 Pricing and regulatory decisions will not mandate how providers deploy their networks or serve their 138

customers, but will only shape economic incentives on companies. 

61

reporting threshold. Internet usage, however, continues to grow rapidly. Low-cost Internet 137

access devices such as Web TVs and network computers (NCs) that have recently come on the

market are likely to fuel substantial Internet traffic growth in the next several months.

A distinction should also be made between the larger class of ESPs -- which include

companies such as voice mail providers, alarm monitoring companies, credit card validation

services, and internal corporate data networks -- and Internet or online service providers. 

Current FCC rules refer only to ESPs, but the arguments LECs are now making about switch

congestion are directed specifically at the small subset of ESPs that provide Internet access. The

fact that Internet usage may be placing new demands on LEC networks is not necessarily a

reason to impose usage charges on enhanced service companies other than ISPs. There may be

arguments that other ESPs should pay usage charges, because they generate costs for LECs that

otherwise cannot be recovered. In fact, the previous debates about the ESP exemption occurred

before there was any significant amount of commercial or residential Internet usage. If the

Commission wishes to consider the LEC arguments about switch congestion, however, the

discussion should only apply to pricing of services for ISPs, not all ESPs. 

3. Responses to Switch Congestion

Addressing switch congestion is ultimately a matter of money. No one argues that LECs

cannot upgrade their networks to remove and prevent blockages. There is, however,

disagreement about the costs of such upgrades, and whether changes in pricing structures would

send efficient economic signals. The ultimate question is whether LECs have appropriate 138

incentives to upgrade their networks in the most efficient manner, and ISPs have appropriate

incentives to use the most efficient available method of access. Most parties agree that, as a

technical matter, packet-switched Internet traffic could be transported more efficiently through a

packet-switched network, rather than tying up the circuit-switched PSTN. However, different

technical solutions will likely be most appropriate in different regions, depending on factors such

as the infrastructure and business plans of the incumbent LEC, the competitive landscape, and

the level of Internet traffic in a specific area. The goal of policy makers should be to create

incentives that encourage these efficient results, rather than choosing any one solution. 

Several technical, economic, and regulatory responses to switch congestion have been

proposed. 

a. Pricing Changes
 The second point is more important because the ultimate goal is to maintain and enhance the network, not to 139

restrict usage. 

See Access Reform Notice at ¶ 288. 140

62

Some LECs argue that, because of the possibility of switch congestion, the Commission

should allow them to assess per-minute usage charges for ISPs to receive calls from their

subscribers. From the LEC perspective, usage pricing would have two salutary effects. First,

because ISPs (and presumably their customers, as ISPs themselves shifted to measured rates to

recover their costs) would be paying more for longer calls, they would have incentives not to

over-use the network. In other words, users would stay connected only as long as they found the

additional connect time worth the cost, and ISPs might have stronger incentives to migrate away

from their current practice of purchasing tremendous numbers of analog business lines. Second,

and more importantly, with usage pricing, LECs would receive more revenue from longer

Internet calls than from shorter ones. Thus, the LECs argue, their revenues would more 139

closely match their costs, which also increase with longer connection times due to the necessary

network upgrades to prevent switch congestion.

The notion of "usage charges" should be distinguished from current interstate access

charges. The discussion of this topic is often framed in terms of whether to "lift the ESP

exemption," or "impose access charges on ISPs." However, even if one agrees with the LEC

arguments, this does not lead to the conclusion that ISPs should pay today's access charges. 

Current access charges far exceed the economic cost of providing access services, and in many

ways are structured in an economically inefficient manner. It would make no sense, under the

guise of creating a more efficient rate structure for ISPs, to impose the existing access charge

system that all parties agree is inefficient. In addition, access charges have been structured based

on the features and service bundles used by IXCs to handle voice calls, which may be different

than those ISPs would choose. The Commission based its tentative conclusion in the Access

Reform NPRM that ISPs should not be subject to current access charges on these sorts of

arguments.140

The real question is whether ISPs should pay some new cost-based usage charges. ISPs

should pay the same charges as IXCs only if those charges are appropriate for a competitive

market and for the manner that ISPs use LEC networks. The Commission could also establish a

separate set of interstate charges for ISPs distinct from those assessed on IXCs, or even distinct

from those for other ESPs with different cost causing characteristics. Finally, if the FCC does

not change the current classification of ISPs as end users, LECs could alter their state tariffs to

impose usage charges on ISPs. Such a result could involve tariffs based on the characteristics of

ISP traffic (many long hold-time incoming calls) that in effect required ISPs to pay usagesensitive rates, or alternate tariffs that ISPs could select voluntarily. The Commission might be

required to respond to changes in state-level pricing for ISPs to the extent that such changes

affected BOC open network architecture (ONA) plans.
See, e.g., J. William Gurley, "Internet Economics:The FCC Chimes In," available on the World Wide Web at 141

<http://www.upside.com>; J. William Gurley & Michael Martin, "The Price Isn't Right on the Internet," Fortune,

January 13, 1997, at 152; Adam Thierer, "End Free Ride on the Internet," Wall Street Journal, March 7, 1997, at

A14.

63

LECs could also fashion and seek FCC approval of experimental or contract tariffs for

services they offer to ISPs. Current FCC rules limit LECs' ability to offer individualized prices,

because of concerns about discrimination and predatory pricing. However, a specialized federal

tariff offering geared to ISPs, especially if developed in conjunction with some large ISP

customers, might prove to be a useful experiment. 

The term "usage charges" itself requires some further qualifications. The cost of shared

telecommunications facilities is generally driven not by total usage, but by usage at peak periods. 

The marginal cost of a off-peak call is often close to zero. For this reason, long-distance pricing

in the United States has traditionally operated on a multi-level model, with calls during daytime

hours (when usage is heaviest) priced highest, and calls during night and weekend hours priced

lowest. Internet usage can cause switch congestion because usage at peak periods may exceed

the capacity of a switch, and because a higher percentage of Internet users engage in extremely

long calls (i.e. more than two hours). A relatively small number of long calls may make a

significant contribution to the degree of congestion on a switch. Therefore, a pricing structure

that incorporated usage charges only for a small percentage of users (for example, those that

were connected more than 200 hours per month), might reduce switch congestion without

affecting the vast majority of Internet users. 

There are many difficulties with peak-load pricing schemes. Users may respond to the

pricing structure by shifting their calling patterns to avoid the peak charges, thereby shifting the

peak. Customers have also shown a strong preference for simple pricing systems, and especially

for those that offer a flat rate for unlimited usage, even if the flat rate would actually result in a

higher bill for their particular level of usage. Nonetheless, more thought should be given to

pricing structures other than straight per-minute charges. Such alternatives may eventually

prove unworkable or undesirable, but they should stimulate creative thinking and a more precise

understanding of the causative relationship between specific usage patterns and congestion. 

At first blush, the economic argument that ISPs should pay usage charges to LECs seems

compelling. Switching and transport capacity in the PSTN are scarce resources, and heavier use

of those resources results in higher costs to the service provider. To the extent that these costs

cannot be recovered from the discrete groups responsible for the heavier usage, rates for all users

will increase. This result seems undesirable as a matter of equity (why should all users pay more

so that a portion of users can access the Internet) and as a matter of efficiency (why should

Internet users be given the misleading signal that unlimited Internet usage is "free" for the

network). At a more general level, if a minute of Internet usage looks the same to the phone 141

network as a minute of voice usage, economic cost-causation principles suggest that they be

subject to the same pricing structure. 

The reductive argument for usage charges is problematic on several levels. Most

fundamentally, it assumes that other aspects of telecommunications pricing follow similar
 Pacific Bell, for example, recently targeted a sales pitch to Internet users in which it offered to waive 142

installation charges, and offers five free months of Internet access for subscribers that purchase a second line.

ETI Study at 27. 143

64

principles of economic efficiency. The same argument about the perils of flat-rated pricing

could be applied to residential local phone service in the United States. There are many classes

of users that can be identified as making or receiving unusually large volumes of calls, such as

teenagers and customer support centers for businesses, yet separate rate structures have not been

established for these groups. All tariffed prices for telephone services involve some level of

averaging, so the mere fact that some users vary from the average does not by itself suggest that

they should pay different rates. 

The argument for usage pricing also assumes that ISPs use the existing, circuit-switched

network, rather than the alternative access technologies described in the next section. An

unanswered question, therefore, is whether LECs would have incentives use the additional

revenues generated by usage pricing to further expand the circuit-switched network, or to invest

in more efficient, "data-friendly" alternatives. To address this concern, if an alternate rate

structure for ISPs were developed, it could be conditioned in some way on LEC commitments to

build out data networks in a specific time frame.

LECs also receive substantial additional revenues as a result of Internet usage. In

particular, second line deployment, which was stable for some time, has increased dramatically

over the last few years. A major reason why many subscribers are ordering second lines is to

support modem connections without tying up a primary voice phone line. LECs recognize that

second lines after often used for data connection, and many LECs are specifically marketing

second lines to consumers for this reason. Recent LEC earnings statements emphasize second 142

line growth as a major contributor to LEC bottom lines. Many homes are wired to support at

least two lines without any additional infrastructure, so second lines often cost LECs little to

install and generate very high profit margins. 

The ETI study estimated that in 1995, BOCs generated revenue from additional residential

lines for online access that was six times the amount Bellcore claimed would be required to

upgrade their networks to handle additional Internet traffic. On the other hand, residential 143

lines in some states are deliberately priced low by state commissions, on the assumption that

LECs will "make up" the revenue through toll usage and "vertical features" such as call waiting. 

In cases where LECs must actually install additional copper pairs, therefore, the profitability of

second lines will depend heavily on decisions of state regulators. Any discussion of costs

imposed on LECs by Internet traffic should attempt to take into account second line growth and

other countervailing revenues.

The metric of usage charges may also be significant. Access charges are metered by

minute, and the billing and accounting systems of the PSTN are generally designed to measure

traffic on a time-sensitive ("per-minute") basis. An appreciable component of carrier costs goes
 Although backbone providers have generally not assessed usage charges, many ISPs have charged some usage 144

fees to end users above a certain usage threshold, and thus may have experience with metering and accounting of

traffic.

 "Special Report: Telcos and ISPs Grapple Over Access Charges," Internet Week, March 25, 1996. 145

65

to support this billing and accounting infrastructure. By contrast, the Internet has developed

under flat-rated pricing and interconnection between backbone providers on the basis of "billand-keep" (no settlements), and thus has none of these accounting mechanisms or costs.144

Once traffic is converted into packet form and routed through the Internet, the notion of a

"minute of use" evaporates. The Internet is a connectionless network. Packet data does not

monopolize a set transmission path for a given period of time, it filters through the network

through multiple routes at varying rates. Thus, packet traffic is more appropriately described in

usage levels based on bandwidth (such as bits per second) rather than time. Concerns about

usage pricing for Internet access tend to involve objections to time-sensitive pricing, not to

bandwidth-sensitive pricing (e.g. a 1.544 megabits per second T-1 circuit being more expensive

than a voice grade connection). Internet backbone providers and ISPs are now discussing

technical and logistical aspects of "bandwidth reservation" systems, under which a user of a

service such as streaming video could pay a higher price for guaranteed bandwidth. Such

differential pricing would likely be voluntary for users, as users that did not wish to pay

additional charges could always switch to a different ISP. 

The LEC networks have been designed to support metering and accounting of traffic for

billing purposes, and LECs today charge usage-sensitive access charges to interexchange carriers

that interconnect with LECs for the provision of long-distance telephony. It would therefore

not be administratively difficult for LECs to measure the total amount of traffic, in minutes of

usage, passing between the LEC and an ISP, and to charge the ISP according to its level of

usage. Because ISP costs would vary with the level of usage their customers generated, such a 145

pricing system would create incentives for ISPs to move to some form of usage-based end-user

pricing. Such a system might impose additional costs on ISPs usage on a per-minute basis, since

ISPs have not generally developed the same type of billing infrastructure of the LECs.

Changing the pricing structure applicable to ISPs could have other, more subtle effects. 

Under the existing system, ISP usage is considered jurisdictionally intrastate, while IXC usage is

jurisdictionally interstate. The imposition of access charges or other federally-mandated usage

charges on ISPs could result in ISP usage being reclassified as interstate. This shift would affect

the operation of the separations system, which allocates revenues between the federal and state

jurisdiction. Such large revenue shifts would also affect the price cap system that governs

interstate rates charged by incumbent LECs, which begins with revenues derived from

separations. 

The purpose of this section is not to suggest that some form of usage charges for ISPs will

necessarily always be the wrong answer as a matter of public policy. Rather, the point is that the

question is complex, and must be viewed in the context of several different factors. More
 A transcript of the Bandwidth Forum, along with statements from many of the participants, is available on the 146

World Wide Web at <http://www.fcc.gov/bandwidth>.

66

comprehensive data on Internet usage, congestion levels, and network costs will be crucial to an

effective discussion of switch congestion and pricing structures for ISPs. 

Although Internet access is usually priced at a flat monthly fee for "unlimited usage," most

large ISPs automatically disconnect users after long periods of inactivity in order to avoid tying

up the ISPs' equipment, such as modem banks. Thus, few users may actually "nail up" lines for

24 hours a day. Software does exist to fool these ISP systems, and as services such as America

Online experience congestion problems due to insufficient numbers of modems, users may be

more likely to keep a connection open once they have actually gotten through. As this example

shows, ISP usage patterns are affected by many factors. The FCC's Notice of Inquiry is

designed to gather data to form a better foundation for policy development. The Commission

also held a public forum on Access to Bandwidth on January 23, 1997, which addressed many of

the questions raised in this paper.146

b. Technical Solutions

The imposition of usage charges on ISPs would not, by itself, solve the problem of switch

congestion. At best, this action would give LECs additional revenue to pay for network

upgrades. Congestion will continue to occur, however, so long as users continue to use the

circuit-switched voice network to connect to the packet-based Internet. Usage charges might

also depress Internet usage, which would reduce congestion but could also stifle the growth of

innovative new Internet-based services. The real challenge is to find ways to take that data

traffic off the PSTN, preferably before it reaches the first LEC switch.

The best answer to the current switch congestion problem will be to remove Internet

traffic, or at least heavy Internet users, from the existing circuit switched network. LECs and

ISPs agree that such a network upgrade would best address their concerns. The two sides differ,

however, on the question of how the Commission’s decision about usage charges for ISPs will

effect the deployment of these new technologies. LECs argue that they have no incentive to

invest in upgrading their networks when they recover no additional revenues from ISPs for

supporting heavy Internet use, especially given the uncertainties about cost recovery in a world

of unbundled network elements as required under the 1996 Act. ISPs argue that LECs will have

no incentives to invest in long-term network upgrades if they recover metered charges that

allow, and even encourage, them to keep investing (and profiting) in the existing circuitswitched network.

There are several methods to address switch congestion. These can loosely be grouped

into four categories:
67

Network Expansion and Aggregation

The most straightforward response to switch congestion is to expand the capacity of the

exiting network wherever it is being stressed. These steps include load balancing (shifting

circuits among sub-units of a switch to better distribute heavy traffic directed a single source

such as an ISP), transferring ISP traffic to a larger central office with greater switching capacity,

adding additional capacity to switches, reducing the concentration ratio of switches with heavy

Internet usage, adding additional interoffice trunking, and ultimately purchasing additional

switches. A slightly more fundamental alternative involves "modem pooling" -- persuading ISPs

to lease large banks of modems operated by LECs in a central location, so that Internet traffic

can be more efficiently aggregated at high-capacity points of the network. A similar approach

involves setting up a single number that ISP customers in multiple areas could call into. LECs

are experimenting with or implementing all these responses today, but ultimately they still

involve routing data traffic through at least one circuit switch at the originating end. 

 As of April 1, 1996, the BOCs and GTE had approximately 485,000 ISDN lines in service, or less then 1% of 147

all access lines. Broadband Week, April 1, 1996. A survey of Internet users in early 1996 found that only 1.4%

used ISDN for Internet access. IDC/Link Resources survey, summarized on Cyberatlas, available on the World

Wide Web at <http://www.cyberatlas.com>.

 Technically, ADSL is one of a larger class of digital subscriber line technologies, referred to as xDSL, and 148

there are several different variants of ADSL itself. 

See Carol Wilson, "Will ADSL Technologies Prove to be ISDN Killers?" Inter@ctive Week, April 22, 1996, at 149

55.

 ADSL bandwidth decreases as loop length increases, up to a maximum loop length of 18,000 feet. In addition, 150

equipment such as loading coils and bridge taps, which are deployed on many local loops, interfere with ADSL

transmission.

69

Workarounds

Most LECs have existing tariffed service offerings that route data through data networks

using frame relay or switched multimegabit data service (SMDS) rather than analog modem

connections to a local switch. However, ISPs have rarely taken these services, because they

believe they will increase their costs over their current practice of purchasing large numbers of

business lines. ISPs have also expressed concerns about ceding control over user access to

LECs. Such reluctance may be due to inefficiencies in state tariffing of such data services,

which may not have been designed with current Internet usage patterns in mind. An alternate

form of workaround, which would not necessarily require ISPs to change their current access

arrangements, involves upgrades to LEC switching or signaling networks. Virtually every major

equipment vendor, including Lucent, Nortel, and DSC, has announced or is developing a

solution to screen data traffic and pull it off the voice network onto a packet-based data network,

either before the first LEC switch or at some point in the interoffice network.

Alternate Access Technologies

A third set of answers involves alternate access technologies to replace the analog modems

that most users now employ for Internet access. ISDN, which is available today in virtually all

LEC central offices but is only used by a handful of residential customers, uses the network in a

more efficient manner than analog modems, and also provides up to 128 kilobits per second of

bandwidth. ISDN line units are generally non-blocking; in other words, ISDN is provisioned 147

so that every line into a switch module has a corresponding path through the switch. However,

ISDN is a circuit-based technology, and thus usage will continue to strain the PSTN. Other new

technologies, such as digital subscriber line (xDSL), which provides up to 6 megabits per second

of downstream throughput over ordinary copper lines, promise to avoid this constraint. xDSL 148

modems can be connected directly to a packet network, thus avoiding switch congestion at the

same time as they increase bandwidth available to end users. However, although prices are 149

dropping rapidly, xDSL modems are currently very expensive relative to analog modems, and a

substantial (but not clearly defined) percentage of LEC loops may not be able to support xDSL

without additional conditioning. 

150
 Actual bandwidth is shared among users and thus usually much lower than the theoretical maximum, but still 151

much greater than possible with an analog modem. 

70

In the long term, the LEC industry has already begun planning to migrate its networks

from their existing circuit switched architecture to an architecture based on asynchronous

transfer mode (ATM) switching. ATM is designed to achieve some of the reliability and quality

of service benefits of circuit-switched technologies, along with some of the bandwidth efficiency

and speed of packet-switching. ATM is now widely used in Internet backbones and corporate

networks, but no ATM switches yet have the necessary features and functions to replace existing

LEC end office switches. In addition, a technical debate is now underway in the Internet

community about the effectiveness of ATM as a data switching platform. LECs do not expect to

even begin this transition for several years, and the transition itself is likely to take years to

complete. Replacing existing end office switches will involve enormous costs. Although this

network upgrade may provide a long-term solution, some more near-term action will be

necessary as Internet usage continues to increase.

Alternate Network Providers

Many cable companies are in the process of deploying cable modems, which typically

provide a maximum theoretical bandwidth of 10 megabits per second, although some newer

cable modems offer only 1.2 megabits per second maximum bandwidth in order to reduce

costs. Cable modems are an always connected, packet-based system, so they do not result in 151

switch congestion when used over a two-way cable system. However, cable companies have

experienced technical difficulties deploying cable modems, as well as upgrading their networks

and operations support systems to handle Internet traffic and the associated customer support. 

These difficulties are aggravated by the highly leveraged position of most cable companies,

which constrains their access to capital. 

In order to deploy cable modems more cheaply and quickly, cable operators are now

considering use of "one way" devices over unimproved cable plant. These one-way cable

modems use the high-speed cable network for receiving data from the Internet, and a telephone

line for upstream transmissions. Although this architecture reduces costs for the cable operator,

it potentially increases the congestion of LEC networks, due to the long holding times. In

addition, due to the reciprocal compensation requirements of the 1996 Act, cable networks that

operate as competitive local exchange carriers may be entitled to compensation for "terminating"

LEC traffic over these connections. 

Wireless systems are another promising means to break the bandwidth gridlock. Some

companies, such as Metricom, already offer wireless Internet access at speeds comparable to

analog POTS lines, typically through municipal 900 Mhz spread spectrum systems. Other

wireless technologies, such as local multipoint distribution service (LMDS) and multipoint

microwave distribution service (MMDS) are being tested specifically for Internet access

applications. Wireless access provides not only a competitive alternative to LECs, but

potentially a means for LECs to offload some of their Internet traffic while keeping their
71

existing customers. Pacific Bell recently signed a wireless resale agreement with the wireless

provider Winstar, in part to offload Internet traffic from Pacific’s switches. Finally, satellites

may provide an alternative for some Internet access. Hughes recently began offering its 400

kilobits per second DirectPC service, although customers are required to purchase a satellite dish

and the system requires use of an analog telephone line for the upstream channel. Thus, like

one-way cable modems, the DirectPC service will not necessarily alleviate congestion of LEC

networks, but may, in fact, increase it.

4. State Tariffing Issues

The revenue effects of Internet usage today depend to a significant extent on the structure

state tariffs. Internet usage generates less revenue for LECs in states where flat local service

rates have been set low, with compensating revenues in the form of per-minute intrastate toll

charges. Because ISPs only receive local calls, they do not incur these usage charges. By

contrast, in states where flat charges make up a higher percentage of LEC revenues, ISPs will

have a less significant revenue effect. ISP usage is also affected by the relative pricing of

services such as ISDN Primary Rate Interface (PRI), frame relay, and fractional T-1

connections, which are alternatives to analog business lines. The prices for these services, and

the price difference on a per-voice-channel basis between the options available to ISPs, varies

widely across different states. In many cases, tariffs for these and other data services are based

on assumptions that do not reflect the realities of the Internet access market today. The scope of

local calling areas also affects the architecture of Internet access services. In states with larger

unmeasured local calling areas, ISPs need fewer POPs in order to serve the same customers

through a local call. 

5. Competitive Dynamics

To the extent that competitors, such as IXCs, cable, or wireless providers, are able to offer

voice or data services to customers in competition with the LECs, there will be pressure on the

LECs to lower their rates or otherwise take action to retain their customers. To the extent that

such competition is driven by the underlying efficiencies and business strategies of companies

using different technologies, such competition will benefit consumers. On the other hand, to the

extent that competitors are able to gain market share primarily as a byproduct of regulatory

restrictions on the LECs, such competitive entry may have detrimental consequences. For

example, some high-speed data architectures proposed by the cable and satellite industry only

provide for downstream transmission. Unimproved cable systems, which were designed solely

for the delivery of video programming into consumers' homes and not for interactive services,

have this characteristic. Cable companies may choose to use their infrastructure to deliver highbandwidth downstream services to users, and use LEC telephone lines for upstream transmission

to a local headend. LECs argue that such systems represent a regulatory anomaly that gives

cable companies an unreasonable competitive advantage in delivering broadband services to

residential users at rates that are in effect subsidized by the LECs. 
72

Competitive alternatives to LEC facilities may also reduce the burdens on LECs. If cable

companies and others enhance their networks to provide two-way service and attract Internet

access customers on the basis of their ability to provide higher bandwidth at lower cost, they

may reduce or reverse the recent increase in Internet access through LEC networks. Such

competition could reduce LEC revenues, because LECs would not receive any payments from

Internet users that switch to cable or other providers, but the burden on LEC networks would

also be reduced. An additional competitive dimension of Internet access pricing concerns the

effects of imposition of access charges on ESPs. By raising the cost for most users of

connecting to the Internet through LEC facilities, such a decision would likely increase the

number of users who find alternative providers, such as cable, to be more cost-effective than the

LECs. Although these alternatives today represent only a limited threat to incumbent LECs, the

possibility of such shifts should at least increase the pressure on LECs to price services to ISPs

efficiently.
See supra section (III)(B)(2)(b). 152

 "High-speed" or "high-bandwidth" access technologies in this context refer to access at speeds substantially 153

greater than the 28.8 kbps now available using analog modems. 

73

V. Availability of Bandwidth 

The Internet is only useful to people if they are able to access it, and the value of the

Internet is, to an increasing extent, dependent on the level of bandwidth available to end users. 

Thus, issues of service availability and affordability, especially with regard to services that

provide higher bandwidth than analog POTS lines, will be central to the development of the

Internet as a mass-market phenomenon that benefits all Americans. 

The Commission has historically played a major role in promoting "universal service,"

which has been understood as the availability of some basic level of telephone service to all

Americans. Some universal service mechanisms, such as the Universal Service Fund (which

provides assistance to high-cost LECs) and the Telecommunications Relay Service Fund (which

underwrites services that allow people with hearing impairments to use telecommunications

facilities), are explicit. Other support for universal service has traditionally been provided

through implicit subsidy flows, in which regulators have allowed certain rates to be set at levels

far in excess of cost so that rates in high-cost or underserved areas can be set at levels deemed

affordable. 

The 1996 Act directs the Commission to preserve and extend universal service, but to do

so in a manner consistent with the development of competition. In addition to the general

language regarding universal service funding, the 1996 Act contains several provisions dealing 152

specifically with availability of advanced communications services. In particular, Section 254

(which promotes universal service) and Section 706 (which discusses incentives for deployment

of advanced telecommunications services) state:

(254)(b)(2) Access to Advanced Services.-- Access to advanced telecommunications and

information services should be provided in all regions of the Nation.

(706)(a) The Commission ... shall encourage the deployment on a reasonable and timely

basis of advanced telecommunications capability to all Americans (including, in particular,

elementary and secondary schools and classrooms)....

In discharging these responsibilities the FCC must address two inter-related issues: the

deployment and pricing of high-speed access technologies, and the availability of existing

services to rural and low-income communities as well as schools, libraries, and others. A

153

major aspect of the Commission's role will be to foster the development of market-based

solutions that make access to the Internet and other interactive services widespread and

affordable. Beyond the specific universal service mandates of the 1996 Act, the Commission's
 Most of the discussion of high-speed Internet access technologies focuses on residential access, since 154

businesses generally already have access to, and resources to afford, high-bandwidth connections through various

dedicated services now available from ISPs and local phone companies. In addition, although the use of Internet

in business applications will doubtless continue to increase and be of great significance, it is the prospect of

widespread individual access to the Internet that creates the promise of "information superhighway" services such

as electronic commerce, online health care, and interactive on-demand entertainment.

 Although the focus of this paper is on the value of high-bandwidth networks for Internet access, such networks 155

may provide many other services. For a discussion of integrated broadband networks prior to the recent growth in

Internet usage, see Robert Pepper, Through the Looking Glass: Integrated Broadband Networks, Regulatory

Policy, and Institutional Change (Office of Plans and Policy Working Paper No. 24, 1988)

74

primary focus should be to remove barriers to availability of high-bandwidth technologies, and

to bring parties together to develop solutions, rather than to mandate particular deployment

patterns.

Universal service policies benefit the Internet because they expand the scope of the

network. If more people can access the Internet, the value of connectivity will increase, and

demand for Internet-related hardware, software, and services will be stimulated. 

A. Deployment and Pricing of High-Speed Access Technologies

Most residential Internet access today uses ordinary analog POTS lines. Although POTS 154

connections have fueled the explosive growth of residential Internet access in recent years, the

low bandwidth available on these lines substantially limits the services that can be delivered to

users, and reduces the value of the Internet experience as users have to wait for information to be

received. Several technologies that are either commercially available today or in development

promise to remove these limitations.155

Figure 11 lists some of the major technologies that may deliver high-bandwidth Internet

access to end users. In almost every case, the actual throughput available to subscribers will

depend on the particular infrastructure and customer premises equipment used, in addition to

factors such as the location of the subscriber. The technologies listed are those which appear

likely to be able to deliver substantially greater bandwidth to a significant number of subscribers

over the next 2-4 years. Other systems, such as those that extend fiber optic circuits to a small

cluster of homes or event each individual home, may eventually supplant all these alternatives. 

Given current deployment plans and the expenses involved, however, widespread

implementation of such systems appears to be significantly farther in the future. 
75

Figure 11 -- Major End-User Internet Access Technologies

Technology Downstream Upstream Summary

POTS 28.8 - 33.6 kbps 28.8 - 33.6 kpbs 94% of homes have POTS service;

(analog voice requires no additional telco investment

telephony) (56 kbps in 1997) and only a computer and (inexpensive)

analog modem at the user premises. 

ISDN 56 - 128 kbps 56 - 128 kbps Approximately 70% of access lines are

(230 kbps under (230 kbps under less than 5% of Internet subscribers

development) development) use ISDN. New pricing,

now capable of supporting ISDN, but

standardization, and marketing efforts

may increase penetration in 1997.

xDSL 384 kbps (SDSL) 384 kbps (SDSL) Significant deployment of SDSL and

HDSL today for corporate networks

and T1 service. Commercial ADSL

deployment by most telcos planned to

begin in 1997. Actual deliverable

bandwidth, especially for ADSL,

depends heavily on loop conditions. 

768 kbps (HDSL) 768 kbps (HDSL)

1.5 - 8 Mbps 12 - 500 kbps

(ADSL) (ADSL)

Cable Modems 1.2 - 27 Mbps 128 kbps - 10 Mbps Several companies are deploying

(shared capacity) (shared capacity) or infrastructure (e.g. @Home, Comcast,

POTS line used for Time-Warner), with commercial

upstream availability in late 1996 or early 1997. 

Many technical questions remain.

Wireless 28.8 kbps 28.8 kbps These are only some of the

(900 Mhz) (900 Mhz) technologies under development that

could provide wireless Internet access

(NII/Supernet band and 2.3 Ghz

auction may also open spectrum for

this application). Actual bandwidth

will depend on environmental factors

as well as details of deployment.

1.5 Mbps (LMDS) 1.5 Mbps (LMDS)

1.5 Mbps (MMDS) 1.5 Mbps (MMDS)

Satellite 400 kbps POTS line used for Several other systems under

(DirectPC) upstream development.
 "Basic Rate Interface" ISDN, which runs over two-wire twisted pair copper, provides two bearer or "B" 156

channels which operate at 56 kbps, and one data or "D" channel that operates at 16 kbps. For data services such as

Internet access, these channels can be "bonded" together to provide "2B+D" transmission at a rate of 128 kbps. 

Farallon recently announced technology that increases the bandwidth of ISDN BRI connections to 230 kbps.

See "Modems," Cyberatlas, available on the World Wide Web at <http://www.cyberatlas.com/modems.html>. 157

 Nick Wingfield, "Vendors Introduce Kinder, Gentler ISDN," C|Net News, March 18, 1996, available on the 158

World Wide Web at <http://www.cnet.com/>.

 Shira McCarthy, "Vendors Team Up for New ISDN Group," Telephony 230:5 (Jan. 29, 1996) at 19. 159

 Consumer Project on Technology Information Policy Notice, "Selected ISDN Tariffs," March 9, 1996. 160

76

B. The ISDN Case Study

 ISDN is by far the most well-established and widely available higher-bandwidth access

technology. ISDN uses existing twisted pair copper phone lines to transmit data at up to 128

kbps. Unlike analog modems, ISDN creates an end-to-end digital connection path, which also 156

facilitates faster call setup times and additional options using a built-in out-of-band "D" channel. 

In order to support ISDN, local exchange carriers must install digital line cards in their central

office switches, and subscribers must purchase new "digital modems" to operate at their

premises. Beyond this investment, however, ISDN does not require any significant

reconfiguration of LEC networks in order to support higher bandwidth than analog transmission. 

ISDN technology has been commercially available for well over a decade, and approximately

70% of existing local access lines in the United States are now configured to support ISDN. 

At the present time, however, despite growing interest in ISDN as an Internet access

technology, only a relatively small number of customers have ISDN lines in service. According

to one study, approximately 1.4% of modem users connected to the Internet using ISDN in early

1996. One barrier to more widespread deployment of ISDN has been the lack of 157

standardization and the large number of site-specific parameters that must be configured when

an end user wishes to purchase an ISDN line. Users must often determine a host of arcane

configuration options, and telephone company personnel must be trained in the various pricing

and configuration options, in order for ISDN to be installed. Several steps are now being taken

to address these provisioning problems, including "one stop shopping" efforts by vendors such as

Motorola and Microsoft that provide customers with a central point for ordering and obtaining

information, and efforts by standards bodies and the local exchange industry to simplify the

process of installing ISDN. Vendors such as AT&T, 3Com, and US Robotics have also 158

launched efforts to make ISDN easier to install.159

Many parties have argued that pricing is another barrier that has constrained ISDN

deployment. Rates charged by local exchange carriers for ISDN service are regulated by state

public utilities commissions, and these rates vary greatly from carrier to carrier. A March 1996

survey of ISDN tariffs showed a variation among major carriers between approximately $30 per

month and over $300 per month for equivalent usage levels. Some ISDN supporters argue 160
See, e.g., Consumer Project on Technology's Comments on Bell Atlantic's ISDN Tariff, Virginia State 161

Corporation Commission Case No. PUC950078 (filed April 19, 1996); Alex Lash, "ISDN Supporters Lodge

Complaints," C|Net News, April 15, 1996, available on the Internet at <http://www.cnet.com/>.

Access Reform Notice at ¶¶ 68-70; End User Common Line Charges, Notice of Proposed Rulemaking, 10 FCC 162

Rcd 8565 (1995). 

 Chris Bucholtz, "ISDN's Move into Suburbs Triggers Rate Hike Request," Telephony 230:3 (January 15, 1996) 163

at 9.

 Specifically, ISDN line units are generally "non-blocking." In other words, every subscriber line going into the 164

line unit can be in use at the same time.

77

that even rates at the low end of this spectrum far exceed the incremental cost to telephony

companies of supporting ISDN service. In many states ISDN is tariffed only as a business 161

service, although residential ISDN offerings are increasingly available. In addition to the

monthly rates, virtually all local exchange carriers now charge some per-minute fees for ISDN

usage above a designated threshold, or charge a higher monthly rate for a higher threshold or

unlimited calling. Carriers argue that these usage-sensitive charges, especially for peak-period

usage, are essential to avoid overuse of network capacity, but consumer groups and others claim

that the costs of providing ISDN service are essentially fixed, and do not vary substantially

based on usage.

An additional component of ISDN pricing is the federal subscriber line charge (SLC). 

Although the vast majority of ISDN rates are encompassed by the monthly rates and usage

charges regulated by state commissions, ISDN users are also subject to the SLC, which recovers

some of the interstate allocated costs of subscriber loops. For residential customers, the SLC is

currently capped at $3.50 per line per month, and for multi-line businesses, the cap is $6.00 per

month. Because ISDN is a derived channel technology that, in addition to providing greater data

bandwidth, also allows multiple voice channels, the question has arisen as to whether multiple

SLCs should be assessed on each ISDN connection. The FCC has requested comment on this

question in the Access Reform NPRM, and has temporarily refrained from imposing more than

one SLC.162

 As Internet usage and demand for higher bandwidth to the home has accelerated, many

LECs have proposed new pricing structures for ISDN. In some cases, such as Bell Atlantic’s

April 1996 proposal, these new structures involve rate decreases. In others, such as Pacific

Bell’s January 1996 request to the California Public Utilities Commission, the new tariffs

include substantially higher rates in response to increases in ISDN usage and concerns about

additional costs to support this usage. Several state commissions are now review LEC 163

residential ISDN tariffs, and are evaluating the incremental costs of offering ISDN service. 

ISDN, however, is not a packet-based technology. Because of certain architectural

efficiencies and the design of ISDN line cards in most local exchange switches, ISDN may place

a less significant congestion burden on the network than analog connections. However, 164

although digital, ISDN was designed to conform to the existing architecture of the circuit-
 The ISDN specification designates only 16 kilobits for the "D" or data channel, because ISDN was designed 165

primarily as an advanced technology to deliver voice. Fortunately, the two "B" channels can both be used to

deliver data, at rates considerably greater than the "D" channel. 

78

switched voice network. Moreover, although ISDN provides greater bandwidth than POTS, it 165

is insufficient for full-motion video and many of the new multimedia applications that are

rapidly becoming available. The unanswered question at this point in time is whether the

window of opportunity for ISDN has passed, or whether ISDN, as the most mature and most

widely available higher-bandwidth service, will be used increasingly over the next several years. 

The FCC is interested in seeing higher bandwidth available to end users. However, the

Commission's role is not to endorse any particular technology, or to artificially subsidize the

deployment of such services generally. Instead, the Commission should investigate areas where

regulatory rules may either be preventing technologies from being deployed, or distorting

investment patterns and incentives for innovation. ISDN tariffs and the application of the SLC

to ISDN may fall within this category. More generally, the deployment of high-bandwidth

Internet access technologies may be constrained by the ability of competitors to take advantage

of the existing network, either by purchasing existing tariffed services from local exchange

carriers, or by leasing pieces of the network and combining them in new ways. 

The FCC's interconnection, access charge, and price cap rules will therefore influence the

deployment of higher bandwidth. In addition, the Commission is in the process of developing a

Notice of Inquiry on innovation, to seek comment on other ways that FCC rules can provide

incentives for both incumbents and competing providers to invest in their networks and deploy

new technologies. Ultimately, only the market will decide which of these investments are wise

and which technologies will succeed, but the FCC must provide a level playing field for those

market forces to operate.

C. Universal Service and Advanced Access Technologies

Section 254 of the 1996 Act sets forth a set of requirements designed to preserve and

advance universal service in an era of new technologies and new forms of competition. The

Commission has historically been committed to universal service in telecommunications, and has

promoted efforts to make telephone service available to all Americans. Universal service has

traditionally been conceived in terms of access to voice telephony. With the development of the

Internet and other interactive computer networks, the Commission and state regulators must

consider whether access to these newer services should also be included in the conception of

universal service. Although most Internet subscribers can access an ISP POP through a local

call, users in some remote and rural areas, or regions with small local calling areas, must pay toll

charges to reach an ISP, which may make it more difficult for those users to take advantage of

the Internet. 
Joint Board Recommended Decision at 398-99, ¶ 790. 166

Id. at 37, ¶ 69. 167

See e.g., Bob Rankin, "SoDak Net: Wiring Rural South Dakota," Boardwatch, August 1996. A recent study of 168

fiber optic network deployment found that advanced communications capabilities were available in most rural

areas. Although not specific to Internet access, this study suggests that, as Internet penetration increases, rural

areas may not be left out. See John Markoff, "A Differing View of the Spread of Technology: Rural Areas in U.S.

Are Not Being Left Out, New Study Finds," New York Times, February 24, 1997, at B6.

 47 U.S.C. §706(a) 169

79

The Federal-State joint board on universal service, formed in accordance with the 1996

Act, recommended that providers of interstate information services not be required to contribute

to the new federal universal service fund. The joint board stated that, to these extent that

information service providers do not offer for a fee any of a listed set of "telecommunications

services," they are not "carriers that provide interstate telecommunications services" as specified

in the 1996 Act.166

The joint board also recommended that Internet access not be considered a "core service"

subject to universal service support under section 254(c)(1). Core services under the Act are 167

limited to telecommunications services, and the Commission is required to consider factors such

as whether the service is available to a majority of residential subscribers in the country. Despite

the increasing levels of Internet usage, Internet access today is not nearly as essential to most

Americans as basic voice grade access to the local phone network. In addition, because most

users access the Internet through the phone network, universal service subsidies to reduce local

phone rates for rural, low-income, and high-cost subscribers will effectively make Internet

access more affordable as well. 

Current data do not provide a good estimate of the percentage of rural subscribers that

cannot access an ISP through a local call. The major national ISPs each offer several hundred

POPs throughout the country, and usually provide access in other areas through a toll-free

number for an additional charge of approximately $5.00 per hour. There is anecdotal evidence

that many rural areas are served by smaller regional and local ISPs, even when national ISPs do

not find it economical to serve those areas. Further time and study will be needed to 168

understand whether market forces alone will be sufficient to ensure affordable Internet access

throughout the country. Given the rapid rate of growth and change in the Internet industry, the

affordability of Internet access today may not be an accurate indicator of the situation in the

future. 

In addition to the requirements of Section 254, Section 706 and 714 of the 1996 Act direct

the Commission and other regulatory bodies to take specific actions in order to make advanced

telecommunications technology widely available. Section 706 directs the Commission, within

thirty months of the passage of the Act, to initiate a notice of inquiry concerning the availability

of advanced telecommunications capability to all Americans, and schools in particular.169

"Advanced telecommunications capability" is defined as "a high-speed, switched, broadband
 47 U.S.C. §706(c)(1) 170

 47 U.S.C. §706(b). 171

 47 U.S.C. §714. 172

 47 U.S.C. §254(h)(1)(B); §254(c)(3). 173

 National Center for Education Statistics, United States Department of Education, Advanced 174

Telecommunications in U.S. Public Elementary and Secondary Schools 1995, (February 1996).

Id. 175

Joint Board Recommended Decision at 224-25, ¶¶ 438-40. 176

Id. at 237, ¶ 462. 177

80

telecommunications capability that enables users to originate and receive high-quality voice,

data, graphics, and video telecommunications using any technology." If the Commission 170

determines that such capability is not being deployed in a reasonable and timely manner, the

Commission is directed to take "immediate action" to remove barriers to such deployment.171

Section 714 establishes the Telecommunications Development Fund to promote the development

and deployment of telecommunications services, particularly by small businesses.172

The 1996 Act contains specific requirements for the provision of services associated with

universal service at discount rates to schools, libraries, and rural health care providers, and

allows the Commission to designate other services to be covered under this requirement.173

Studies have shown that advanced services such as Internet access are not yet widely available in

classrooms, especially in low-income areas. Only nine percent of all instructional rooms

(classrooms, labs, and library media centers) were connected to the Internet as of early 1996. 

174

Schools with large proportions of students from poor families are half as likely to provide

Internet access as schools with small proportions of such students. 

175

Internet access will also be important for rural health care facilities. Telemedicine allows

doctors in remote areas to share data with experts elsewhere in the country, greatly enhancing

the level of care. These services often involve transmission of high-resolution images, and

therefore require large amounts of bandwidth. The FCC has formed a Telemedicine Task Force

which has made recommendations for making this bandwidth available to health care providers.

The joint board recommended a system of discounts, between 20-90%, for schools and

libraries that purchased telecommunications and other services under this provision, to be funded

by a fund of up to $2.25 billion per year. Under the joint board's recommendations, ISPs 176

would be able to provide these services, and receive subsidies. The joint board concluded that it

would be impractical to separate the "conduit" services offered by ISPs and online service

providers from "content," even though universal service subsidies are designed to fund only the

connectivity portion of the service. The recommendations, however, leave open the question 177
81

of whether a system in which ISPs need not contribute to the universal service funding

mechanism, but may benefit from it, creates a competitive distortion. 

Even if services are provided at discount rates, schools and libraries will desire the most

economical means of providing Internet connectivity. For example, the wireless NII/SUPERnet

system may, in some areas, provide more cost-effective network access for school campuses

than wired local area networks. Thus, the general issues about the economics of high-bandwidth

access technologies will be important in this area as well. 

 
 Outside the United States, local telephone service is usually charged on a per-minute basis as well. 178

See generally "Too Cheap to Meter?," The Economist, October 19, 1996, at 23. 179

82

VI. Conclusion

This working paper has reviewed many difficult and complex issues that have arisen as the

Internet has grown to prominence. I have attempted to identify government policy approaches

that would have a positive influence on the development of the Internet. This final section seeks

to place the challenges described throughout this paper into a broader context.

 

A. The Internet and Competition in Telecommunications

The movement toward deregulation and local competition in telecommunications in the

United States may be the single most significant development for the future of the Internet. The

decisions that the FCC, state regulators, and companies make about how to create a competitive

marketplace will determine the landscape in which the Internet evolves. The shape of local

competition will influence what types of companies are able to provide Internet access to what

categories of users, under what conditions, and at what price. The removal of barriers between

different industries -- such as the prohibition on BOCs offering in-region long-distance service --

will accelerate the convergence that is already occurring as a result of digitalization and other

technological trends. 

Internet providers are potentially both substantial customers of circuit-switched voice

carriers, and competitors to them. It is ultimately in the interests of both ISPs (who depend on

the PSTN to reach their customers) and LECs (who derive significant revenue from ISPs) to

have pricing systems that promote efficient network development and utilization. If the costs of

Internet access through incumbent LEC networks increase substantially, users will have even

stronger incentives to switch to alternatives such as competitive local exchange carriers, cable

modems, and wireless access. 

Dial-up Internet access today tends to be priced on a flat-rated basis, for both the PSTN

portion of the connection and the transmission of packets through Internet backbones. By

contrast, interexchange telephone service tends to be charged on a per-minute basis. However, 178

both networks run largely over the same physical facilities. There is some evidence that Internet

and long-distance pricing are beginning to move towards each other. This paper has discussed 179

some of the arguments about usage pricing for Internet connections through the PSTN; similar

debates are occurring among Internet backbone providers in response to congestion within the

Internet. With the development of differentiated quality of service mechanisms on Internet

backbones, usage pricing seems likely to become more prevalent on the Internet, although usage

in this context may be measured by metrics other than minutes.
83

In the telephone world, flat-rated pricing appears to be gaining ground. The FCC

established the subscriber line charge (SLC), because the fixed costs it represented were more

efficiently recovered on a flat-rated basis. The Access Reform proceeding raises questions about

whether other usage-sensitive charges (such as the Transport Interconnection Charge and the

Carrier Common Line Charge) should be replaced with flat-rated charges, and there was

substantial debate in the Interconnection proceeding about whether LEC switching capacity

should be sold on a flat-rated basis in the form of a "switch platform." Pressure toward flat-rated

pricing is also arising for business reasons -- for example, Southwestern Bell has reportedly

considered offering a flat-rated regional long-distance plan when it receives interLATA

authorization. Customers in the U.S. seem to prefer the certainty of flat-rated pricing even

where it winds up costing more for their particular level of usage.

There are, of course, important differences in the architectures of the Internet and the

public switched telephone network. However, both of these architectures are evolving. There

will not be one universal pricing structure for the Internet or the telephone network, for the

simple reason that there will not be one homogenous network or one homogenous company

running that network. Technology and business models should drive pricing, rather than the

reverse. 

Today, the vast majority of Internet users and ISPs must depend on incumbent LECs for

their connections to the Internet. These incumbent LECs have huge investments in their existing

circuit-switched networks, and thus may be reluctant, absent competitive pressure, to explore

alternative technologies that involve migrating traffic off those networks. The economics of the

Internet are uncertain, since the market is growing and changing so rapidly. Competition will

enable companies to explore the true economics and efficiencies of different technologies. The

unbundling mandated by the 1996 Act will allow companies to leverage the existing network to

provide new high-bandwidth data services.

Competition can lead to instability or confusion, especially during periods of transition. 

Monopolies provide certainty of returns that, by definition, cannot be achieved in a competitive

market. With many potential players, forecasting the future of the industry can be difficult. 

Companies must choose between different technologies and business models, and those

companies that do not choose wisely will see the impact on their bottom lines.

Yet, as the Internet demonstrates, uncertainty can be a virtue. The Internet is dynamic

precisely because it is not dominated by monopolies or governments. Competition in the

Internet industry, and the computer industry that feeds it, has led to the rapid expansion of the

Internet beyond anything that could have been foreseen. Competition in the communications

industry will facilitate a similarly dynamic rate of growth and innovation.

B. The Right Side of History

The legal, economic, and technical underpinnings of the telecommunications infrastructure

in the United States have developed over the course of a century, while the Internet as a service
84

for consumers and private businesses is less than a decade old, and the national framework for

competition in local telephone telecommunications markets was adopted scarcely more than a

year ago. Challenges that seem insurmountable today may simply disappear as the industry and

technology evolve. 

As significant as the Internet has become, it is still near the beginning of an immense

growth curve. America Online, the largest ISP, has grown from under a million subscribers to

eight million in roughly four years. But those eight million subscribers represent only a fraction

of the eighty million households served by AT&T. The revenues generated by the Internet

industry, although growing rapidly, pale in comparison to those generated by traditional

telephony. Only about 15% of the people in the United States use the Internet today, and less

than 40% of households even have personal computers. A decade from now, today's Internet

may seem like a tiny niche service. Moreover, as Internet connectivity is built into cellular

phones, television sets, and other household items, the potential number of Internet hosts will

mushroom beyond comprehension. Computers are now embedded in everything from

automobiles to cameras to microwave ovens, and all of these devices may conceivably be

networked together. The Internet may exert the greatest influence on society once it becomes

mundane and invisible.

The growth potential of the Internet lends itself to both pessimistic and optimistic

expectations. The pessimist, having struggled through descriptions of legal uncertainties,

competitive concerns, and bandwidth bottlenecks, will be convinced that all these problems can

only become worse as the Internet grows. The optimist, on the other hand, recognizes that

technology and markets have proven their ability to solve problems even faster than they create

them. 

The global economy increasingly depends on networked communications, and

communications industries are increasingly shifting to digital technologies. Bandwidth is

expanding, but so is demand for bandwidth. None of these trends shows signs of diminishing. 

As long as there is a market for high-speed connections to the Internet, companies will struggle

to make those high-speed connections available in an affordable and reliable manner. Once a

sufficiently affordable and reliable network is built, new services will emerge to take advantage

of it, much as the World Wide Web could take off once the Internet had reached a certain level

of development. 

Difficulties and confusion may arise along the way, but improvements in communications

technology will continue to provide myriad benefits for individuals, businesses, and society. In

the long run, the endless spiral of connectivity is more powerful than any government edict. 
APPENDIX A -- INTERNET ARCHITECTURE

The diagram on the following page illustrates some of the mechanisms for

accessing the Internet. Although this illustration provides greater detail than the

conceptual diagrams in Section II, it remains greatly simplified in comparison to

the actual architecture of the Internet.