HELLERSTEIN TELECOM & TECHNOLOGY REVIEW- March 8, 1999- Insight on AOL's Broadband Future

Welcome to the second issue of 1999 of the HELLERSTEIN TELECOM & TECHNOLOGY REVIEW, amonthly free newsletter covering significant industry and regulatory developments in the telecommunications andtechnology industries. We have changed the newsletter's name to better reflect the stories and topics that will becovered this year. The newsletter is published by Hellerstein & Associates, a telecommunications and technologyresearch group that provides its clients with a competitive edge through market research, competitive intelligence,and regulatory analysis.

NOTE: The Hellerstein & Associates Website is located at www.jhellerstein.com. Please keep the suggestionscoming and send all comments or suggestions to Judith Hellerstein at Judith@jhellerstein.com.

This issue will focus on some of the insight gained at the Federal Communications Bar Association's CommonCarrier Practice Committee held on March 3, 1999. George Vradenburg, Senior Vice President and GeneralCounsel of America Online spoke about AOL's broadband future.


Vradenburg began by discussing how the Internet has changed the way people work, live, learn, andplay--connecting everyone to everything. It has created new opportunities for businesses, countrieS, and people byleveling the playing field for everyone. Hellerstein & Associates has written often about how the Internet economyis redefining how people do business, how they communicate, how they shop, and how they learn on a globalbasis. The Web and the Internet continue to change the face of retail, from financing and insurance to clothing.

As the Internet market continues to explode, demand for greater bandwidth and faster connection speeds has led toseveral technological approaches developed to provide broadband access to all consumers. Vradenburg stated that AOL wants to make marketing arrangements both with cable and wireless providers. He stated that he thought both DSL and Cable modem were unproven technologies and come with a whole host of problems revolving aroundcosts, provisioning, scaleability, and even technology. AOL's primary goal is to leverage its market share to deliver broadband technologies that are reasonably and affordable priced. Cable and DSL technologies are thusthe only two technologies that meet these goals. He contended that no wireless consumer technology in use today currently approaches these goals.

Since AOL introduced its flat rate pricing, usage on its network has grown exponentially, from 15 minutes a month to over 60 minutes. Vradenburg expects this usage to continue to grow exponentially, but would be stymied by certain policy decisions, such as the FCC's most recent decision on reciprocal compensation and its 706 report to Congress.

Vradenburg stated that he was extremely concerned that the FCC's recent decision on reciprocal compensationmight open the door to per minute access charges on ISPs. He stated that per-minute charges will result in lessusage of the internet, rather than in more usage. One only has to look to Europe to see the effect of per-minutecharges on the growth of Internet. Internet usage in Europe is way behind the US precisely because of access beingcharged by the minute. AOL's network usage is also low, only 10-15 minutes a month compared to over 60 minutes a month for the US. Hellerstein & Associates agrees that it is imperative that Internet remain free of regulation and allowed to grow at the same hyper growth it has been. It is not only the future of the Internet that isat stake, but also the future of electronic commerce and its ability to spur US economic growth.

In the past five years, information technology (IT) has been responsible for more than one quarter of real economicgrowth, creating some 15 million new jobs (more than 25% of all new jobs created) and resulting in the lowestunemployment in the past 24 years. At the same time, IT industries have helped keep inflation down, to the lowestit has been in 30 years. It is also why the US is one of the few countries that has managed to escape the economicproblems that have ravaged Asia and some European countries.

Vradenburg also criticized the FCC for its recent 706 inquiry decision not to take any action in speeding up thedevelopment of the broadband access network, chiding the FCC for its inability to exercise policy leadership. Instead of working with industry, think tanks and others to come upwith a new framework, the FCC's inaction is troubling. Hellerstein & Associates also believes that the FCC's recentadvanced services decision was faulty. The decision left more questions unaswered than answered, especiallywhen it used comparisons that do not seem to make much sense, such as comparing the growth of black & whiteand color TV and cellular to the development of broadband. Cellular grew slowly not because of lack of infrastructure or consumer demand, but because of failed regulatory policies that created a duopoly. A more correctanalogy would be to look at the growth of PCS. Since the FCC began auctioning off PCS licenses, competitionamong differing providers of wireless services has increased significantly. Competition has lead to lower prices,high usage, and increased innovation. It is this market that the FCC should have compared broadband access to. Under this benchmark, perhaps the FCC Commissioners would have come to different conclusions about the state ofbroadband deployments.

Vradenburg is right when he calls for the FCC to work with industry to create a new regulatory framework for thisnew Internet dominated economy, but instead of following his own advice, AOL has engaged in sparing matchwith local and state regulators, other industry players and even the FCC. It is this highly charged duel that has increased the political stakes and thus made it harder and harder for the FCC to craft new policies. Hellerstein & Associates believe that it was this political indecision and pressure that led to the FCC's do-nothing response in its Advanced Services inquiry.

The inability to agree on a new framework is why policy decisions will be more important to AOL's future success,than technology decisions. Vradenburg talked about the importance of all industry players to agree to some internalmonitoring of privacy and security of personal information. Vradenburg stated that one of AOL's biggest issue isfinding a way to gain the trust and confidence of its subscribers, government regulators and officials at all levels, ofits new standards and policies adopted to guarantee the security and privacy of information collected.

Vradenburgstated that until industry can come together and craft strong privacy policies, regulatory authorities will likely beforced to take action, just as European regulators and other government officials felt compelled to do so. Anyregulatory or government action will have a deleterious effect on the Internet industry.


On the issue of cable unbundling Vradenburg stated that AOL was not asking the Commission to treat cableoperators as common carriers, nor to impose Title 2 obligations or regulations on cable operators. In fact, AOLwould like to see cable operators retain their Title 6 status. AOL is asking for non-discriminatory access to theexisting broadband cable infrastructure on a competition policy framework.

We found Vradenburg's comments on the type of agreement AOL would like to make with the Cable MSOs mostinteresting. Vradenburg stated that AOL would like to offer the same deal to cable operators that @Home offers,eg., cable operators would receive two-thirds of all revenue from @Home subscribers, with @Home keeping onethird. Vradenburg argued that AOL's entrance into this broadband cable marketplace would not alter the incentivesthe cable operators created when they started @Home, as these incentives would still be there. Moreover, Vradenburg stated that AOL would just be opening up the field even more, as there will now be two playerscompeting for subscribers rather than one, effectively speeding up the time period needed to fully reimburse Cable MSOs for their infrastructure costs. Vradenburg stated that he felt that what concerned the cable operators most wasthe Cable MSO's desire to control the growth of broadband access and to control how they scaled their networks.Vradenburg stated that the cable operators appeared to be fearful of opening their networks up to what Vradenburgcalled the "uncontrollable hyper-growth" of the Internet.


When asked when AOL would be announcing more DSL deals with other ILECs, Vradenburg answered that AOLwas in discussions with many of the large providers of phone service. Vradenburg stated that AOL's strategy is tofirst make deals with larger phone and cable companies, before talking to any smaller phone companies.Vradenburg stated that the larger providers would allow AOL to significantly increase its footprint and operationalarea; the smaller companies do not have this capability.

Moreover, Vradenburg felt that many companies were waiting to see how the cable unbundling issue would besettled. Vradenburg hinted that some ILECs were seriously considering creating a similar setup in their companiesas the cable MSOs created with @Home, in hope of capturing more of the broadband revenue. Many of thesecompanies had created similar companies modelled on @Home previously, such as TeleTV and Americast andthese have all failed and thus many people involved in these discussions remain hesitant about making anotherattempt. Vradenburg stated that until other ILECs, beside Bell Atlantic, finalize their DSL business models andchoose their strategic partners, no new deals will be forthcoming.

On the Bell Atlantic deal, Vradenburg stated that AOL would be responsible for all marketing, sales, and customersupport issues and problems. He also stated that AOL would create consumer customer service standards that itpromised to meet and also would have a series of performance measures and standards that it expected Bell Atlanticto meet. Although Vradenburg did not state what type of penalties would be meted out if Bell Atlantic did not meetits performance goals, Hellerstein & Associates believes that AOL would likely impose some type of penalties onBell Atlantic and its enforcement of these measures is likely to be swift, both because it is AOL's brand name onthe line and also since consumers have low tolerance for any AOL problems. As we saw with AOL's previouscustomer service problems, AOL's size and past problems make it an easy target for media and consumer advocatesresulting in AOL's actions being watched closely by various governmental consumer protection agencies.

Hellerstein & Associates is interested in learning what its readers think of these issues. Please send all commentsdirectly to Judith Hellerstein at Judith@jhellerstein.com . If you would like more information on this topic please e-mail Judith Hellerstein at Judith@jhellerstein.com.

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