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March|April 2004
How I Lost the Big One By Lawrence Lessig
The White Wall By Stephanie Mencimer
Call Forwarding By Nicholas Thompson
Down With Discretion By Michael S. Gerber

Call Forwarding

A new technology allows consumers to make cheap, clear phone calls over the Internet. Will the FCC allow it to flourish?

By Nicholas Thompson

WHEN ALEXANDER GRAHAM BELL transmitted his voice over 100 yards of wire in the first public demonstration of the telephone in 1876, the Brazilian emperor Dom Pedro II exclaimed, "My God, it talks." The invention demonstrated a truth articulated by the sci-fi master Arthur C. Clarke almost a century later: "Any sufficiently advanced technology is indistinguishable from magic."

Since then, advances in telephone technology have been useful but unspectacular. But now it's again time for something worthy of Dom Pedro's exclamation. Thanks to a rapidly growing technology called Voice over Internet Protocol (VoIP), if the regulators get the regulations right, we could rid ourselves of the need for telephone poles and $80 monthly phone bills within a few years. Making a call would cost no more than sending an e-mail.

To understand why, start with the premise that sounds and letters are no different from a computer's perspective; both are transformed into strings of ones and zeros. Sending a three-megabyte photo to a friend employs about as many ones and zeros as chatting with him for five minutes.

The current price difference between traditional phone calls and e-mails comes down to the ways that they are transported. The phone call travels over what's called a circuit. Whenever you call someone, a line must open that directly connects only the two of you and is closed to all information except your voices. On the Internet, the e-mail splits into many different packets, each of which zips to the final destination over the fastest available routes before being reassembled at the end. Phone calls initially have to cross over slow copper wires and are taxed at several steps along their journey. The e-mail travels entirely over fiber and isn't taxed at all.

Picture two families aiming to get from New York to San Francisco. The members of the first have to trudge a few blocks to a nearby street corner. Then they all climb on a bus headed across the country over a heavily taxed highway. Unfortunately, although the road is clear of other traffic, the bus can't reroute when it runs into a Utah snowstorm and slows to a crawl. The family reaches its destination with everyone in one piece, but tired and bedraggled.

The second family slips out of the apartment door directly onto a high-speed train. Everybody rides swiftly across the country, dodging toll booths, and never worrying about the Utah snowstorm because the train has already split up into different parts, with one daughter zooming through Arizona's deserts, and another through a clear pass open in the northern Rockies. When the family hits San Francisco, everyone reunites, feeling crisp and relaxed.

Five years ago, phone traffic couldn't travel smoothly over the faster network, as its "train cars" would crash or derail. The VoIP users back in 1999 sounded as if they'd stuffed their mouths full of cotton candy. But engineers and improved network infrastructure have solved the cotton-candy problem, and anyone with a high-speed Internet connection can now use VoIP. With broadband, VoIP now sounds exactly the same as talking over the phone network.

Not surprisingly, VoIP seems likely to start booming soon, and many large telephone companies have committed themselves to future VoIP use. MCI, for example, has said that it expects to be using the technology exclusively by 2005. In addition, hardware companies like Cisco have started doing brisk business in helping offices revamp their internal phone systems with VoIP. Cable Internet providers, most prominently Time Warner Cable, have announced that they will use the Internet to offer residential phone service in addition to cable television and straight Internet connections.

In addition, a few startups, led by a New Jersey company named Vonage, allow residential users to route their calls from their normal phones through their computers to anybody else's phone worldwide. This makes the service nearly identical to traditional phone service, except that unlimited local and domestic long-distance service costs only $34.95 a month. Several online companies allow users who have downloaded specific software to use headsets to freely call fellow downloaders. The most successful is Stockholm-based Skype, a company whose software has been downloaded more than six million times since last August.

All of this action has created turmoil, and the Federal Communications Commission will soon have to lay down rules that will govern the American VoIP market. If the FCC chooses the right approach, our phone prices will plummet, and many consumers will feel as if they've just pulled rabbits out of their hats.

The core question for the FCC is whether to classify VoIP as an "information service" or as a "telecommunications service." If the FCC picks the former, VoIP will fall under what is known as Title One of the 1996 Telecommunications Act, which will make VoIP essentially regulation-free, much like other Internet content. If the FCC chooses the latter, the government will regulate VoIP under Title Two and the mountain of regulations piled on the telephone industry over the past century.

The choice is stark, but not simple. The two definitions are derived from the categories of "basic" and "enhanced" service in the 1934 Telecommunications Act, which created the FCC. A basic, or telecommunications, service is a direct exchange over a single line. An enhanced, or information, service is something that the company has added to or manipulated. The FCC classifies a standard telephone call as a telecommunications service; Internet access and voice mail are information services.

The strongest argument for regulating VoIP as a telecommunications service is that if VoIP looks like a phone, acts like a phone, and sounds like a phone, then it is a phone. The Minnesota Public Utilities Commission used this logic when it ruled last August that Vonage, which advertises itself as "the broadband phone company," should be considered a telecommunications service and thus subject to state regulations and fees.

But VoIP can go well beyond regular phones because of the technology's direct connection to the Internet. Many VoIP services include the ability to send text or graphical messages at the same time. Soon, people could be leaving each other "video mail" messages, instead of just voice mail. VoIP is also used in ways that don't at all resemble traditional phone uses. Players of the video game Dungeon Siege, for example, can communicate orally with each other through VoIP while facing the villains in the kingdom of Ehb.

As a Minnesota federal trial court ruled last October while overturning the state utilities commission, Congress intended in the 1996 act to leave Internet-dependent technologies alone in order to spur new technology. According to the court, "state regulation would effectively decimate Congress's mandate that the Internet remain unfettered by regulation."

ON DECEMBER 1, THE FCC BEGAN FORMAL DELIBERATIONS about the matter with a public hearing in Washington, a process it is now replicating nationwide. The hearing room of the FCC headquarters was packed that day, and the consensus among the panelists seemed clear. Of the 20 people who testified, 19 expressed a desire for the commission to keep its distance. Michael Powell, the commission's current chairman and a Bush favorite, introduced the hearing like this: "We should come to this forum with a sense of regulatory humility, mindful that it is entrepreneurs, not governments, who came up with the idea of making high-quality, inexpensive phone calls over the Internet."

Like Powell, many technology-savvy people take it as dogma that the Internet will thrive only in the absence of regulation—a view built up largely in the early 1990s, as Internet use in the United States soared ahead of the rest of the world, in part because the Clinton Administration and Congress set a clear policy of minimal regulation.

But this policy had a central flaw: A lack of government regulation and enforcement can create a vacuum in which the biggest players set the rules. Early in the Bush Administration, for example, the FCC refrained from enforcing a key requirement of the 1996 act stating that the four regional phone companies, or Baby Bells, which control all the copper phone lines running into people's homes, must lease those lines to competitors. Upstart DSL companies had laid millions of miles of fiber-optic cable. But to reach customers they needed access to the "last mile" of copper lines. According to most experts, the Baby Bells stonewalled with almost no consequences from the FCC, helping to drive the upstarts into bankruptcy.

A similar situation could occur with VoIP. The Net offers nearly infinite options when it comes to the content on your screen. Anyone online has access to at least 10 newspapers from Zambia. But there are far fewer options when it comes to the companies that provide the pipes bringing in that information. Most people have only two choices for high-speed broadband access: the local bell's DSL or the cable from the local cable company. Very few markets have competing DSL or cable providers, and only 1.6 percent of broadband users get access through satellites.

This effective duopoly has helped keep broadband prices high (around $50 a month) and use low. Only 15 percent of residences have broadband access. It also creates the condition for a potentially significant problem. If Time Warner Cable, or Verizon, wanted customers to use only its VoIP service, the company might block users from accessing Skype or Vonage, or it could make the cotton-candy problem return for users of competing services.

This issue has arisen several times in the past, with the principle at stake often called "network neutrality." After AT&T purchased cable broadband pipes in 1999, a senior executive there named Daniel Somers raised the specter of blocking customers from watching video transmitted over the web, which would have competed with cable television. AT&T did not spend $56 billion on a cable network "to have the blood sucked out of our veins," he said.

Still, the threat of purely punitive blocking remains largely speculative, partly because a company doing so would face a public backlash. AT&T Broadband, which merged with Comcast in 2002, hasn't blocked streaming video yet, and no broadband companies currently block users from VoIP.

IF THE QUESTIONS ASKED BY COMMISSIONERS at the December hearing are any indication, the FCC's prime regulatory concern is that untaxed VoIP calls could seriously deplete the $5 billion of annual subsidies called "universal service." Since the New Deal, the federal government has heavily taxed urban telephone users to promote the deployment of phones in rural America. Without the fund, much of North Dakota wouldn't have affordable phone access—and untaxed VoIP could seriously deplete the fund. That would be bad for the folks on the Great Plains and for anyone who wants to call them.

In addition, over the century and a quarter that phones have been in use, they have come to play a critical role in America's law enforcement. People in trouble dial 911 on a phone and the local police station quickly determines their location. But VoIP allows a user in a Bangkok hotel to make a call that originates from his home phone number. Compounding this challenge, VoIP is hard to wiretap. The FBI could tap into any long-distance circuit. It's much harder to intercept packets.

Fortunately for those who hope for limited regulation, these issues are solvable without classifying VoIP as a telecommunications service. For universal service, the government could compensate for the fees lost because of untaxed VoIP calls from another part of the budget. Or it could transfer the subsidies that maintain rural telephone use into a program that subsidizes rural broadband use, giving North Dakotans access to VoIP along with the rest of the Net.

With the 911 issue, companies may be induced to solve the problem if enough people refrain from signing up for VoIP because the fire department won't know where they're calling from when they dial in to say their house is up in flames. Right now, for example, Vonage allows users to enter their home address on its website, relaying that information to the police when a 911 call is made. The FBI's difficulty in wiretapping is a real problem, but no bigger than the bureau's difficulties in tracking e-mail.

Under the Bush Administration, major FCC decisions have generally boiled down to fights between big guys and small guys, with Chairman Michael Powell and the commission's majority siding with the big ones. He has refused to force big cable companies to open their lines to little ones and has allowed big DSL companies to flummox their smaller competitors. He has successfully supported media conglomeration on several occasions, including last summer, when he relaxed FCC restrictions on broadcasting companies and newspapers and permitted them to move into new markets and expand where they already operate. Put charitably, his decisions are guided by an ideological belief that markets work best when a few big players battle it out themselves. A cynic would say that each of his choices has benefited large donors to the Republican Party.

Either way, with VoIP, the big telecommunications players might seem apt to favor strong regulation. Small VoIP companies like Vonage are currently very lightly taxed. Imposing some regulations or taxes on VoIP could harm Vonage and its peers, perhaps driving them out of the market and benefiting their larger competitors.

But the Verizons of the world seem unconcerned by small VoIP companies. They see most of their profits coming from offering many integrated services—cell phones, Internet, VoIP, and more—and they fear that slowing the U.S. VoIP market could slow their own growth, while perhaps even helping foreign firms such as Skype. Vonage, right now, doesn't need to be squished.

The law, the politics, and the organizational biases of the FCC all suggest that the commission should, and will, only minimally regulate VoIP. There will be a few law enforcement and universal-service caveats, but probably nothing explicitly preventing the big DSL and cable incumbents from thwarting their smaller competitors. That's worrisome, but still a better result than the FCC's subjecting VoIP to a battery of archaic regulations. For people who have broadband, VoIP will boom—and resemble magic.

Nicholas Thompson is a senior editor at Legal Affairs.

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