Dueling Fools

Dueling Fools
June 23, 1999

Open Access:
AOL v. Excite@Home

Open Access Bull Argument
by Louis Corrigan (tmfseymor@aol.com)

"Open Access" is the catch phrase used to describe a complicated quasi-legal, quasi-PR battle that's recently rocked the shares of America Online (NYSE: AOL) and its would-be rival Excite@Home (Nasdaq: ATHM). I assume we're all pretty familiar with AOL, the leading Internet service provider (ISP), with over 17 million monthly U.S. subscribers. For those who don't know Excite@Home, it's a joint Internet portal/broadband cable modem access company that's controlled by AT&T (NYSE: T) and partly owned by most of the major U.S. cable companies.

The Open Access dispute comes down to something simple: When you finally get the opportunity to sign up for high-speed Internet access via a cable modem, do you want to have to pay an unnecessary toll to @Home? More concretely, should you be able to make one payment to AOL (or whoever your ISP is), or should you be required to make two ultimately more costly payments (one to @Home and one to your ISP) to get faster access to your current service plus unwanted access to @Home?

I choose door #1, which is not just the best solution but the most likely outcome of the currently raging debate. Actually, my argument is necessarily multi-tiered.

First: Option one clearly serves consumers best because it means we'll all pay just a little bit more rather than a whole lot more to enjoy our currently comfortable Internet experience at much faster speeds. It also means we won't have to pay for a service we don't want and won't use.

Second: A crucial June 3 ruling by the U.S. District Court in Oregon concluded that local governments, which control the granting and renewing of cable franchises, do have the right to require cable operators to open door #1. That's because local governments can protect competition.

Specifically, the Portland case pitted AT&T and its newly acquired Tele-Communications Inc. (TCI) cable systems against the City of Portland and related defendants such as U.S. West (NYSE: USW), GTE (NYSE: GTE), and the Oregon Internet Service Provider Association. AT&T needed Portland's government to approve its acquisition of TCI's systems. On December 17 of last year, Portland said fine, but... AT&T must agree to offer "nondiscriminatory access" to its cable customers to all Internet providers, not just @Home. That is, AT&T shouldn't expect to use its local cable monopoly to turn @Home into a cable Internet access monopoly.

Concretely, cable companies operate their transmission equipment at what's called a "headend." A company like @Home connects its private interstate network to a local cable system at this headend, thus allowing cable subscribers to reach the World Wide Web. The City of Portland simply said that AT&T needed to let other ISPs install their transmission equipment at the headend, too. In turn, the ISPs would pay AT&T a fair price for that access.

"No way," said AT&T. So on December 29, Portland rejected the transfer of control. That left the folks at AT&T foaming at the mouth. Annoyed, they took the city of Portland to court, charging that federal statutes preempt such local regulation of cable; that the decision violated AT&T's First Amendment rights by forcing its cable system to broadcast content it didn't want to broadcast; that Open Access imposed an excessive burden on interstate commerce; and that the ruling violated something called a "contract clause."

"No, no, no, and no," said Judge Owen Panner, in his June 3 ruling.

Judge Panner agreed that Portland could regulate AT&T's local cable platform as an "essential facility," meaning something "that competitors can't duplicate and that is otherwise unavailable." And according to antitrust law, a "business that controls such an essential facility may not exclude competitors without a 'legitimate business reason for the refusal.'"

AT&T contested the point by asserting that federal law prevents a cable system from being regulated as a "common carrier," defined as a service of a "quasi-public character." Judge Panner said that argument was irrelevant since "[r]equiring that a business allow its competitors access to an essential facility is not the same as regulating that business as a common carrier."

Third: Regardless of what happens with the Open Access legal battle, AOL and (other ISPs involved in the openNET coalition) will win the war.

AT&T's general counsel Jim Cicconi has said he has "zero expectations that the [court] decision will stand." The company has already filed an appeal.

Moreover, Federal Communications Commission (FCC) Chairman William Kennard recently said there would be "chaos" if every local regulator could impose their own rules for Internet access via cable. "It is in the national interest that we have a national broadband policy," Kennard told a convention of cable execs last week. The FCC reportedly would like to get local government regulators out of cable's way while staying out of the way itself.

At the same time, though, the FCC clearly wants cable operators to act reasonably. Thus far, cable operators have refused to do so, arguing, for instance, that it's technically difficult if not impossible for multiple ISPs to provide Internet access over the same lines. A test last week at GTE's cable system in Clearwater, Florida, revealed that routers equipped with special software permit a cable system to handle multiple ISPs no problem.

AT&T may win on appeal or the FCC may bail it out. Still, it makes sense for AOL -- and other ISPs such as EarthLink (Nasdaq: ELNK) and MindSpring (Nasdaq: MSPG) -- to lobby for Open Access because the lobbying will educate lawmakers and consumers about the issue. Once educated, both groups ought to be so supportive of AOL's position that AT&T and other major cable operators will be forced to negotiate reasonable broadband access terms. And that benefits consumers by optimizing options and keeping monthly charges down.

Fourth: Although cable operators, particularly AT&T, have a financial stake in @Home's success, they're stupid to alienate America Online or its millions of customers.

The fact is, cable companies want to offer digital TV, local and long-distance telephony, and high-speed data transmission, but consumers will be able to get all three from other parties. Providers of digital broadcast satellite, like Hughes Electronics' (NYSE: GMH) DirecTV, will soon be able to provide local programs, allowing them to compete better with cable. Plus, the Baby Bells are rolling out Digital Subscriber Line (DSL) high-speed Net access. And long-distance is cheap and getting cheaper with the build-out of competitive digital networks that offer quality telephony via Internet-style packet transmission. Plus, wireless satellite access to the Internet will eventually offer another option.

In other words, "connectivity" can be taken for granted. The "pipes" are really something of a commodity. That means AOL's millions of customers are the real asset here. Let's say BellSouth (NYSE: BLS) does a deal with AOL and satellite TV (both possible): Why do I even need cable then? Let's say MediaOne (NYSE: UMG) does deals with AOL for Internet access and AT&T for long-distance. Then why do I need BellSouth? I'm a customer up for grabs, and an increasingly valuable customer at that. The best way for a telephone or cable company to grab me is to give me high-speed Internet access first and sell it to me in partnership with AOL. Companies that fail to do that won't just lose the added revenue streams from selling me additional services; they may lose all my business.

What does all this mean for Excite@Home? I'm not sure, but it doesn't seem good. Still, I'm dying to hear Bill's argument.

Next: The Bear Argument