CONGRESS OF THE UNITED STATES

CONGRESSIONAL BUDGET OFFICE

A

PAPER

DECEMBER 2003

Does the 

Residential

Broadband

Market Need

Fixing?

CBO

CBO

A

P A P E R

Does the Residential Broadband

Market Need Fixing?

December 2003

The Congress of the United States O Congressional Budget Office 
Note

Numbers in the tables and text may not add up to totals because of rounding.

The cover photo of a cable modem circuit is courtesy of CableLabs.
Preface

A s the Internet becomes more widely used by consumers, more households want a

fast connection to it (usually called broadband) at home. Although that use of high-speed

Internet access has grown as fast as the use of any recent consumer good has, many observers

argue that the broadband market is not functioning properly, either for reasons internal to it

or because of government regulation. This Congressional Budget Office (CBO) paper—

prepared at the request of the Senate Budget Committee—reviews the recent trends in the

market for residential fast Internet access to determine whether there are impediments to the

market’s growth. In keeping with CBO’s mandate to provide objective, impartial analysis,

this report makes no recommendations.

Philip Webre of CBO’s Microeconomic and Financial Studies Division prepared the paper

under the supervision of Roger Hitchner and David Moore. The paper benefited from the

comments of Steven Wildman, Andrew Odylzko, Harold Furchtgott-Roth, Gerald Faulhaber, John Berresford, and Coleman Bazelon. Within CBO, Tom Woodward, Mark Lasky,

and Kathy Gramp contributed helpful suggestions.

Leah Mazade edited the manuscript, and Christine Bogusz proofread it. Maureen Costantino designed the cover. Angela Z. McCollough prepared drafts of the paper, Lenny Skutnik

produced the printed copies, and Annette Kalicki prepared the electronic versions for CBO’s

Web site (www.cbo.gov).

Douglas Holtz-Eakin

Director

December 2003

Contents

Summary ix

Introduction 1

Overview of the Residential Broadband Market 2

Technologies Used for Residential Broadband Delivery 3

Increased Subscriptions and Revenues 5

Geographic Dispersion of Subscriptions 7

The Supply Side: Competition Now and in the Future 8

High Fixed Costs: A Barrier to New Market Entrants 9

Convergence of Communications Technologies and

Competition in Related Home Markets 14

Regulation 17

Supply and the Performance of the Market 22

The Demand Side: Public Goods and Constraints on Content 25

Claims About Public Goods 25

Entertainment-Oriented Content on the Internet 27

Conclusions 29
vi DOES THE RESIDENTIAL BROADBAND MARKET NEED FIXING?

Tables

S-1. High-Speed Internet Access Lines in Residences and

Small Businesses x

S-2. Investment by Regional Bell Operating Companies xiii

1. High-Speed Internet Access Lines in Residences and

Small Businesses 6

2. Percentage of Zip Codes Nationwide with High-Speed Internet

Access Subscribers, by Number of Providers 7

3. Investment by Regional Bell Operating Companies 24

Figures

S-1. Percentage of Zip Codes Nationwide with High-Speed Internet

Access Subscribers, by Number of Providers xi

S-2 Market Share of Competitive High-Speed Internet Access

Providers xii

1. Market Share of Competitive High-Speed Internet Access Providers 9

2. Households That Subscribe to a Satellite Video Service 16

3. Shares of the Market for Local Telephone Service, by Provider Type 17

4. Cellular Telephone Subscribers 18

5. Cable Telephone Subscribers 19

6. Equipment Investment by Regional Bell Operating Companies 25
DOES THE RESIDENTIAL BROADBAND MARKET NEED FIXING? vii

Boxes

1. The Case of Wi-Fi 13

2. Trends in Prices for Multichannel Video Programming and

Local Telephone Services 15

3. Has Federal Regulation Hindered Local Telephone Companies’

Investment in Broadband? 20

4. Existing Federal Programs to Promote Adoption of High-Speed

Internet Access 28

Summary

Households and small businesses have adopted

high-speed Internet access, also known as broadband,

at a rapid rate over the past three years. Data published by the Federal Communications Commission

(FCC) show that as of December 2002, 17.4 million

households and small businesses subscribed to highspeed lines for Internet access, up from only 1.8 million in December 1999 (see Summary Table 1). A

regional view of the data also indicates rapid growth.

In 1999, more than 40 percent of the zip codes in the

United States did not have even a single subscriber to

a broadband service, according to the FCC. At the end

of 2002, only 12 percent of zip codes had no such

subscribers (see Summary Figure 1). Indeed, broadband’s rapid rate of growth is rivaled only by that of

the most successful of recently introduced consumer

electronics products, such as cellular telephones. 

Yet some observers maintain that the market is expanding too slowly. They contend that flaws in the

market’s structure impede even more rapid growth

and the benefits it would bring to the economy, and

they argue that the federal government should

intervene—by providing financial incentives—to

encourage such growth. Advocates of federal action

have thus introduced two dozen bills to accelerate the

deployment of high-speed Internet access—in many

cases, by means that would increase federal spending

or decrease revenues. This Congressional Budget

Office (CBO) report analyzes the development of the

residential broadband market (a category that covers

both households and small businesses) to assess

whether structural features or regulatory obstacles (or

both) impede its further rapid growth.

The local networks that supply telephone and cable

television services also provide most of the high-speed

access to the Internet that is purchased by small businesses and households. Among markets nationwide,

the combined share of broadband service provided by

local telephone and cable companies averages more

than 90 percent. That feature of the supply side of the

residential market for high-speed Internet access raises

the possibility that the two dominant firms in each

individual market might be able to keep prices above

the cost of providing service. If that occurred, too few

people might subscribe to a broadband service at too

high a price relative to the prices that would prevail in

a more competitive market—a situation known as a

market failure. Many advocates of federal intervention

maintain that that is what has happened. Claims of a

failure on the demand side of the market are more diverse and in general are less important for the market’s

operation.

CBO’s analysis concludes, however, that nothing in

the performance of the residential broadband market

suggests that federal subsidies for it will produce large

economic gains. That finding is relevant in addressing

claims about broadband’s future contribution to the

economy and the support that some advocates of federal intervention draw from those claims. Specifically,

if the market is functioning adequately, economic

gains from interventions to increase the number of

subscribers are likely to be offset by losses in other

markets, leaving the economy as a whole worse off.
x DOES THE RESIDENTIAL BROADBAND MARKET NEED FIXING?

Summary Table 1.

High-Speed Internet Access Lines in Residences and Small Businesses

(Thousands)

Dec.

1999

June

 2000

Dec.

 2000

June 

2001

Dec.

2001

June

2002

Dec.

2002

Asymmetric Digital Subscriber Linesa 292 772 1,595 2,491 3,616 4,395 5,529

Other Wired Technologies 47 112 176 138 140 224 213

Cable Modem Services 1,402 2,215 3,295 4,999 7,051 9,157 11,343

Fiber-Optic Cable 1 * 2 3 4 6 15

Satellite and Other Wireless Technologies 50 64 102 182 195 202 257

Total 1,792 3,164 5,170 7,812 11,005 13,984 17,357

Source: Congressional Budget Office based on Federal Communications Commission, High-Speed Services for Internet Access: Status as of December 31,

2002 (June 2003), Table 3.

Note: * = rounds to zero.

a. With asymmetric lines, the speeds at which customers can receive data are by design much greater than the speeds at which they can send information.

Economic efficiency (allocating resources to the uses

that will most enhance society’s well-being) is not the

only reason that federal policymakers might decide to

subsidize telecommunications services. Concerns

about equity and regional economic development may

also enter into their considerations. However, those

issues are beyond the scope of this analysis, which addresses only the question of economic efficiency.

Overview of the Residential 

Broadband Market

Small businesses and households can connect to the

Internet through broadband or dial-up connections.1

Broadband access to the Internet is distinguished from

dial-up access provided by a conventional telephone

line on two dimensions: speed and availability. Broadband access allows subscribers to connect (with either

outgoing or incoming transmissions—usually incoming) at a speed of at least 200,000 bits of information

per second. By contrast, dial-up services typically operate at less than 56,000 bits per second. Broadband’s

performance also exceeds that of dial-up access in that,

typically, it is always “on” (dedicated and immediately

available).

As noted earlier, local telephone and cable television

companies currently dominate the residential broadband market. In December 2002, high-speed Internet

access through a cable modem accounted for 65 percent of all broadband subscriptions carried by households and small businesses, and digital subscriber line

(DSL) service accounted for 32 percent. Telephone

companies deliver DSL service through their existing

wired telephone networks using a special modem,

which transmits the computer signals at frequencies

above the range of human hearing and thus does not

interfere with voice telephone service. Cable television

companies deliver their broadband service by using an

unused channel on their cable network and a special

modem.

The Supply Side: Competition

Now and in the Future

Currently, the major cable and telephone companies

maintain their large share of the broadband market at

the expense of the growth of their competitors’ share

(mainly satellite companies and competitive providers

that use the telephone companies’ wired networks; see

1. The markets for Internet access that serve big corporations and

institutions are substantially larger and better developed than

the residential market, in part because those organizations,

whether business, not-for profit, or governmental, came to

value high-speed Internet access both as users and providers of

information more rapidly than did residential consumers. This

report does not address those larger markets.
DOES THE RESIDENTIAL BROADBAND MARKET NEED FIXING? xi

Summary Figure 1.

Percentage of Zip Codes Nationwide with High-Speed Internet

Access Subscribers, by Number of Providers

Source: Congressional Budget Office using data from Federal Communications Commission, High-Speed Services for Internet Access (various years).

Note: The data are for lines that provide high-speed Internet access to residences and small businesses.

Summary Figure 2). Both the incumbent local telephone company and the local cable franchise deliver

their broadband service over extensive and costly wired

networks that were originally designed and built for a

different purpose. Those networks create a particular

structure of costs. Delivering any service is expensive

to begin with because the network has to be built. But

once it is in place, service can be delivered at a relatively lower cost. That combination of high startup

and low operating costs makes it particularly difficult

for would-be competitors to enter the market. As a

consequence, some observers are concerned that telephone and cable companies will continue to increase

their share of the market and keep prices above the

level they would reach if the market was competitive.

In that circumstance, too few people would buy

broadband services and those who did would pay too

much for them.

Two developments could prevent that outcome. First,

new competitors could enter the market. Second,

competition in the larger telecommunications markets

could force the telephone and cable companies to behave competitively in the broadband market, even

without a larger number of competitors in that market. 

New Entrants into the Residential 

Broadband Market

New competitors could enter the residential broadband market by using either wired or wireless technologies to connect their customers to the Internet. Much

of the existing competition in the market comes from

firms that use wired technologies. Until 2003, the

FCC required incumbent local telephone companies

to lease frequencies on their telephone lines to competitive companies that wanted to provide DSL service. In February 2003, the commission announced

the start of a three-year transition to gradually eliminate those leasing requirements. The final outcome of

that transition is as yet unknown because the FCC’s

decision is being challenged in the courts and the

Dec. 1999 June 2000 Dec. 2000 June 2001 Dec. 2001 June 2002 Dec. 2002

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

50%

No Providers One or Two Providers Three or Four Providers Five or More Providers
xii DOES THE RESIDENTIAL BROADBAND MARKET NEED FIXING?

Summary Figure 2.

Market Share of Competitive

High-Speed Internet Access Providers

Source: Congressional Budget Office based on Federal Communications

Commission, High-Speed Services for Internet Access (various

years).

Note: Competitive providers (for example, satellite Internet suppliers) are

providers other than the local cable and telephone companies.

commission had planned in any event to revisit its decision in three years. However, even before the regulatory change, some competitive DSL providers went

bankrupt because of the slowdown in investment in

telecommunications equipment beginning in 2001.

The remaining competitive DSL firms face uncertain

prospects, and their share of the market is quite small.

The most prominent technological alternatives in the

category of wired high-speed Internet access are new

fiber-optic cable networks and the use of existing electric power lines. Despite widespread interest in fiber

optics, the latest estimates by the FCC suggest that

only 15,000 households and small businesses use it to

connect directly to the Internet, and few analysts anticipate rapid deployment of fiber networks in the near

future. Moreover, the most likely agents of fiber deployment are telephone companies, which means that

such a development would add capacity to the market

but not a new competitor. Power lines that transmit

electricity are already connected to most residences

and small businesses and thus appear to offer a potential broadband connection. In April 2003, the FCC

began a major study of that form of broadband communications. However, whether the use of power lines

to provide high-speed Internet access is technically

viable is unclear. Also uncertain is how the cost of that

alternative compares with that of cable modem or

DSL service. 

Wireless technologies do not at present offer much

competition to the local telephone and cable companies in the broadband market; in 2002, they accounted for less than 2 percent of residential broadband connections (see Summary Table 1). The FCC

continues to make additional portions of the electromagnetic spectrum available for use, and private firms

regularly announce new initiatives that use wireless

data technology. To date, however, wireless broadband alternatives—including the use of satellite systems—serve only niche markets and limited geographic areas. The latest wireless broadband technologies are designed to overcome many of the problems

that constrained earlier wireless systems, but the industry’s history of past high expectations and subsequent

limited success or even failure suggests that a waitand-see attitude might be appropriate. 

One popular new wireless technology, Wi-Fi, is successful within its rather narrow domain. Designed for

connecting local computer networks to large numbers

of users without the need to run costly wires, Wi-Fi

has since been adopted by consumers (largely as a way

of sharing their single DSL or cable modem connection among multiple home computers) and by institutions with large existing facilities, such as universities

or hotels (as a way of providing broadband at low cost

to peripatetic users). However, few firms have figured

out how to profit directly from providing Wi-Fi service (although manufacturers of Wi-Fi hardware are

profiting from its popularity). Furthermore, a Wi-Fi

base station ultimately requires its own wired or wireless link to connect to the Internet.

Competition in Related Markets

Limited prospects for growth and competitive threats

in their core business markets could spur local teleDec. 2000 June 2001 Dec. 2001 June 2002 Dec. 2002

0%

5%

10%

15%
DOES THE RESIDENTIAL BROADBAND MARKET NEED FIXING? xiii

Summary Table 2.

Investment by Regional Bell Operating Companies

(Billions of dollars)

1996 1997 1998 1999 2000 2001

Investment

Structures and equipment 19.7 20.0 20.2 27.5 35.7 32.4

Research and development 0.2 0.2 0.1 0 n.a. n.a.

Total 19.9 20.2 20.3 27.5 35.7 32.4

Memorandum:

Operating Revenues 78.7 80.4 86.0 90.4 109.2 108.7

Total Investment as a Percentage

 of Operating Revenues 25.3 25.1 23.6 30.4 32.7 29.9

Source: Congressional Budget Office using data from Federal Communications Commission, Statistics of Communications Common Carriers (various years).

Note: n.a. = not available.

phone and cable companies to compete more vigorously in the broadband market. As of December 2002,

competitive providers in the telephone service market—which in many cases include the same cable television companies that compete with the phone companies in the broadband market—accounted for

10 percent of all residential telephone lines and

13 percent of all telephone lines nationwide. New

competitors have also entered the core markets of cable television providers. From June 1998 to June

2002, the number of households that received multichannel video programming from a satellite service

doubled, rising from 9.2 million to 18.7 million (or

18 percent of all households with televisions). By contrast, subscriptions to cable video service increased by

only 5 percent during that period. To defend their

core markets, both local telephone and cable television

companies have begun to lower their prices for customers who are willing to buy a bundle of services—

for example, telephone, cable television, and broadband access—from the same provider.

Supply and the Performance 

of the Market

Available indicators of the broadband market’s performance are mixed. Price competition is not vigorous, at

least not by the standard currently set in the market

for cellular telephone service. (Like the broadband

market today, it was at one time limited to only two

providers but now has four to six competitors in every

major market in the country.) Systematic data on

broadband prices are sparse; however, existing information suggests that although DSL service providers

have dropped their prices slightly (once rebates and

other special offers are taken into account), cable providers have raised theirs to match the initially higher

DSL rates. Recently, some of the largest DSL providers, including Verizon and SBC, lowered their prices

to levels substantially below those of several of their

major cable competitors. That move has not yet

drawn widespread response from the cable companies.

Data specifically on the broadband investments of the

two dominant firms are not available, but the high

overall rates of spending by telephone and cable providers along with the rapid increase in the geographic

availability of broadband suggest that both types of

firms are investing in new broadband capacity. Indeed,

between 1996 and 2001, the four largest local telephone companies (companies that were part of the old

Bell system) increased their spending on new structures and equipment by 64 percent (see Summary Table 2). Cable companies also raised their investment

spending substantially, increasing it by 68 percent over

five years. Investments of that magnitude indicate

that, thus far, the negative consequences of the market’s domination by the local telephone and cable

companies have been limited. 
xiv DOES THE RESIDENTIAL BROADBAND MARKET NEED FIXING?

Some observers contend that both the regulations that

have required telephone companies (but not cable

companies) to open their networks to broadband competitors and uncertainty about whether those regulations will be in effect in the future have discouraged

even higher levels of investment. The FCC’s recent

decision to suspend the requirement that telephone

companies share their wired networks with competitive broadband providers, although subject to litigation and state regulatory interpretation, may reduce

whatever restraint that rule might have had on telephone companies’ investment in the broadband market. Nevertheless, evidence of a rapid rise in investment by the telephone companies during the period in

which those regulations were in effect suggests that the

deterrent to such spending that the regulations provided has been limited.

The Demand Side: Public Goods 

and Constraints on Content

The claims of problems on the demand side of the

broadband market derive from underlying arguments

about public goods and constraints on the content

that is available for downloading over the Internet.

Public goods are those goods that once they have been

provided can be consumed by an additional person at

no cost and for which it is inefficient to exclude any

one consumer from receiving them. (National defense

is the most frequently cited example of a public good.)

Economists generally believe that private markets will

supply too small an amount of a public good if they

are left to their own workings.

Communications networks have attributes of a public

good because an additional subscriber to a network

provides a benefit to the existing subscribers—an additional person to communicate with—that is available

to all of the network’s members at little or no additional cost. Because a would-be subscriber fails to account for that “network effect” in calculating the benefits of subscribing, too few people will subscribe compared with the number that will maximize economic

well-being. In the case of high-speed access to the

Internet, however, the availability of traditional dialup access through telephone lines, a slower but still

relatively effective alternative, substantially reduces the

extent of losses in economic well-being that might be

attributable to network effects.

The observation that broadband access is an input that

can be used to produce certain public services is the

basis for the claim of a second potential failure on the

demand side of the market. Services such as public

health or education have some of the characteristics of

a public good, and government policies promote their

availability in a variety of ways, including subsidization of high-speed Internet access at so-called public

portals (for example, libraries). However, the use of

high-speed Internet access to disseminate those services does not suggest a market failure in that delivery

mechanism, nor does it suggest that subsidies to

households and small businesses are necessarily the

most efficient way to provide more public goods. Existing subsidies for Internet access are also intended to

address concerns about lack of access in low-income

areas.

A third demand-side issue is the claim that constraints

on the entertainment-oriented content that is available

over the Internet (for example, restrictions on the

number of their products that movie and music producers make available) represent a failure in the market. That claim is not relevant because questions about

efficiency and the regulation of entertainment products lie outside of the market for high-speed Internet

access. For example, the desirability of a broadband

connection might be increased if restrictions arising

from copyright protections could be ignored, but the

lessening of those protections might have negative

consequences as well—for the development of new

content and the efficiency of the markets that produce

it.

Conclusions

Although the residential broadband market is not

characterized by a large number of competitive providers, the forces of supply and demand seem to be

working to offer an increasing number of households

and small businesses a choice of high-speed Internet
DOES THE RESIDENTIAL BROADBAND MARKET NEED FIXING? xv

service from among a range of providers. The number

of subscribers is growing dramatically; in short, the

market is booming. Some of the problems that remain, such as uneven availability, are a function of the

market’s relative youth and immaturity and are not

necessarily permanent features. The current domination of many markets by only two broadband providers, however, could turn out to be more long-lived.

Does the Residential Broadband

Market Need Fixing?

Introduction

Households and small businesses are rapidly adopting

high-speed, or broadband, access to the Internet. Nevertheless, some policymakers and analysts believe that

this process has not proceeded as rapidly as its potential contribution to the economy merits. They advocate federal intervention in the development of the

broadband market, including subsidies, to spur additional users.1

Broadband access to the Internet is a premium service:

its extra speed relative to the dial-up access (through

local telephone lines) that was initially available allows

households and small businesses to connect to Internet

sites more rapidly and download files more quickly, be

they music, data, or software. The “always-on” feature

of most broadband services provides an instantaneous

response, similar to that achieved by depressing the

power button on a television’s remote control. If the

service is functioning properly, it is always available

for e-mail or browsing the Internet. In short, consumers of broadband receive a better service for which they

pay a higher price.

Why has the availability of broadband access for

households and small businesses become a policy

issue? In a market economy, the best outcome for

most products and services comes from allowing

markets to work without specific constraint or encouragement, and policymakers usually leave the market to

determine a product’s or service’s ultimate success. In

the case of high-speed Internet access, policymakers

might choose to stand aside and let the market determine which firms and technologies win or lose and

which consumers decide to take up or forgo broadband service. Ample precedent exists in recent years

for that kind of laissez-faire stance. For example, the

Federal Communications Commission (FCC) has not

actively promoted cellular telephone service, other

than by making more licenses available for portions of

the electromagnetic spectrum. The technology has

largely succeeded on its own. Yet in the recent past,

the Congress has considered roughly two dozen bills

that propose to subsidize the adoption of high-speed

Internet access in the country as a whole or in particular geographic areas.

Advocates of federal intervention argue that the broadband market for households and small businesses deviates so far from the norms of a competitive market

that it requires government action. In cases in which a

market’s performance appears to fall short of the best

possible outcome (often called a “market failure”), the

federal government has sometimes intervened to improve the market’s functioning. According to advocates of intervention, conditions on both the supply

and demand sides of the broadband market prevent

prices from signaling producers and consumers to buy

and sell both the quantity and quality of broadband

services that make the most efficient use of society’s

scarce resources. That inefficiency, they contend, results in slower growth than there might have been in

the absence of those supply and demand constraints. 1. Advocates of federal action also argue that the market has not

grown in as geographically balanced a manner as the potential

benefits might suggest.
2 DOES THE RESIDENTIAL BROADBAND MARKET NEED FIXING?

Although economists recognize that a market’s imperfections can keep it from allocating resources efficiently, they have become increasingly hesitant to recommend intervention. Most markets exhibit some

imperfections in either supply or demand, but the majority of them manage to function to the satisfaction

of most participants and of society as a whole. Moreover, efforts to solve perceived problems through government action can create problems of their own. In

some instances, policies may exacerbate existing difficulties or create new ones. Regulations and subsidies

often distort the choices of consumers and producers

in ways that encourage behaviors that are as socially

undesirable as the original market failure they were

designed to cure. In many cases, policies that were intended to address temporary problems become permanent and persist long after the original problems have

been eliminated. Thus, the economist’s lexicon includes “government or regulatory failure” as well as

“market failure.”

This Congressional Budget Office (CBO) report addresses two questions about the broadband market.

First, is there evidence to suggest that the conditions

of supply and demand in the market keep it from

working well enough to provide the bulk of the social

benefits that should come with its full development?

And second, are any imperfections of sufficient magnitude to justify federal intervention, with all the costs

that such involvement might entail?

Telecommunications policy is often made for reasons

other than market failure. Promoting the development

of rural areas and ensuring equality of opportunity are

often cited as reasons for policies that are pursued independently of whether the overall market is working

well or not. This report does not address those issues. 

It also does not address high-speed Internet access for

large institutions—for example, corporations, not-forprofit organizations such as universities, and government agencies. Their use of broadband is substantially

greater and better developed than use in the residential

market because they saw the value of high-speed

Internet access early on for providing information and

services to their clients and making the public aware of

their products. Such institutions also needed highspeed access because of the number of individual users

(employees, students, or staff) each of them represents.

Overview of the Residential 

Broadband Market

Broadband access to the Internet is distinguished from

dial-up (or narrowband) access on two dimensions:

speed and availability. In its reports on broadband, the

FCC defines a service as high speed if it can transmit

at least 200,000 bits per second (bps) in either direction (outgoing or incoming).2

 For browsing the Internet, that speed may be sufficient, if occasionally frustrating for users accustomed to faster connections. By

contrast, the fastest dial-up services connect at a speed

of 56,000 bps, but the actual service is usually much

slower because of imperfections on the line. This report follows the FCC’s convention in defining highspeed Internet access, or broadband, as 200,000 bps 

in either direction.3

Broadband offers superior performance relative to

dial-up access because of another feature: typically, it

is always “on” since the connection is dedicated. The

user does not have to go through the procedure common in dial-up access of connecting to the Internet

service provider and launching the appropriate software application. As a result, the computer may be

used more spontaneously rather than as a tool with a

setup period. Although the time needed to dial up and

log on to a narrowband service may not be large in an

absolute sense, it seems to affect the way the computer

is used and the way its utility is perceived by the consumer.

2. A bit (or binary digit) is a zero or a one in computer language.

The FCC recognizes an additional category of advanced broadband service, which can transmit at least 200,000 bits per second in both directions. Because residential consumers (in contrast to large institutional customers) do not typically use highspeed capacity for outgoing transmissions, CBO focused its

analysis on “high-speed” service.

3. By contrast, institutional connections often run at about

1.5 million bps in each direction. 
DOES THE RESIDENTIAL BROADBAND MARKET NEED FIXING? 3

This report follows popular usage and treats broadband and dial-up Internet access as largely separate

markets. Some analysts argue that the distinction between the two is not sufficient to characterize them in

that way, and the majority of observers agree that the

two are to some extent linked because the existence of

dial-up access limits the prices that providers can

charge for broadband. The working assumption of this

analysis, however, is that the dial-up and broadband

markets are moving apart and a growing number of

consumers view slow access to the Internet as an increasingly unsatisfactory substitute for high-speed connection.

The overall market for Internet access can also be

parsed in other ways. For example, in the residential

segment of the market, local telephone companies

have many fewer customers than the cable companies

have. By contrast, cable companies are barely to be

found as providers of high-speed Internet service to

large businesses and other big institutional clients.

Much of their service is provided by using the local

telephone company’s infrastructure, either directly or

through contractual arrangements. As a result, if policy decisions designed for one segment of the market

were not properly crafted, they could affect segments

in which the competitive conditions were very different.

Much of the data collected and published by the FCC

on residential broadband lumps two similar groups

together—small businesses and households. The consumers in both groups are relatively small buyers, have

few technological alternatives, and in general possess

limited technological expertise. CBO follows the

FCC’s convention and for the purposes of this report

refers to the two groups collectively as the residential

broadband market.

Technologies Used for Residential 

Broadband Delivery

Currently, the bulk of residential high-speed access to

the Internet is provided by cable modem, digital subscriber line (DSL), terrestrial fixed wireless, and satellite technologies.4

 Cable systems are the most widely

used means of access; DSL is a distant second, with

the others minor players at this point. Satellite and

fixed terrestrial broadband have such a small share of

the market that most data sources group them in a

single wireless category. Other technologies, such as

transmitting signals through the electrical wires, have

been successful in the laboratory and in some pilot

tests but are not yet being offered commercially.

Cable Modem Systems. Most cable television companies have upgraded their structures, equipment, and

wires to provide fast Internet access through one of

their unused channels. Such upgrades are usually part

of a larger effort that allows the companies to provide

more channels of digital video services and, in some

cases, telephone service. In many instances, cable operators have installed a “backbone” of fiber-optic cable

in their distribution systems to increase their capacity

and reduce the need for intermediate electronics,

which cost money and introduce distortion. Thus, in a

modern “cable” system, only the last few segments of

the distribution system still use the coaxial cable that

gives the technology its name. At each residence or

business, the cable is plugged into the cable modem,

just as it might be into an additional television. The

computer is attached in its turn to the modem

through a computer network cable.

By its very nature, the cable system makes users share

its limited capacity. Consequently, as more households

log on to the system, each receives a smaller amount of

capacity, which leads to congestion and slowdowns at

times of peak use. Industry analysts assume that as the

demand for data services grows, cable companies will

increase the amount of fiber-optic cable in their systems to boost capacity and reduce the bottlenecks. Today, cable modem service is generally faster than DSL

4. For an extended discussion of residential broadband technologies, see Federal Communications Commission, Deployment of

Advanced Telecommunications Capability to All Americans in a

Reasonable and Timely Fashion: Third Report (February 6,

2002), Appendix B; and National Research Council, Broadband: Bringing Home the Bits (Washington, D.C.: National

Academy Press, 2002), pp. 120-160.
4 DOES THE RESIDENTIAL BROADBAND MARKET NEED FIXING?

service, and consumers have generally experienced

fewer troubles in getting the service up and running.

The cable companies enjoy an advantage over local

telephone companies in the residential broadband

market, in part because they were able to agree on a

common standard for the required modem early on.

Consequently, the necessary complements—equipment and training—were produced in a timely way. 

Cable modem services are typically provided by the

local cable monopoly franchise, but in a few cities,

competing companies have installed a second cable

line and are providing both cable video services and

fast Internet access.

Digital Subscriber Line Service. All DSL service uses

the existing telephone wires and is typically provided

by the local telephone company (or incumbent local

exchange carrier, as it is often called). However, it can

also be provided by a competitive company that rents

the local company’s lines or equipment, or both.

DSL technology works by splitting into two parts the

electromagnetic spectrum available to carry data over

the telephone line. Low-frequency waves carry the

voice signal, and high-frequency waves, above the

range of human hearing, carry the computer data signal. DSL service can be of several types, the most important being asymmetric digital subscriber line

(ADSL), which is what most residential customers get

when they contract for the service. With ADSL service, the speeds at which customers can receive data

are by design much greater than the speeds at which

they can send information. Other types of DSL service

are usually more expensive and generally provide a

higher level of operation. For the most part, this report follows the convention used by most analysts and

does not distinguish between the different kinds of

service.

DSL technology has several limitations that have prevented local telephone companies from making the

service available to a large fraction (possibly as much

as a third overall) of the households in their service

area. DSL service is distance sensitive—in most instances, customers have to be within 18,000 feet of the

central telephone office that serves them. However,

technological improvements and the wider use of remote terminals are lessening that restriction. An additional limitation for some local telephone companies

is that earlier investments made to improve the quality

of voice traffic have proved incompatible with conventional DSL technology.

Terrestrial Fixed Wireless Systems. In a fixed wireless

system, the service provider attaches a radio transmitter/receiver to a customer’s premises, and that device

communicates with the provider’s central antenna site.

In general, terrestrial fixed wireless services are characterized by the portion of the electromagnetic spectrum

over which the services are provided (each portion has

different physical characteristics).5

 The services that

operate at the lower bands of the spectrum can be provided from as much as 35 miles away from the central

antenna hub. By contrast, the services that operate in

the upper bands are limited to between two and five

miles from the central hub (because the signals can be

easily disrupted by precipitation or tree foliage). Other

services require that the radio transmitter be in the

central antenna’s direct line of sight, which means that

to serve a large area economically, providers must negotiate line-of-sight access individually with the owners of tall buildings.

Because of their characteristics, the various services

have each attracted a different clientele. The lowerband wireless systems have been more widely used for

residential service, because they can reach dispersed

geographic areas.

Satellite Residential Internet Service. Internet service

provided by satellite operates similarly to the video

services that such technology provides. A ground station beams up the data signal to the satellite, which

then transmits it to the area within its reach. Customers with the requisite equipment can receive and unscramble the signals. However, unlike video signals,

which are the same for all subscribers, the Internet sig5. This discussion is derived in large part from Federal Communications Commission, Annual Report and Analysis of Competitive Market Conditions with Respect to Commercial Mobile Services: Sixth Report (June 20, 2001), Appendix A.
DOES THE RESIDENTIAL BROADBAND MARKET NEED FIXING? 5

nals are customized for individual residences, which

increases their cost.6

 Most satellites orbit the earth at

some distance; thus, the data they transmit are delayed

slightly because the signal can travel only at the speed

of light. However, the delay in sending and receiving

signals is not thought to be as troublesome for satellite

Internet access as it is for voice transmissions. 

Satellite broadband service may be two way or one

way. In both of those cases, the customer receives information through the satellite; however, in one-way

service, the customer transmits information through a

conventional dial-up connection.

Satellite broadband service suffers from many of the

same drawbacks that are associated with terrestrial

fixed wireless service; for example, the satellite receiving “dish” has to have direct line-of-sight access to the

satellite, which for most of the United States means

the southern sky. Mountains and even tall buildings

can block that access, and bad weather can degrade the

signal. However, because it is wireless, satellite service

is usually thought to have a comparative advantage

over wired technologies in remote areas.

In a number of cases, suppliers of satellite service have

entered and then quickly exited the market, making

the supply of such service seem uneven.7

 In other

cases, satellite firms have continued to support existing

subscribers but have not accepted new ones. Such

practices leave open the question of how available this

service is to the consumer seeking to subscribe to

broadband access.

Increased Subscriptions and Revenues

The number of households and small businesses that

subscribe to a service providing broadband access to

the Internet has grown quite rapidly. According to

FCC data, the total number of broadband lines used

by households and small businesses increased almost

tenfold between December 1999 and December 2002,

rising from 1.8 million to 17.4 million.8

 Over the

same period, the number of DSL subscriptions rose by

a factor of 19, cable modem subscriptions increased

eightfold, and the broadband wireless services market

quintupled in size (see Table 1). By 2002, CBO estimates, 27 percent of all households with computers

and 28 percent of all households with Internet access

had broadband service.9

Cable modem and DSL service dominate both the

absolute number of residential high-speed lines and

the growth in such subscriptions that has occurred in

recent years. In December 1998, the FCC reported

that 375,000 households and small businesses had cable or DSL broadband subscriptions.10 By December

2002, 16.8 million subscribers had high-speed Internet access through one of those two alternatives. Thus,

for the two most prominent technologies combined,

the number of subscribers rose by a factor of 45 in

four years, for an average annual rate of growth of 159

percent. Despite the recent higher growth rate of DSL

service, as noted above, cable modem subscriptions

still outnumber DSL subscriptions by roughly two to

one.

6. Satellite service is likely to remain a niche or premium product

in the residential broadband market because of the limited capacity of each transponder (the device that relays the communications signals) and the cost of increasing their numbers. 

The transponder’s limits do not matter as much for broadcasting a single set of programs (video service) as they do for responding to Internet communications and “surfing” by many

individual users.

7. See, for example, Patrick Olsen and Gail Mitchell, “DirecTV

Broadband to End Internet Service,” Chicago Tribune, December 17, 2002, p. 8.

8. Federal Communications Commission, High-Speed Services for

Internet Access: Status as of December 31, 2002 (June 2003),

Table 3, available at www.fcc.gov/wcb/iatd/comp.html.

9. That calculation ignores small business subscribers because the

FCC does not break out those data. See Federal Communications Commission, High-Speed Services for Internet Access: Status as of December 31, 2002; and Eric Newburger, Home Computers and Internet Use in the United States: August 2000, Current Population Reports, P23-207 (September 2001), p. 1.

10. Federal Communications Commission, Deployment of Advanced Telecommunications Capability to All Americans in a

Reasonable and Timely Fashion: First 706 Report (February 2,

1999).
6 DOES THE RESIDENTIAL BROADBAND MARKET NEED FIXING?

Table 1.

High-Speed Internet Access Lines in Residences and Small Businesses

(Thousands)

Dec.

1999

June

 2000

Dec.

 2000

June 

2001

Dec.

2001

June

2002

Dec.

2002

Asymmetric Digital Subscriber Linesa 292 772 1,595 2,491 3,616 4,395 5,529

Other Wired Technologies 47 112 176 138 140 224 213

Cable Modem Services 1,402 2,215 3,295 4,999 7,051 9,157 11,343

Fiber-Optic Cable 1 * 2 3 4 6 15

Satellite and Other Wireless Technologies 50 64 102 182 195 202 257

Total 1,792 3,164 5,170 7,812 11,005 13,984 17,357

Source: Congressional Budget Office based on Federal Communications Commission, High-Speed Services for Internet Access: Status as of December 31,

2002 (June 2003), Table 3.

Note: * = rounds to zero.

a. With asymmetric lines, the speeds at which customers can receive data are by design much greater than the speeds at which they can send information.

Households are adopting high-speed Internet access as

rapidly as they have adopted any telecommunications

service in the recent past. For example, cellular telephone service, now available in most regions of the

country, took six years to reach 7.5 million subscribers, a feat that the residential broadband market

achieved in 3.5 years.11 That high adoption rate for

broadband is all the more remarkable considering that

the market for service to households and small businesses started in earnest only in the late 1990s. Before

the mid-1990s, the Internet itself was used mainly by

academic researchers and technophiles. Clearly, however, neither cell phones nor broadband Internet access

is as widely adopted as television or landline telephone

service is and thus not as central to the typical consumer’s participation in economic and civic life.

The rapid increase in subscriptions for residential

broadband access has led to a rapid rise in companies’

revenues. CBO estimates that in 2000, subscription

charges for broadband, leaving aside installation fees

and promotional discounts, were about $1.5 billion.

By 2002, that stream of revenues had grown to between $7 billion and $8 billion (depending on estimates of prices).12 That increase was due to both the

rise in the number of subscriptions that was discussed

above and higher prices for cable modem service (discussed later). By comparison, the FCC estimates that

in 2002, subscribers and advertisers paid $43.8 billion

to the cable industry—in addition to their fees for

high-speed Internet and cable telephone service.13 Local telephone companies earned even more; in 2001,

the most recent year for which the FCC has published

data, households and businesses paid those companies

about $116.5 billion.14

Because cable and local telephone businesses are “mature,” their sales of subscriptions for high-speed Internet access to households and small businesses represent

a substantial fraction of their annual growth. Between 

11. Gerald R. Faulhaber, “Broadband Deployment: Is Policy in the

Way?” in Robert Crandall and James Alleman, eds., Broadband: Should We Regulate High-Speed Internet Access? (Washington, D.C.: AEI-Brookings Joint Center for Regulatory

Studies, 2003), p. 226.

12. The annual average prices for cable modem and DSL service

come from ARS, Inc., a market research firm in La Jolla, California (www.ars1.com).

13. Federal Communications Commission, Annual Assessment of

the Status of Competition in the Market for the Delivery of Video

Programming: Ninth Annual Report (December 31, 2002), Table 4.

14. Federal Communications Commission, Statistics of Communications Common Carriers, 2001 (September 12, 2002), p. 170.
DOES THE RESIDENTIAL BROADBAND MARKET NEED FIXING? 7

Table 2.

Percentage of Zip Codes Nationwide with High-Speed Internet

Access Subscribers, by Number of Providers

Number of

Providers

Dec.

1999

June 

2000

Dec.

2000

June 

2001

Dec.

2001

June 

2002

Dec.

2002

None 40.3 33.0 26.8 22.2 20.6 16.1 12.0

One 26.0 25.9 22.7 20.3 19.3 18.4 17.3

Two 15.5 17.8 18.4 16.7 15.7 16.2 16.8

Three 8.2 9.2 10.9 13.2 13.1 13.3 14.4

Four 4.3 4.9 6.1 8.2 9.1 9.6 10.3

Five or More 5.7 9.2 15.3 19.3 22.0 26.3 29.1

Source: Congressional Budget Office using data from the Federal Communications Commission.

1998 and 2001, cable and local telephone companies’

total revenues (including those for broadband services) 

rose by an average of roughly $6.6 billion per year;15

between 2000 and 2002, the broadband market grew

by roughly $3 billion per year. Thus, CBO estimates

that the growth of broadband subscriptions accounted

for 45 percent of the cable and local telephone companies’ increase in total revenues.16

Geographic Dispersion of Subscriptions

Subscriptions for residential broadband service have

become much more widely dispersed geographically

over the past few years, according to surveys by the

FCC. At the end of 1999, 40 percent of zip codes nationwide had no broadband subscribers (see Table 2).17

By December 2002, that figure was substantially

smaller: only 12 percent of zip codes had no broadband subscribers. Much of that broader geographic

reach is the result of suppliers’ increasing the number

of regions in which they make their service available.

Thus, over the same period, the percentage of zip

codes in which five or more providers of broadband

service had subscribers rose from 6 percent to 29 percent. Consequently, not only is broadband more

widely available than it was a few years ago but it is

also available from a larger number of sources.

The FCC’s zip code data have potential shortcomings,

both on the upside and the downside. Most notably, it

would seem that the data were understated because

once satellite providers entered the residential broadband market, service was available to virtually any subscriber who wanted it throughout most of the lower

48 states. However, high prices and other factors have

substantially limited satellite subscriptions.

Furthermore, the fraction of the population that has

high-speed Internet access available could be larger

than the FCC’s count indicates because the zip codes

that have seen increases in service have generally been

those with the most people. In the most populous

50 percent of zip codes, 99.5 percent or more of their

residents have access to high-speed Internet service.18

Overall, only 2 percent of U.S. residents live in zip

codes that have no broadband subscribers, which indicates that many of the problems of supply that were

15. According to the Semiannual Wireless Industry Survey conducted by the Cellular Telecommunications & Internet Association, revenues from cellular telephone service represented another $39.8 billion at the end of 2002 and grew at an annual

average rate of $6.4 billion between 1998 and 2002. However,

cell phone revenues do not increase the revenues attributable to

the companies’ wired networks and so are not included here.

16. Revenues were $1.5 billion in 2000 and between $7 billion

and $8 billion in 2002, therefore increasing by roughly

$6 billion in 2001 and 2002, or about $3 billion per year.

17. Federal Communications Commission, Deployment of Advanced Telecommunications Capability to All Americans in a

Reasonable and Timely Fashion: Third Report.

18. Federal Communications Commission, High-Speed Services for

Internet Access: Status as of June 30, 2002 (December 2002),

Table 11, available at www.fcc.gov/wcb/iatd/comp.html.
8 DOES THE RESIDENTIAL BROADBAND MARKET NEED FIXING?

more common two or three years ago have been resolved.

Yet to some extent, the FCC’s zip code data may overstate how available broadband services are to residential consumers. For instance, a provider may offer service and hence have subscribers in only one part of a

zip code. Although the FCC might count that entire

zip code as having a provider, residents in some portions of it would not have access to broadband service

or would have fewer providers than the FCC’s data

indicated. DSL providers in particular have reported

substantial problems in increasing that technology’s

availability. Verizon, for instance, indicated that as of

spring 2003, it could not provide DSL service to

roughly 40 percent of the households in the areas it

serves; that figure rises to 50 percent in some markets.19 DSL providers had planned to have 95 percent

of their structures and equipment upgraded and able

to provide broadband by 2003. However, some industry observers suggest that only about two-thirds of

their infrastructure is ready.20 By contrast, cable companies have upgraded 90 percent of their infrastructure.

Finally, the FCC’s data on broadband subscribers do

not distinguish between households and small businesses. Providers may have programs aimed at the

more developed business segment of the market, leaving residential consumers without options that are targeted toward them.

The Supply Side: Competition

Now and in the Future

As noted earlier, most residential broadband markets

are dominated by two large providers: a telephone

company and a cable company. The FCC has reported

that as of December 2002, there were only one or two

providers with broadband subscribers in 34 percent of

zip codes in the United States.21 In other markets, a

number of smaller firms—that in most cases use the

local telephone company’s infrastructure—provide

some competition to the main residential broadband

companies. Those competitive providers held a significant share of the overall residential broadband market

in the last half of the 1990s but have declined in importance during the past two years. In December

2000, such companies (mainly satellite firms and

competitive broadband providers that use wired networks) accounted for 11.5 percent of all high-speed

connections to residences and small businesses.22 By

December 2002, their share had fallen to 7.0 percent

(see Figure 1).

In general, analysts argue, markets with a small number of competitors will perform inefficiently relative to

more competitive markets in which a larger number of

firms establish the prices for services. In a market with

only two providers, known as a duopoly, the two

dominant competitors, recognizing that price competition ultimately would leave them worse off, might

succeed in keeping prices above the level that a market

with a large number of competitive firms would reach.

In that case, those producers’ gains would be society’s

losses: fewer consumers would have broadband than

the number that would subscribe to a service in a

more competitive market, and they would pay more

for it.

Because the broadband market is still developing, it is

premature to say that the currently dominant companies have established a duopoly. As noted earlier,

many consumers consider dial-up access to the

Internet an acceptable substitute for broadband, which

limits the pricing power of the dominant firms. Yet a

policy concern remains because for some other consumers, dial-up access is seen as a poor substitute for

broadband. Thus, if local telephone and cable companies were able to secure their position and exercise

19. Peter Howe, “Verizon Battling on Broadband,” Boston Globe,

May 15, 2003, p. A1.

20. Lara Warner, Bryan Kraft, and Julia Belladonna, The Broadband Battle 2003: A Crossroads for High-Speed Data (New

York: Credit Suisse/First Boston Equity Research, April 3,

2003), p. 8.

21. Federal Communications Commission, High-Speed Services

for Internet Access: Status as of December 31, 2002.

22. Based on Federal Communications Commission, High-Speed

Services for Internet Access (various years).
DOES THE RESIDENTIAL BROADBAND MARKET NEED FIXING? 9

Figure 1.

Market Share of Competitive

High-Speed Internet Access Providers

Source: Congressional Budget Office based on Federal Communications

Commission, High-Speed Services for Internet Access (various

years).

Note: Competitive providers (for example, satellite Internet suppliers) are

those other than the local cable and telephone companies.

market power in providing high-speed Internet access,

they might be able to maintain prices above those that

would apply in a competitive market.

Even if the share of the two dominant firms in most

local markets is large and growing, a key policy question is whether the current conditions on the supply

side of the market (discussed in the subsections below)

are likely to persist. If they are not, the case for federal

intervention is weakened, particularly in the context of

the ongoing deregulation of the telecommunications

sector as a whole. In the near term, two factors might

reduce the power of the dominant suppliers—or at

least the potentially negative effects of their large share

of the market. First, actual and potential new entrants

to the market could limit the current major producers’

ability to keep prices high. Second, competitive pressures in the “home,” or core business, markets of the

cable television and telephone companies that provide

high-speed Internet service might cause them to compete more vigorously in the residential broadband

market.

High Fixed Costs: A Barrier to New

Market Entrants

Neither of the dominant providers of high-speed

Internet access entered the market as a new firm bringing a new service to consumers. Instead, both the cable

television and local telephone companies that share the

market for high-speed access offer broadband service

as extensions of the television and telephone services

that account for the bulk of their revenues and that

require the extensive wired network that each controls.

That last factor—that history and current technology

dictate that a wired network is at present the most economical means of delivering broadband to households

and small businesses—is the most basic condition on

the supply side of the residential market.

The costs of the cable television and telephone networks used to deliver broadband differ in amount but

are similar in that they are characterized by high levels

of fixed and “sunk” (generally, irreversible) costs.

Those kinds of costs make it likely that the average

cost of broadband service will decline as new subscribers join the network.23 The cost of upgrading a preexisting cable or telephone network to provide highspeed Internet access is substantial; however, once the

upgrade has been made, providing service to additional subscribers requires relatively modest investments in the network’s infrastructure (although such

investments are larger for DSL providers than for cable systems). Furthermore, once service to the new

subscribers is in place, the cost of continuing it is low.

23. For an analysis of the costs of local telephone service, see

F. Gasmi and others, Cost Proxy Models and Telecommunications Policy: A New Empirical Approach to Regulation (Cambridge, Mass.: MIT Press, 2001), Chapter 5. For a discussion

of the relationship between the local telephone companies’

cost structure and barriers to entry into the market for local

telephone service, see Federal Communications Commission,

Report and Order and Order on Remand and Further Notice of

Proposed Rulemaking (adopted, February 20, 2003; released,

August 21, 2003), paragraphs 73-91.

Dec. 2000 June 2001 Dec. 2001 June 2002 Dec. 2002

0%

5%

10%

15%
10 DOES THE RESIDENTIAL BROADBAND MARKET NEED FIXING?

For would-be competitors, that cost structure impedes

their entry into the market. They would have to make

substantial initial investments simply to start providing service. At the same time, the incumbent companies would have the option of resisting such competitors by reducing their prices. In addition, the investments that a new entrant would have to make—

mostly the so-called last-mile connections to residences and businesses—would be in large part irreversible because they would be “illiquid” (the new entrant would find it difficult to sell the investments if it

decided to leave the market). That factor makes those

investments particularly risky and thus presents a further obstacle to would-be entrants.

Broadband service is not the principal product of 

either the cable or the local telephone companies.

Rather, in both instances, the service overlays a network that was designed and built to serve other functions—a so-called legacy network. Because so many of

the costs of providing broadband service are common

to the network’s legacy services as well, it is difficult to

properly allocate those costs among the services that

are provided and the customers that are served. That

limitation complicates any analysis of how current

costs in the residential broadband market compare

with those that would prevail in a competitive market.

Entry by Firms That Use Wired Technologies. Before

the dramatic slowdown in investment by telecommunications firms that began, roughly, in 2001, investment in new wired technologies, such as fiber-optic

cable, or modification of the wired network used to

distribute electricity were seen as competitive alternatives to the cable and telephone networks.24 To date,

the opportunities offered by those alternatives have yet

to be realized. 

Optical fiber is an important component of every

broadband network, regardless of the technology being used to provide the last-mile connections to customers (and are a central component of the Internet

itself). Because it can carry much more data than rival

mediums can, fiber-optic cable is often considered

“future-proof,” meaning that it will be a long time

before new technologies require higher capacity than it

can provide. But in only a few instances is fiber actually used to deliver broadband Internet access over the

last mile to residential subscribers. The FCC’s latest

publication on fiber-optic cable reports that only an

estimated 15,000 households and small businesses get

broadband services through fiber.25

With that small a fraction of today’s market, fiber is

unlikely to become a significant competitor in most

residential markets in the next few years. One reason is

that fiber networks require new installation, and the

most expensive piece of that work is labor—which is

not subject to the kinds of cost reductions that other

products in the electronics sector, such as computer

chips and computer disk drives, have experienced. Another issue is that fiber systems may pose problems in

existing residential settings—such as requiring specialized, expensive telephones with separate power supplies.

Those problems aside, the likeliest candidate to develop and install a fiber network would be the existing

local telephone company. Indeed, several companies

have already joined together to begin developing common specifications for future fiber systems, a move

that could lower their costs (through economies of

scale in producing such materials).26 That kind of investment would not increase the number of competitors in the broadband market; rather, it would increase

the local telephone company’s broadband capacity.

24. This section of the paper discusses entry by firms that build

and use their own facilities. FCC regulations permit competitive firms to provide service by renting the wires and switches

ordinarily used by the incumbent companies. That type of

market entry is discussed later.

25. Federal Communications Commission, High-Speed Services

for Internet Access: Status as of December 31, 2002, Table 3.

26. Ben Charny, “Baby Bells to Twist Fiber Together,” CNET

News, May 29, 2003, available at http://news.com.com/2100-

1037-1011333.html; and Bruce Hammond, “As Fiber Plans

Move Forward, Bells Turn Eyes to Multiple Forms of Video

Services,” Telecommunications Report, November 15, 2003,

pp. 1 and 39.
DOES THE RESIDENTIAL BROADBAND MARKET NEED FIXING? 11

By contrast, most potential broadband customers are

currently connected to the wired network that is used

to transmit electricity—in addition to any connections

they might have to telephone and cable television networks. That third wire is a potential connection to the

Internet. Several power companies are running field

tests to determine the economic and technical viability

of using power lines to transmit broadband signals.27

And in April 2003, the FCC began a formal study of

that form of broadband access.28

Since the technology is only in the field-testing phase,

it could be years, if ever, before power-line broadband

service becomes a major competitor in the residential

market. Currently, it is unclear whether the existing

power grid can be used to provide broadband and

whether the costs of “conditioning” the grid will allow

Internet access through power lines to be competitive

with cable modem or DSL service. 

Entry by Firms That Use Wireless Technologies. The

prospects are also uncertain for new broadband market

entrants that use wireless technologies; a variety of

opinions exist about the economic viability of one

technology or another. Recent experience in the markets for cellular telephone and satellite video service

has shown, however, that if a technology provides service comparable with that offered by the telephone

and cable companies, new firms can enter the market

successfully and, as in the case of cell phone service,

provoke significant price competition. 

The evidence is mixed about whether wireless technologies will increase the number of competitors in the

residential broadband market in the near term. The

problem is not a lack of public or private efforts. The

FCC has made and continues to make portions of the

electromagnetic spectrum available for terrestrial fixed

wireless Internet access and other types of wireless data

transmission, and companies regularly announce

broadband initiatives that employ new wireless technologies. But many such initiatives in the past have

proved limited in their scope, serving only niche markets and small geographic areas; others have been economic disappointments. The problems firms face in

introducing new wireless data technologies are myriad

and range from technical to financial.29 (For instance,

some of the technologies require a direct line of sight

between the transmitter and the receiver, a factor that

increases costs and restricts where such technologies

can be used. In other instances, reception can be degraded by bad weather or even leafy trees.) The latest

broadband wireless technologies are designed to overcome many of those problems, but the industry’s history of high expectations that remain unfulfilled suggests that a wait-and-see attitude might be appropriate.

Broadband service provided by satellite is a prime example of the mixed record of wireless broadband providers. Like those of many wireless technologies, satellite connections are sensitive to location and weather.

In addition, satellite companies have entered and left

the market in quick succession, leaving customers unsure about the continued availability of service. Nevertheless, broadband service provided through satellite

technology remains attractive, especially to customers

in remote locations.

Wireless broadband providers who wanted to enter

larger urban markets might not find it easy, for several

reasons. First, newcomers to the market would start

offering services in a few areas or cities at a time, but

the wired incumbent (DSL or cable) providers could

be expected to respond by reducing their prices, which

would add to the already high costs of entry faced by

new providers. Second, the existing providers would

already have signed up the “easy” customers, the ones

27. In some cases, electric power companies are participating in

broadband investments that use conventional technologies. 

Their power-line poles, easements, and rights-of-way, as well

as their access to capital, make them valuable partners in such

projects.

28. Federal Communications Commission, Notice of Inquiry,

Docket 03-104.

29. This discussion is based on a review by Greg Caltabiano of

SOMA Networks (a wireless broadband provider) titled

“Lessons Learned: Requirements for the Profitable Last Mile”

(Telephony Online, April 9, 2003), available at http://

telephonyonline.com/ar/telecom_lessons_learned_

requirements/index.htm.
12 DOES THE RESIDENTIAL BROADBAND MARKET NEED FIXING?

with the highest level of demand, and a new entrant

would have to break into the market without a backlog of demand to cushion the financial requirements

of entry and during the initial stage of operations.

Third, a new competitor entering the broadband market would differ from either the satellite companies

entering the multichannel video (cable) market or the

digital cellular telephone companies entering the analog cell phone market. In the latter two instances, the

entrant companies had superior technology with

which to compete—superior in the sense that they

could offer a much wider array of features (more stations from the satellite providers or more options,

such as voice mail and caller I.D., from the digital cell

phone firms). But in the case of households that have

preexisting wired access, wireless technology currently

has little by which to distinguish itself, except price.

Notwithstanding such obstacles, firms that offer wireless alternatives have made substantial headway in

competing with wired incumbents in both the telephone and multichannel video markets. Wireless telephone service has grown rapidly as a new and distinct

telecommunications option. Evidence has been accumulating over the past few years that some customers

are substituting wireless for wired telephone service.30

In the wireless broadband market, wireless firms have

made inroads in rural areas where the larger broadband providers are not yet offering service.31

Although existing telephone companies are also using

wireless technologies to expand their share of the residential broadband market, their entry into the wireless

arena does not increase the number of competitors in

the market. For example, Verizon alone has several

technical trials or commercialization projects under

way that use wireless data technologies:

# Technology that is now undergoing a technical

trial in Northern Virginia would expand Verizon’s

geographic DSL capabilities to allow it to serve

households and businesses that lie beyond the current distance limitation.32

# A service introduced in the Washington-Baltimore

and San Diego areas would permit the company

to offer mobile broadband services by using its

cellular network, upgraded with the so-called

third-generation (or 3G) cellular technology.33

(That service is seen as a premium product and is

not aimed at the residential market.)

# A technology introduced in Manhattan would

permit Verizon DSL subscribers to use a different

wireless technology—so-called Wi-Fi—to access

the Internet at broadband speeds simply by being

within 300 feet of designated pay telephones.34

(Box 1 discusses the Wi-Fi technology.)

Verizon expects that the new services will take some

sales away from its wired offerings (just as its cellular

telephone service to some extent steals sales from its

traditional telephone services). For the most part,

however, it anticipates that the new services will complement or expand its current offerings. 

30. Matt Richtel, “F.C.C. Backs Phone Number Portability,”

New York Times, November 12, 2003.

31. On November 4, 2003, the FCC held a showcase and workshop for rural wireless Internet service providers to highlight

the potential of wireless broadband in rural areas. The workshop presentations and a video are available at www.fcc.gov/

osp/rural-wisp.html.

32. Roy Mark, “Trial by Broadband,” ISP Planet, August 6,

2002, available at www.isp-planet.com/news/2002/

vz_020806.html.

33. Ben Charny, “Verizon Spends a Billion Dollars on 3G,”

CNET News, September 3, 2003, available at http://

news.com.com/2100-1039-5070870.html. Analog cellular

systems represented the first generation; today’s digital technology is the second generation; and advanced digital technology offering broadband and other services is referred to as the

third generation.

34. Barnaby Feder, “Verizon Sets Up Phone Booths to Give Access to the Internet,” New York Times, May 14, 2003. The

FCC has recently begun regulatory proceedings to increase

the radio spectrum available for license-exempt uses, such as

Wi-Fi. See Kenneth Carter and others, Unlicensed and Unshackled: A Joint OSP-OET [Office of Strategic Planning and

Policy Analysis-Office of Engineering and Technology] White

Paper on Unlicensed Devices and Their Regulatory Issues (Federal Communications Commission, May 2003).
DOES THE RESIDENTIAL BROADBAND MARKET NEED FIXING? 13

Box 1.

The Case of Wi-Fi

Wi-Fi is currently the most successful wireless link

to the Internet. It was originally designed to allow a

computer network, whether in an organization or at

home, to connect its computers internally at broadband speeds without needing to have run wires

through walls.1

 Wi-Fi serves many of the same purposes for a computer network that a cordless phone

serves at home.2

 But just as the cordless phone’s base

station needs a telephone line through which to connect to the public telephone network, so Wi-Fi base

stations need a broadband connection to the

Internet (commonly called backhaul) to provide

broadband service to their clients. Also like the cordless phone, Wi-Fi devices use low-power transmitters, which limits their range to about 300 feet.

Building on the success of Wi-Fi in corporate- and

home-network markets, hotels, airports, and other

hospitality industry firms began using the technology to offer fast Internet access to business travelers

and others whose only alternative was a slow dial-up

mode. The hotel or other business must still have its

own broadband access to the Internet to provide the

link between the Wi-Fi “hot spot,” as the area

around a Wi-Fi base station is called, and the Internet. In other instances, community groups have

connected downtown areas to provide Wi-Fi Internet access for entire sections of a city by using overlapping hot spots. Similarly, universities and other

organizations have blanketed their campuses with

Wi-Fi coverage. In every instance, however, the WiFi base stations are linked to the Internet by a second broadband connection, either wired or wireless.

The limit of 300 feet on its transmitter’s range and

the need for a broadband connection for the Wi-Fi 

1. John Markoff, “Led by Intel, True Believers in Wi-Fi Say

It Will Endure,” New York Times, July 14, 2003, p. C1.

2. Because Wi-Fi is governed by many of the same Federal

Communications Commission regulations that apply to

cordless telephones, it uses the same frequencies in the radio spectrum.

base station restrict the technology from delivering

broadband access in most residential situations.

Manufacturers of electronics equipment are now

trying to extend Wi-Fi’s success by increasing the

distance at which it can be used.3

 In one effort, several manufacturers have banded together to promote

a successor, WiMAX, which they argue will be more

appropriate for the residential broadband market.4

Simultaneously, businesses that offer Wi-Fi service

are trying to make it more profitable. The broadband connection from the Wi-Fi hot spot to the

Internet may cost a business several hundred dollars

a month. Yet Starbucks, which has almost 2,000 hot

spots in its coffee shops nationally, reports daily average use of only two customers per spot.5

 Other

issues for businesses that must be resolved include

congestion and security. Most fundamentally, the

business model for the technology remains unclear

because generally, the use of Wi-Fi is free. A hotel

might provide both Wi-Fi and cable television at no

charge to make their rooms more attractive to travelers. Similarly, colleges and university campuses

may not charge for Wi-Fi separately from their

other computer network services. If Wi-Fi is to

spread beyond the confines of universities and hotels, which ultimately subsidize it through the sales

of other services, businesses need to find a way to

charge for its use.

3. Some industry analysts argue that Wi-Fi has been more

successful than previous wireless technologies because the

manufacturers adhered to openly available, nonproprietary

standards and worked to ensure interoperability for the

products of different manufacturers. That move helped

expand the market, they contend, which in turn allowed

economies of scale that further reduced costs and made the

equipment even more popular.

4. Information about WiMAX is available at www.wimax

forum.org.

5. See “Bubble Trouble,” The Economist, June 26, 2003.
14 DOES THE RESIDENTIAL BROADBAND MARKET NEED FIXING?

Convergence of Communications Technologies

and Competition in Related Home Markets

The local telephone and cable television companies

that compete in the broadband market also confront

one another—but in different roles—in their respective home markets. The cable companies are currently

wired entrants in the local telephone market and may

play a larger role in the future. And additional investment in the telephone network could allow telephone

companies to compete in the multichannel video market.35 As incumbents, both telephone and cable companies see little chance of substantial growth in sales

and profits in their home markets. As entrants into

one another’s home markets, their prospects are

brighter, but the risks are greater and the competitive

environment more complicated, comprising decisions

about investment (which is often high in cost and irreversible), pricing, and responses to third-party competitors that employ alternative technologies.

With multiple roles and points of competition, the

wired incumbents in the local telephone and cable

television industries might reap even greater profits if

they effectively coordinated their efforts. Yet coordination also poses problems that could spill over into the

broadband market and make the companies’ current

dominance less profitable. As yet, the telling signal of

competition—price decreases—has not emerged in

either home market (see Box 2). 

Competition in the Market for Multichannel Video

Programming. In the market for the distribution of

multichannel video programming, satellite providers—mainly those offering the new smaller-dish

technology—increased their share of all households

that subscribed to a multichannel video programming

service from 9.8 percent in 1997 to 21 percent in

2001.36 Throughout the 1990s, direct satellite broadcasters that used small-dish receivers increased their

subscriber base substantially, from 2.2 million subscribers in 1994 to 19.2 million subscribers in 2002

(see Figure 2).

In the late 1990s, the number of both satellite and cable subscriptions had been growing, although satellite

subscriptions grew much more rapidly than did cable

subscriptions. Then in 2001 and 2002, the growth in

cable subscriptions stagnated. Early data for 2002 indicate that growth in subscriptions to satellite services,

combined with a weak economy, may have reduced

annual growth in the number of cable subscribers to

less than half a percentage point.37 According to the

FCC, 98 percent of television households nationwide

already have access to cable service, and approximately

65 percent (or 69 million households) subscribe.38

Consequently, cable companies can count on no new

large groups of unserved households to add to their

market. For them, broadband offers a new and substantial source of funds, and they have already invested

significant sums in trying to tap that source. The FCC

reports that in 2002, cable companies collected

$5.6 billion, or 11.3 percent of their total revenues,

from subscriptions to their broadband, telephone, and

interactive television services.39

Continuing competitive pressure from the satellite

companies may force cable firms to look for additional

ways to differentiate themselves. To compete with the

satellite companies, cable companies have increasingly 

35. Telephone companies have a long history of failed pilot projects in the market for delivery of multichannel video programming. For a survey of those attempts, see “Premier of

Video on Demand,” USA Today, October 12, 1994, available

at www.usvo.com/history/usatoday10-94.html.

36. Federal Communications Commission, Annual Assessment of

the Status of Competition in the Market for the Delivery of

Video Programming: Eighth Annual Report (January 14, 2002),

Table C-1; and Annual Assessment of the Status of Competition

in the Market for the Delivery of Video Programming: Ninth

Annual Report (December 31, 2002), Table B-1.

37. Federal Communications Commission, Annual Assessment of

the Status of Competition in the Market for the Delivery of

Video Programming: Ninth Annual Report, p. 3.

38. Ibid., Table 1. The FCC reports that substantial criticism and

uncertainty surround that estimate and notes that different

sources put the share of cable’s availability as low as 78 percent (see pp. 9 and 10).

39. Ibid., Table 4.
DOES THE RESIDENTIAL BROADBAND MARKET NEED FIXING? 15

Box 2.

Trends in Prices for Multichannel Video Programming 

and Local Telephone Services

A look at competition and prices in the primary

markets of the two major broadband providers, or

market “incumbents”—cable systems and local telephone companies—reveals no decrease in prices

even though their market shares have been eroding

as new competitors enter the market. Cable companies have maintained and even increased prices

when faced with competition in the video distribution market. As their competitors’ share of the market has grown, cable systems have competed by offering more programming rather than by lowering

prices. According to the Federal Communications

Commission’s (FCC’s) latest report on cable prices,

rates for video programming service rose by 7.3 percent between July 2000 and July 2001.1

 However,

the average number of channels carried by cable systems also increased; thus, on a per channel basis,

rates rose by 1.5 percent during that period.

That kind of increase is nothing new. The Bureau of

Labor Statistics (BLS) reports that between 1993

and 2002, the price of cable service for urban consumers rose at an average annual rate of 4.7 percent.

By comparison, the consumer price index (CPI) as a

whole (the cost-of-living measure that BLS maintains, which is commonly used to gauge inflation)

rose by 2.3 percent per year during the same period. 

1. Federal Communications Commission, Report on Cable

Industry Prices (April 4, 2002), Table 1. For a discussion of

those prices, see Steven S. Wildman, Assessing QualityAdjusted Changes in the Real Price of Basic Cable Service

(East Lansing, Mich.: Quello Center for Telecommunications Management and Law, Michigan State University,

September 10, 2003). 

However, the CPI measure for cable service may

overstate the price rise because it does not adjust for

the increase in the number of channels or for the

higher-quality digital service that cable systems now

offer.

Similarly, prices for local telephone service over the

1993-2002 period, as measured by the CPI, generally rose with the index as a whole, or by roughly 2.4

percent per year. The FCC reports a lower figure for

the average annual price increase for local service—

1 percent for the period from 1993 through 2001.2

Since the FCC and BLS both use the same 95 cities

to calculate their averages, methodological differences—in particular, what each agency includes under the umbrella of “local telephone service”—must

account for the divergence in results.

Analysts have proposed various explanations for why

those incumbents have managed to maintain or even

increase their prices when faced with new entrants

into the market who have had some success in

claiming a share of it. Some observers argue that,

notwithstanding the new entrants, the incumbent

providers still have substantial market power—that

is, they are able to keep prices above the level that

would apply if the market was competitive. Other

analysts contend that although some markets have

seen new entrants and more competitive pressures

on incumbents, in most markets there is little range

of choice (especially in local telephone service).

2. Calculated from Federal Communications Commission,

Trends in Telephone Service (May 2002), Table 14.1.
16 DOES THE RESIDENTIAL BROADBAND MARKET NEED FIXING?

Figure 2.

Households That Subscribe to a

Satellite Video Service

(Millions)

Source: Congressional Budget Office using data from Sky Research (an

industry research group), available at www.skyreport.com/

dth_counts.cfm.

offered services—in particular, voice telephone and

broadband—that the satellite firms cannot offer as easily or as cheaply. That competition may force the cable companies into increased competition with the incumbent local telephone companies over a range of

services.

By contrast, the competition that incumbent cable

television companies face from wired entrants is not

great: it exists in only 2 percent of markets.40 According to industry data, competitive broadband service

providers currently serve about 1 million of the approximately 69 million households that subscribe to

cable. Of those 1 million households, 460,000 customers subscribe to cable modem services.41 The competitive broadband providers offer the same range of

services that the incumbent cable providers do: multichannel video programming, Internet broadband, and

voice telephone. In the wake of the slowdown in telecommunications investment that began in 2001, those

competitive cable providers have concentrated on expanding the number of their subscribers within the

area that they serve rather than expanding the number

of areas in which they offer service.

Although those entrants do not represent a large number of subscribers in total, they can be a source of substantial competition in some local video programming

markets. The General Accounting Office found that in

markets in which the incumbent cable company faced

a competitive cable firm, cable video rates were on

average about 15 percent lower than they were in similar markets that had no such competition.42

Competition in the Market for Residential Local Telephone Service. Competitive companies thus far have

captured only a small fraction of the residential market

for local telephone service. In December 1999, competitive local telephone companies provided telephone

service to 3.4 million local access lines serving households and small businesses, out of the 143.1 million

such lines nationwide.43 By December 2002, competitive local telephone firms were providing service to

14.4 million of the nation’s 141.4 million residential

and small-business access lines, or 10.2 percent of the

total. Incumbent local telephone companies saw the

40. General Accounting Office, Issues Related to Competition and

Subscriber Rates in the Cable Television Industry, GAO-04-8

(October 2003), p. 9.

41. John Goodman, Broadband Service Providers Association: Overview Presentation (Washington, D.C.: Broadband Service Providers Association, May 2003).

42. General Accounting Office, Issues Related to Competition.

43. Federal Communications Commission, Local Telephone Competition: Status as of December 31, 2002 (June 2003), Tables 1

and 2. The growth of competition in the market for nonresidential access lines is more pronounced. If larger enterprises are

included, competitive local telephone companies provided

24.8 million local access lines, or 13.2 percent of all such lines.

1994 1995 1996 1997 1998 1999 2000 2001 2002

0

5

10

15

20

25
DOES THE RESIDENTIAL BROADBAND MARKET NEED FIXING? 17

Figure 3.

Shares of the Market for Local

Telephone Service, by Provider Type

(Millions of local telephone lines)

Source: Congressional Budget Office using data from Federal Communications Commission, Local Telephone Competition: Status as of

December 31, 2002 (June 2003).

number of their subscribers shrink during that period,

from 139.8 million to 127.0 million (see Figure 3).

As noted earlier, the increasing popularity of cellular

telephones also poses challenges to the wired network.44 According to the industry’s trade association,

about 5 percent of cell phone subscribers (or approximately 7 million subscribers at the most recent count)

have simply ended their conventional telephone subscription. Even for the majority of cell phone users,

who do not completely disconnect their landline, the

cell phone represents continuing competitive pressure,

requiring the local wired telephone companies to upgrade technologies to offer features and convenience.

Moreover, the country’s 140 million cell phone subscribers install fewer second lines, use fewer pay

phones, and otherwise reduce the revenues flowing

from the traditional landline network. (Figure 4 shows

the growth in cell phone subscriptions over the past

decade.)

At the same time, the current state of competition in

the market for wired local telephone service illustrates

particularly well the difficulty of overcoming the barriers to market entry that a wired network presents.

Only about a quarter of the landlines provided by

competitive local telephone companies use facilities

that were actually built by those firms; the majority of

competitive companies lease some combination of facilities from the incumbent firms.45 About a third of

the lines that competitive telephone firms use are provided by cable companies, and the growth in the cable

companies’ share of the market in the past several

years may signal their future competitive intent (see

Figure 5).

Local telephone companies are under substantial pressure to find new ways to pay for their high fixed costs.

Competitors such as the cable companies and the cell

phone service providers have over the past four years

reduced the number of lines from which the incumbent local telephone companies derive revenues. Those

strains may force the local phone companies into more

vigorous competition with the cable companies over

residential broadband.

Regulation

In the Telecommunications Act of 1996 (Public Law

104-104), policymakers reduced the barriers to entry 

44. Local telephone companies are also cell phone providers and so

may be cannibalizing their own sales. Statistics on cell phone

subscribers come from the Cellular Telecommunications &

Internet Association’s Semiannual Wireless Industry Survey,

available at www.wow-com.com/industry/stats/surveys/. For a

discussion of the cell phone’s challenge to wired local telephone service, see Federal Communications Commission,

Eighth Report and Analysis of Competitive Conditions with Respect to Commercial Mobile Services (June 26, 2003), pp. 49-52.

45. Federal Communications Commission, Local Telephone Competition: Status as of December 31, 2002, Table 3. Because the

FCC does not break down those data into residential and nonresidential categories, CBO could not calculate the number of

residential lines provided by competitive local telephone companies.

Dec. 1999 Dec. 2000 Dec. 2001 Dec. 2002

0

20

40

60

80

100

120

140

160

Incumbents

New Entrants
18 DOES THE RESIDENTIAL BROADBAND MARKET NEED FIXING?

Figure 4.

Cellular Telephone Subscribers

(Millions, at year’s end)

Source: Congressional Budget Office using data from the Semiannual

Wireless Industry Survey of the Cellular Telecommunications &

Internet Association, available at www.wow-com.com/industry/

stats/surveys/.

into the telephone services market by directing the

FCC to establish regulations that allowed potential entrants to rent the incumbent local telephone companies’ existing network or its components on very favorable terms. Until recently, the FCC’s rental policy

also applied to broadband service provided through

the telephone lines. That policy has been the object of

much criticism and lies at the hub of the current debate about asymmetric regulation.

Industries that rely on networks to deliver their services—electricity and natural gas are examples outside

of the telecommunications sector—have typically been

regulated. The reason is that at least initially, those

networks were associated with such large economies of

scale and presented such formidable barriers to other

firms that wanted to enter the market that consumers

would have faced an unchecked monopolist if regulation had not provided some protection. The cable and

local telephone networks that dominate the emerging

residential broadband market are no exception. Early

in their existence, the two networks were both regulated; currently, the telephone companies are subject

to more direct regulation than the cable companies

are. 

Specifically, the Telecommunications Act of 1996 requires incumbent local telephone companies to rent to

their would-be competitors, as a package or as individual items, seven federally designated elements of their

system at prices calculated to mimic what a competitive market would have provided to wholesale customers, given the advancing technology found in this industry. The competitors are free to pick and choose

which of those elements they need for their business

and to rent them at those relatively low prices. Cable

providers of broadband access face no such requirement to rent their facilities to competitors. (Box 3 discusses how regulation has affected investment by local

telephone companies.)

In addition to the provisions noted above, regulators

imposed specific line-sharing requirements on local

telephone companies with regard to residential broadband service. Specifically, the local telephone companies have been obliged to allow competitive DSL firms

to rent the high-frequency portion of the incumbent

firms’ telephone lines—the lines that the phone companies are using to provide ordinary voice service

—and pay a fee only for the portion of the spectrum

that they use. If those requirements were removed,

competitive DSL providers would probably have to

rent a second telephone line at the full price, even

though they would only be using the high-frequency

portion of it. The increase in their costs from the

second-line rental would vary from state to state; however, according to one industry estimate, that change

alone would boost the cost of competitive firms’ DSL

service in parts of California by roughly $20 per

month (from $6 per month to $26 per month).46 A

more likely scenario is that two companies—a competitive voice service provider and a competitive DSL

provider—will lease the entire line and split it into a

low-frequency (voice) section and a high-frequency

DSL portion.

46. See John Borland, “Feds Mull Broadband Market Shake-Up,”

CNET News, January 6, 2003, available at http://news.

com.com/2100-1033-979356.html.

1992 1994 1996 1998 2000 2002

0

20

40

60

80

100

120

140

160
DOES THE RESIDENTIAL BROADBAND MARKET NEED FIXING? 19

Figure 5.

Cable Telephone Subscribers

(Millions)

Source: Congressional Budget Office using data from the National Cable and Telecommunications Association, available at www.ncta.com/industry_overview/

indStats.cfm?statID=13.

Note: Q = quarter.

In August 2003, the FCC issued an order to phase out

the line-sharing requirement for residential broadband

service over three years.47 It is too early to tell what the

result will be; competitive suppliers are still formulating their responses within the market and the legal

system, and the decision is already under challenge in

the courts. Should the decision stand, the overall market share (and possibly the number) of competitive

suppliers of residential DSL service will probably decline. However, the supply of DSL is unlikely to be

greatly affected because the FCC’s most recent data 

show that the incumbent local telephone companies

account for 95.1 percent of DSL lines nationwide.48

The FCC’s order also established that the federal government would only impose sharing requirements on

future fiber-optic or next-generation-technology networks that the local telephone companies built to serve

homes if the local telephone company then elected to

retire the existing copper network.49 In that case, the

incumbent company would have to offer competitive

providers access to the low-frequency (voice) portion

of the line.

47. Federal Communications Commission, Report and Order,

paragraphs 255-269.

48. Federal Communications Commission, High-Speed Services

for Internet Access: Status as of December 31, 2002, Table 5.

49. Federal Communications Commission, Report and Order,

paragraphs 272-280.

2000 Q1 2000 Q2 2000 Q3 2000 Q4 2001 Q1 2001 Q2 2001 Q3 2001 Q4 2002 Q1 2002 Q2 2002 Q3 2002 Q4

0.0

0.5

1.0

1.5

2.0

2.5

3.0
20 DOES THE RESIDENTIAL BROADBAND MARKET NEED FIXING?

Box 3.

Has Federal Regulation Hindered Local Telephone Companies’

Investment in Broadband?

Federal regulations require certain local telephone

companies—but not cable companies—to rent their

phone lines as well as their switching equipment to

their broadband competitors at wholesale prices determined by regulators. Advocates of relieving the

local telephone companies of that line-sharing responsibility posit that the low prices that the regulators have set dampen those companies’ incentives to

invest in new facilities. Those advocates argue that

the cable companies, which did not have similar requirements, rolled out their cable modem broadband service to households much more rapidly than

the telephone companies rolled out their digital subscriber line (DSL) service and captured the lion’s

share of the market for residential broadband in the

United States. Advocates also point to the broadband markets in some other countries to support

their argument. There, DSL has played a much

larger role than it has in the United States—further

evidence, according to those advocates, that the linesharing requirements have had a deleterious effect

on the telephone companies’ investments.

But proponents of eliminating the requirements

have produced little evidence of the extent to which

the local telephone companies’ limited success thus

far to compete in the residential broadband market

can be explained by the facilities-sharing rules. Some

analysts argue that the difference in when the telephone companies offered broadband service and

when the cable companies did was largely due to the

dynamics of each of their home markets. The cable 

companies had substantial motivation to develop

and offer high-speed Internet access as part of the

enhanced capabilities they were planning to provide 

to stave off competition from satellite television

companies. By contrast, the telephone companies

had conflicting incentives, including the cost of

sharing facilities as the regulations required. Certainly, however, the telephone companies were in

the best position of any participant in the market to

see the overall demand for connectivity.1

 They knew

the number of second telephone lines that were dedicated to Internet connections, and they could also

see the millions of minutes during which residential

consumers used the telephone network to connect,

through their dial-up access, to Internet service providers. No other individual Internet service provider (or cable company) could see the total demand

for Internet connections.

Some analysts further argue that the telephone companies deferred investing in broadband because it

threatened to “cannibalize” some of their more profitable businesses. For example, many residential 

customers who bought broadband connections then

canceled their second telephone lines, which they 

1. Gerald R. Faulhaber, “Broadband Deployment: Is Policy in

the Way?” in Robert Crandall and James Alleman, eds.,

Broadband: Should We Regulate High-Speed Internet Access

(Washington, D.C.: AEI-Brookings Joint Center for Regulatory Studies, 2003), pp. 223-244.

Many observers maintain that the low rental rates for

infrastructure and the line-sharing requirements have

weakened the local telephone companies’ incentive to

invest. They further argue that the cable companies’

much larger share of the residential broadband market

results directly from those deterrents to investment.

The evidence indicates, however, that both the cable

and the telephone companies have invested substantial

amounts in the broadband portions of their business,

although the telephone companies might have invested more had regulatory policy been different and

less uncertain. As discussed below, the larger local telephone companies have probably invested more of their

income in broadband since enactment of the 1996 
DOES THE RESIDENTIAL BROADBAND MARKET NEED FIXING? 21

Box 3.

Continued

had used to dial up the Internet and lessen traffic 

on their main line. Similarly, many business customers of the telephone companies were leasing

dedicated high-capacity private lines (referred to in

the industry as T-1 lines) that were capable of carrying 1.5 million bits of data per second and that cost

businesses between $500 and $800 per month (before figuring in ancillary distance-related charges).

The telephone companies feared that their customers would substitute a business DSL line, which

costs between $60 and $300 per month, depending

on speed and other factors.2

 

Consequently, to avoid losing the profits from the

additional residential and high-capacity business

lines, the local telephone companies did not enter

the broadband market as rapidly as the cable companies did, which risked no loss of other business. 

Some analysts point out that it was only after the

cable companies began signing up large numbers of 

subscribers—many of whom presumably discontinued their second telephone lines—that the telephone

companies began to enter the residential broadband

market in a serious way.

2. Many of those points come from Faulhaber, “Broadband

Deployment.” Lara Warner, Bryan Kraft, and Julia Belladonna, in their analysis The Broadband Battle 2003: A

Crossroads for High-Speed Data (New York: Credit

Suisse/First Boston Equity Research, April 3, 2003), raise

some of the same issues.

Furthermore, some analysts believe that although

the upgrading of the physical plant (both wires and 

equipment) required to carry high-speed data

proved more difficult than either the cable operators

or the local telephone companies had anticipated, it

proved substantially more difficult for the local telephone companies. They had forecast that they

would have upgraded 95 percent of their plant by

2003; according to some industry observers, they

have upgraded only about 66 percent. (For example,

Verizon indicated that as of spring 2003, it could

not provide DSL service to roughly 40 percent of

the households in the areas it serves.)3

 By comparison, cable companies have upgraded 90 percent of

their infrastructure.

Despite such constraints, the number of DSL lines

in service has grown rapidly, from 292,000 in December 1999 to 5.5 million by December 2002, an

average annual rate of growth of 166 percent. During the same period, cable modem service enjoyed

average annual growth of 100 percent. Nevertheless,

with their head start relative to the telephone companies (as discussed above), cable operators continue

to maintain their lead in the residential broadband

market in the face of the increased financial commitment to DSL by the large local telephone companies over the past several years.

3. Peter Howe, “Verizon Battling on Broadband,” Boston

Globe, May 15, 2003, p. A1.

telecommunications law. Furthermore, as Box 2 notes,

the relative shares of the residential broadband market

claimed by the cable companies and the local telephone companies may be due more to the dynamics

of competition in their different home markets than to

the regulations governing local phone companies.

In any event, the litigation over the FCC’s regulations

is not likely to end soon. The commission’s recent order devolves much of the regulatory authority to the

states. Disagreements and uncertainty are likely to follow that authority to the state level.
22 DOES THE RESIDENTIAL BROADBAND MARKET NEED FIXING?

Supply and the Performance of the Market

It is not clear whether the local telephone and cable

television companies’ current dominance of the broadband market is slowing consumers’ adoption of broadband service. Indicators of the industry’s performance

are mixed. Competition in pricing is tepid compared

with that in the cellular telephone market, which at

one time was also limited to two providers but now

has four to six competitors in every major sales area in

the country. Similarly, price competition is more vigorous in the market for dial-up Internet access, which

has many more providers than the broadband market

has. A further indicator of less competitive pressure is

that the broadband market has seen few of the other

tactics that are typically used in competition. For example, neither of the dominant parties has engaged in

the kinds of negative advertising about products that

they often employ on policy issues or that cable television and satellite providers regularly engage in in the

multichannel video programming market. However,

both the local telephone and cable television companies have rapidly invested to expand their networks—

a positive aspect of performance.

Competition in Broadband Pricing. Changes in prices

by the dominant broadband firms do not yet suggest

that they are aggressively competing. But the lack of

consistent, verified data on prices prevents rigorous

analysis of the recent trends in residential broadband

charges. Patterns of pricing are evolving, and suppliers

are still exploring the nature of the demand they face,

which is to be expected in such a rapidly growing market. Consequently, the movements of prices may have

several competing explanations. 

Throughout the late 1990s, the prices charged for

broadband service declined, according to industry

sources.50 The technologies used to provide that service became less expensive, and at least part of those

cost reductions appears to have been passed on to consumers. Alternatively, firms may have been cutting

prices to gain a larger share of the market, a common

strategy among technology firms at that time.

However, beginning in 2000, the price of cable modem service began to rise while that of DSL service

remained constant or even declined, say reports by two

groups of industry analysts that have tracked prices for

broadband service since that year.51 Both groups also

found that the prices of cable service were on average

initially much lower than those for DSL service, although the studies differ on exactly how much. Nationwide, monthly DSL subscription rates in 2000

averaged between $45 and $50, according to the studies. Monthly cable Internet subscriptions ranged from

$8 to $17 less (depending on the study and date). The

two groups agree that throughout 2000 and 2001,

cable system operators raised their prices for broadband service while DSL providers lowered theirs or

kept them constant. By the end of that period, prices

for cable modem service were only 13 percent to

18 percent lower than prices for DSL service, or

roughly $7 to $8 per month lower. Both studies indicate that in 2002, DSL subscription rates averaged $2

to $5 per month more than the $39 to $42 per month

charged for cable Internet service.52

Recently, discounts and some outright cuts have signaled new competition in prices for broadband service. In 2003, Verizon, for example, decreased its DSL

50. Association for Local Telecommunication Services, The State

of Local Competition: 2001 (Washington, D.C.: Association

for Local Telecommunication Services, February 2001),

p. 31. Neither the Bureau of Labor Statistics nor the FCC has

collected price statistics on broadband service over a long

enough period to construct a price series. Consequently, for

its analysis, CBO relied on data from market research firms

and other industry observers.

51. The estimates of broadband prices are taken from ARS, Inc, a

market research firm in La Jolla, California (available at

www.ars1.com) and from Warner, Kraft, and Belladonna,

The Broadband Battle 2003.

52. In 2002, the method for calculating prices in one of the studies changed, according to its authors, to include the initial

discounts that broadband operators had widely begun to offer. (Such discounts might include an initial lower rate that

then jumped after three or six months.) Because the other

study analyzed revenue per subscriber, it had always included

such discounts.
DOES THE RESIDENTIAL BROADBAND MARKET NEED FIXING? 23

price from $45 to $50 a month to $35 per month.53

The company also offers a lower price of $30 a month

for DSL if the customer also takes certain other

Verizon services. Other telephone companies have

similar offers.54 For the time being, the cable companies have not responded with price cuts of their own.

But discounts for bundles of services offered by both

the telephone and cable companies are an additional

sign of competition on the basis of price. (The bundles

also affect the prices that the companies charge for

voice telephone and cable television services.)

Competition Through Investment and the Use of New

Broadband Technologies. The fragmented data that

are available on investment suggest that both local

telephone and cable television providers have been investing to increase their broadband capabilities. CBO

was unable to obtain specific data on the broadband

investments of the two dominant providers, but the

high overall rates of investment it found suggest that

the companies are competing in building up their capacity to deliver broadband service.

The high rates of investment can be explained in several different ways. The cable and local telephone

companies could be investing to deter new entrants to

the market by establishing capacity in excess of demand in areas where they currently provide broadband

service and foreclosing the easy sales that entrants

might attempt to achieve in underserved areas. Alternatively, cable and telephone companies might be investing simply to keep up with demand. Whatever the

explanation, it is unclear whether the rapid buildup in

capacity will lead to more or less competitive price and

service offerings in the future.55

Most important, the high rate of investment by the

dominant firms means that even if they are beginning

to acquire some durable power in the broadband market, that power is not preventing a very rapid rate of

growth of supply and service. In other words, the negative consequences of such power, should it become

established, have not been felt on the supply side of

the market. Another implication, however, of the

growth in investment is that the barriers to entry associated with high fixed and sunk costs will not be coming down soon. If anything, they are being reinforced.

Investment by Telephone Companies. The incumbent

local telephone companies have been spending a great

deal of money to upgrade their infrastructure. Over

the past six years, the four largest local telephone companies (companies that were part of the old Bell system) have spent an average of 28 percent of their total

annual operating revenues to purchase new structures

and equipment (see Table 3).56 That share rose through

2000 but fell with the general decline of investment in

telecommunications structures and equipment that

occurred in 2001 and 2002.57 By way of perspective,

for the economy as a whole over the same period, investment in structures, equipment, and software represented 12.3 percent of gross domestic product. Thus,

on the dimension of physical investment, the tele53. In some locales, Verizon offered discounts from its price of

$50 per month by giving promotional rates for the first three

or six months and only then boosting the rate to $50. In

other areas, it offered a rate of $40 per month as the standard

fee.

54. James Hu, “Endless Summer of DSL Discounts,” CNET

News, July 7, 2003, available at http://news.com.com/2100-

1034_3-1023465.html?tag=fd_lede1_hed.

55. Jean Tirole, The Theory of Industrial Organization (Cambridge, Mass.: MIT Press, 2001), Chapter 8.

56. CBO used the data series for total plant added rather than the

more customary one for total plant in service (TPIS). The

difference between the two series is that the former includes

all new construction (jobs that are already in service as well as

those not yet completed). However, the difference in the two

measures is not substantial. Under the TPIS measure, the incumbent telephone companies have invested an average of 24

percent of their total annual operating revenues in new structures and equipment. Both sets of figures exclude investments

by the companies’ cellular telephone subsidiaries. See Federal

Communications Commission, Statistics of Communications

Common Carriers (various years).

57. The decline in investment by the regional Bell operating

companies has been less dramatic than the drop in investment

in communications equipment and structures for the U.S.

economy as a whole. Economywide, such investment rose by

75 percent between 1996 and 2000 and then fell by 20 percent, in nominal terms, in 2001. By contrast, the investment

by Bell companies rose by 81 percent but fell by only 9 percent.
24 DOES THE RESIDENTIAL BROADBAND MARKET NEED FIXING?

Table 3.

Investment by Regional Bell Operating Companies

(Billions of dollars)

1996 1997 1998 1999 2000 2001

Investment

Structures and equipment 19.7 20.0 20.2 27.5 35.7 32.4

Research and development 0.2 0.2 0.1 0 n.a. n.a.

Total 19.9 20.2 20.3 27.5 35.7 32.4

Memorandum:

Operating Revenues 78.7 80.4 86.0 90.4 109.2 108.7

Total Investment as a Percentage

 of Operating Revenues 25.3 25.1 23.6 30.4 32.7 29.9

Source: Congressional Budget Office using data from Federal Communications Commission, Statistics of Communications Common Carriers (various years).

Note: n.a. = not available.

phone companies have been rapidly introducing new

capacity (and presumably services) in their market. 

The data are not available to determine how much of

the companies’ total investment was intended for the

voice telephone market (to convert from an analog to

a digital system) rather than the broadband market.

But the limited information that can be assembled

indicates that investment by the former Bell telephone

companies that is most closely related to residential

broadband service rose even more rapidly than did

total investment by those companies.58 Improving

voice service requires investment in both circuit and

digital switching equipment. Both types of equipment

are also required to provide DSL service, but increasing the availability of that service requires more intensive investment in circuit equipment. The share of

their investment dollar that the regional Bell operating

companies spend on circuit equipment has increased

steadily since 1995, while the share devoted to digital

switching equipment has decreased (see Figure 6). The

growing share of spending for capital goods likely to

be used in providing DSL service is even more impressive in the context of the upward trend in overall investment spending by the former Bell companies.

Those data are also consistent with the previously

noted growth of both DSL availability and of the

number of customers buying the service.

Each of the above indicators is imperfect on its own.

Taken together, however, they suggest that the major

telephone companies have been expanding their

broadband capabilities at a rapid rate.

Investment by Cable Companies. Cable system operators have a similarly aggressive pattern of large capital

investment. In 1999, the industry’s revenues totaled

$36.8 billion, and capital investment totaled

$10.6 billion, or 29 percent of revenues.59 In 2000,

cable companies spent $15.5 billion on such investment. And in 2001, the FCC estimates, the industry

invested $17.8 billion to build new facilities or upgrade old ones—or, to put it another way, in two

years, the industry increased its capital spending by 68

percent.

58. In the case of two of the Bell companies, Qwest and SBC,

some or all of their investments in broadband were made by

subsidiaries that are not required to report them to the FCC.

Thus, a significant fraction of investment in DSL service is

not reflected in the federal statistics.

59. Federal Communications Commission, Annual Assessment of

the Status of Competition in the Market for the Delivery of

Video Programming: Eighth Annual Report, Table B-4, and

Annual Assessment of the Status of Competition in the Market

for the Delivery of Video Programming: Ninth Annual Report,

paragraph 35.
DOES THE RESIDENTIAL BROADBAND MARKET NEED FIXING? 25

Figure 6.

Equipment Investment by Regional

Bell Operating Companies

(As a percentage of all investment)

Source: Congressional Budget Office using data from Federal Communications Commission, Statistics of Communications Common

Carriers (various years).

To a large extent, the cable companies upgraded their

facilities in response to a strategic threat from satellite

companies to their core multichannel video programming business, not because of a greater commitment

to compete in the market for broadband. Yet once the

cable companies had upgraded their networks to provide digital television service and added channels to

match the satellite offerings, providing cable modem

service was much less expensive.

The Demand Side: Public Goods and

Constraints on Content

The claims of a failure on the demand side of the residential broadband market rest on arguments about

public goods and the observation that removing constraints on the content that can be transmitted over

the Internet might make broadband more attractive to

consumers. If the issues related to public goods were

significant, the market could be judged as providing

too few broadband subscribers compared with the

number that would maximize society’s economic welfare. And if any and all content, copyright protections

notwithstanding, was made available for downloading

over the Internet, more people would probably subscribe to high-speed access (because the files for such

material in many cases are very large). That latter policy, however, could pose substantial costs for economic efficiency because it would reduce the incentives to produce such content.

Claims About Public Goods

Public goods are goods that, once provided, can be

consumed by an additional person at no cost and for

which it is costly (or at least inefficient) to exclude any

one consumer from receiving them. National defense

is an example and is sometimes called a pure public

good. Other goods—for example, communications

networks, education, and public health—to a greater

or lesser extent have attributes of a public good. Private markets, left to their own workings, are likely to

supply too small an amount of a public good.

Network Effects. If network effects are present, a

good’s (or service’s) value to a person rises as the number of other people who consume the same kind of

good rises.60 For example, a phone system increases in

value as the number of people who can be reached

through it grows.61 In that case, an additional subscriber to a network provides a benefit to the existing

subscribers—in the form of an additional person with

whom to communicate.

Communications networks have some of the attributes

of a public good because the additional subscriber to a

network provides a benefit to the existing subscribers

that is available to all subscribers at little or no addi60. S.J. Liebowitz and Stephen E. Margolis, “Network Effects and

Externalities,” in Peter Newman, ed., The New Palgraves Dictionary of Economics and the Law (New York: MacMillan,

1998), pp. 671-675, available at wwwpub.utdallas.edu/

~liebowit/palgrave/network.html.

61. That increase in value is one rationale for federal subsidies for

universal telephone service, although the centrality of telephone communications to modern economic and social life is

the more commonly used justification.

1995 1996 1997 1998 1999 2000 2001

0%

5%

10%

15%

20%

25%

30%

35%

40%

Circuit Equipment

Digital Switching

Equipment
26 DOES THE RESIDENTIAL BROADBAND MARKET NEED FIXING?

tional cost and from which it is difficult to exclude an

existing subscriber.62 Because a would-be subscriber

fails to account for the value of the network’s expansion in calculating the benefits of subscribing, too few

people will subscribe compared with the number that

will enhance economic well-being to the greatest degree.

The Internet itself is a creation of such network effects. The protocols that regulate traffic on the

Internet are voluntary. Other computer networks and

their conventions predated the widespread popularization of the Internet, but in many cases they could not

interconnect. Yet as more people, data, and organizations became available over the Internet, those other

networks, such as CompuServe, found that they, too,

had to connect to it and comply with its protocols

—which for many networks meant losing their independent identity—or risk losing their subscribers.

Network effects are certainly present in the current

market for residential broadband services, but they are

probably small. Within the narrow category of

Internet-based residential communications, dial-up

access is likely to account for most of the network

gains from connecting to the Internet because most

people can already use that kind of service to send and

receive e-mail, retrieve files, and perform most other

Internet-related tasks. Another factor that is likely to

reduce any network gains specifically attributable to

residential broadband is the multiplicity of communications and broadcast networks. (For example, many

people have high-speed Internet access through work

or at school.)

Nor does the presence of network effects necessarily

mean that the market will fail to develop appropriately

without government action. The market for fax machines, which are subject to network effects, offers an

example. A single fax machine is useless. But if most

of the vendors and clients with which a firm does

business have fax machines, then it becomes a useful

business tool. Initially, fax machines were very expensive and not widely used, but once technological advances drove down their price, they quickly became

much more widespread. The federal government had

little involvement in the market for fax machines because they were largely considered the province of

businesses. Consequently, popular pressure for federal

intervention was limited.63

The fax machine market would probably have developed differently if the federal government had subsidized it, but in that event, the economy might also be

worse off today. The point that is most relevant for

this analysis is that no one can say whether the market

for fax machines would have developed any more rapidly with federal subsidies than it did without them,

especially once the distortions and inefficiencies that a

federal subsidy program would inevitably entail were

factored in. For example, federal subsidy programs

could have mandated a specific technology that subsequently became obsolete or favored particular firms

rather than technological innovators. 

Broadband’s Role in Providing Public Goods. Highspeed data transmission has become an input in the

production of several key services that have a public

good component—for example, education and public

health. Claims have been made that those services are

not produced in sufficient quantity and that wider

adoption of broadband would help compensate for

their underproduction. This analysis does not address

the question of whether certain public goods are adequately provided. Analysts would agree, however, that

subsidizing vehicles for the delivery of a public good is

less effective than directly subsidizing the provision of

the public good itself. Furthermore, the federal government typically does not subsidize other inputs to

the production of public goods—for example, pencils,

electricity, or natural gas—that are usually considered

more important to schools and health centers than are

advanced telecommunications.

62. People can be excluded from a network, but once they are part

of it, they typically have access to all other individuals in it.

63. For a discussion of network effects and the fax market, see

Nicholas Economides and Charles Himmelberg, Critical Mass

and Network Size with Application to the U.S. Fax Market, Discussion Paper No. EC-95-11 (New York: Stern School of Business, New York University, 1995), available at www.stern.nyu.

edu/networks/referenc.html. 
DOES THE RESIDENTIAL BROADBAND MARKET NEED FIXING? 27

In any case, the federal government already subsidizes

public health services and education and, more specifically, broadband access for some rural health care providers and for educational institutions. It also has

other programs that attempt to bring broadband to

rural areas. Those efforts have been justified less on the

basis of providing public goods and more on the basis

of equity. Most prominently, the Telecommunications

Act of 1996 established a program of subsidies to provide advanced telecommunications for schools and

public libraries. The program is technology neutral

—it does not mandate that the subsidies be used for

high-speed Internet access—but many if not most of

the schools who receive the subsidies are using them

for that and for related services. The subsidies are

more generous for schools and libraries in less affluent

communities in which broadband and Internet access

in general are likely to be less common than they are

in higher-income areas. The most recent farm bill also

provided loans and loan guarantees for the development of rural broadband infrastructure. (Box 4 discusses those programs.)

Entertainment-Oriented Content on the Internet

A final claim of failure on the demand side of the

broadband market is not related to the market itself

but to the content that is available over the Internet.

Ultimately, the demand for broadband is a derived

demand: consumers buy the connection so they can

communicate with others, retrieve information, or

download entertainment-oriented content. Technical

or legal limits on a consumer’s ability to access, download, and share such materials decrease the value

associated with the monthly cost of a broadband connection and, some analysts argue, in turn reduce the

demand for residential high-speed Internet access.64

The core of the argument is that the ability to directly

download movies, music, and other entertainmentoriented content will for many consumers justify the

additional money that a broadband connection entails.

Ordering a CD from an online store does not require

a high-speed connection. But downloading a movie or

a quantity of music directly is time-consuming with a

dial-up link. Much of the Internet’s content at present

is not geared to traditional popular entertainment—

aside from material that might be infringing on the

entertainment companies’ intellectual property rights.

Adding that type of content to the material currently

available, those analysts implicitly argue, might bring a

whole new audience to broadband, an audience that so

far has resisted its allure. 

That analysis has several shortcomings, the most important being that most residential consumers already

have access to a broadband conduit for entertainmentoriented content through cable and satellite television

and radio. In addition, the analysis raises technological, business, and legal issues.

# Technological Issues. Most domestic high-speed

Internet service is not fast enough to download

some types of content—for example, movies in

real time. Consequently, some method would

have to be developed to allow subscribers to

download large amounts of digital content in advance to be played back later—for example, on a

television set. Those arrangements would take

time and resources to set up and coordinate, although many of the elements currently exist.

# Business Issues. The business models in this market

are in their infancy and untested. A few of the

large media companies have just begun to sell

their content over the Internet; they had delayed

in part because of concerns about copyright infringement. Although the services that permit free

downloading of music are very popular, it is unclear how that popularity might be turned into a

stream of revenue on which a business could be

built. Recent attempts to create commercial sites

for downloading music for a fee have proved attractive to the public but are too new to be declared financially successful.65

# Legal Issues. Entertainment copyright policy and

law are in a state of flux. With the advent of each

64. Lawrence Lessig, “Who’s Holding Back Broadband?” Washington Post, January 8, 2002, p. A17.

65. Nick Wingfield and Ethan Smith, “With the Web Shaking Up

Music, A Free-for-All in Online Songs,” Wall Street Journal,

November 19, 2003, pp. A1 and A6.
28 DOES THE RESIDENTIAL BROADBAND MARKET NEED FIXING?

Box 4.

Existing Federal Programs to Promote Adoption of High-Speed Internet Access

The federal government currently subsidizes highspeed Internet access and other forms of advanced

telecommunications in many of the uses from which

public benefits are most likely to result. In a number

of instances, that translates into subsidies for broadband access to the Internet. The targets of those subsidies are schools and libraries, rural health care providers, and rural broadband providers.

Schools and Libraries

The Telecommunications Act of 1996 (Public Law

104-104) established a program of subsidies for advanced telecommunications at schools and public

libraries.1

 The cost of the program is capped at

$2.25 billion per year, but annual expenditures have

been running below that level. The program is

“technology neutral”: it does not mandate broadband connectivity, but many if not most of the

schools that receive the subsidies use them for that

purpose and for related services. The subsidies are 

1. Congressional Budget Office, Federal Subsidies of Advanced

Telecommunications for Schools, Libraries, and Health Care

Providers (January 1998).

larger for less affluent schools and communities in

which the use of broadband and the Internet in general are less common than in higher-income areas.

The portion of the subsidy program directed toward

schools continues to receive more attention from

policymakers than does the funding for libraries.

Recent evidence suggests that the schools’ component is indeed providing lower-income children

with access to computers and the Internet. According to recent Department of Education figures,

99 percent of all public schools have Internet access;

among schools in the bottommost category

(75 percent or more of a school’s students qualify

for a reduced-price lunch), 97 percent are connected

to the Internet.2

 Similarly, in 2001, 87 percent of

classrooms in all public schools were connected, up

from 51 percent in 1998.3

2. Department of Education, National Center for Education

Statistics, Internet Access in U.S. Public Schools and Classrooms: 1994-2001 (September 2002), p. 14.

3. Ibid., p. 16.

new technology, the rights and responsibilities of

both producers and consumers of intellectual property must be redefined. That process is under way.

Notably, the federal agency with the lead responsibility for broadband deployment, the FCC, has

only a marginal role in copyright policy.

The market for video cassette recorders (VCRs) offers

an instructive historical precedent as federal intervention in the residential broadband market is being considered. The VCR developed as an entertainmentoriented consumer product without a need for federal

subsidies. Entertainment copyright owners fought

against consumers being allowed to use VCRs, but the

federal government did nothing to promote the technology other than by its adjudicating the balance of

rights between copyright holders and consumers.66 Yet

once the limits to the copyright holders’ rights were

delineated, new consumer services—for example,

video sales and rentals—developed rapidly without

further federal intervention. Movie studios made more

of their material available and lowered prices. And revenues in the movie industry rose dramatically.

66. James Lardner, Fast Forward: Hollywood, The Japanese, and the

VCR Wars (New York: W.W. Norton & Company, 1987).
DOES THE RESIDENTIAL BROADBAND MARKET NEED FIXING? 29

Box 4.

Continued

Rural Health Care Providers

The portion of the federal subsidy program directed

toward nonprofit rural health care providers cannot

claim as much success as the schools’ component.

Rural health care providers are not making full use

of the subsidies that are currently available. In 2001,

the program provided telecommunications subsidies

to fewer than 800 nonprofit health care providers.

(In the first three years of the program, it distributed

only $13 million in subsidies.)4

 The low level of utilization of the program has spurred the Federal

Communications Commission (FCC) to begin regulatory proceedings to change it and make it more

responsive to the rural providers’ needs.

Rural Broadband Providers

Title VI of the Farm Security and Rural Investment

Act of 2002 (Public Law 107-171) authorized

$20 million a year for four years to provide loans

and loan guarantees to rural telecommunications 

4. See the 2001 annual report of the Universal Service Administrative Company (the organization that administers the

universal service programs), available at www.universal

service.org/reports/2001/.

companies to encourage them to offer broadband

service in rural areas. However, to date, subsequent

appropriation laws have prevented the Rural Utilities Service (the federal agency in charge of the Department of Agriculture’s rural telecommunications

subsidies) from making any loans or providing loan

guarantees to build, acquire, or improve broadband

facilities in eligible communities.

Yet even without that program, rural telecommunications companies have been rapidly increasing their

broadband offerings. In a 2001 survey, the National Exchange Carriers Association (an association,

mandated by the FCC, of 1,100 mainly small and

rural local telephone companies) found that more

and more of their members were providing digital

subscriber line (DSL) service. In 1999, only 151 of

the member companies surveyed offered DSL service. But by 2001, 557 companies offered it, and

another 66 planned to do so soon, an increase of

269 percent in two years.5

5. National Exchange Carriers Association, Paving the Digital

Highway: NECA 2001 Access Market Survey (Whippany,

N.J.: NECA, 2001), available at www.neca.org.

Conclusions

Rapid diffusion of high-speed access to the Internet

for households and small businesses will unleash a

whole series of benefits for consumers and for the national economy, proponents often argue. A recent

study tried to quantify some of the more palpable benefits and found that by 2025, universal broadband deployment could provide the nation with roughly

$300 billion to $500 billion of new consumer benefits

annually.67 The central issue for this analysis is not the

magnitude of those benefits but whether there is reason to believe that the market will be unable to realize

them without the federal government’s intervention.

Over the next 25 years, consumers are likely to be

better off not only because of the spread of residential

broadband but also because of advances in a wide

range of products, including automobiles and computers, and in old as well as new technologies. If the

67. See Robert Crandall and Charles Jackson, The $500 Billion

Opportunity: The Potential Economic Benefit of Widespread Diffusion of Broadband Internet Access (Washington, D.C.: Criterion Economics, July 2001), available at www.criterion

economics.com/documents/Crandall_Jackson_500_ Billion_

Opportunity_July_2001.pdf. Many of the benefits would be

reflected in increases in gross domestic product (GDP), but in

other instances, the increases in consumer welfare (through, for

example, reduced shopping time) would not trigger a parallel

increase in GDP.
30 DOES THE RESIDENTIAL BROADBAND MARKET NEED FIXING?

government subsidized broadband service to increase

consumers’ welfare, it would encourage households

and small businesses to buy more high-speed Internet

access than they would otherwise have purchased, substituting the benefits of broadband for those that

might be enjoyed by consuming other goods or services. Yet if the market for broadband is working tolerably well, as CBO’s analysis concludes, it is likely

that consumer demand and market developments

—uninfluenced by subsidies—will draw resources toward the production of a bundle of goods and services

that will grant an even higher level of well-being. The

losses of welfare that are likely to result if the government intervenes are a real cost of broadband subsidies

as are the direct spending or tax benefits that some

advocates of intervention claim are justified by failures

in the broadband market.

The personal computer (PC) has provided the type of

benefits to the economy that proponents of residential

broadband hope it will provide in the future. PCs

have diffused throughout the economy over the past

25 years, fundamentally changing the way business is

conducted (as well as other aspects of economic life)

and creating broad new benefits for consumers. Yet

outside of funds for public schools and other areas of

clearly defined public interest, the federal government

has provided no subsidies for the technology’s diffusion.68 Indeed, in circumstances similar to those facing

the broadband market today, PC technology changed

so rapidly that it might have been difficult for any federal subsidy program to keep up with new developments. As a result, such a program could easily have

distorted the incentives prevailing in the marketplace

and ultimately slowed the pace of technological advances.

The market for high-speed Internet access for households and small businesses has only a small number of

competitors and a tendency toward duopoly, yet it

does not currently appear to need “fixing.” Consumers’ preferences and income and the economic cost of

providing the service largely hold sway and determine

the number of broadband subscribers and the amount

that they pay for service. The number of broadband

customers is growing at a rapid pace, and current providers face the prospect of new broadband market entrants and other competitive pressures from converging telecommunications markets. Many of the problems that remain, such as uneven distribution and

availability of broadband, are a function of the market’s immaturity and not necessarily permanent features. 

68. The federal government has provided some subsidies for the

research and development underlying the personal computer,

both through the tax code and through grants to computer

scientists at universities. Those existing federal subsidies fund

research for the development of broadband as well. See National Research Council, Funding a Revolution: Government

Support for Computing Research (Washington, D.C.: National

Academy Press, 1999).



This publication and others by CBO

are available at the agency's Web site:

www.cbo.gov