Sunk Costs: A Cautionary Tale

How the FCC wasted $45 billion on rural “broadband” and what the current FCC/Congress/Administration should have learned.

Sunk costs, as an economics concept, is easy to understand. It’s an economist’s way of counseling others about regret. In short, don’t make future decisions to rationalize past mistakes. Yet, leaders in Congress, the FCC and the Biden Administration are preparing to repeat the mistakes of the past, justifying the same programs and using the same tools and processes that caused the digital divide in the first place. Before spending an additional $100 billion of public money on rural broadband, avoiding the mistakes of the past decade would be a good place to start.

Lesson Number 1: The digital divide was not a consequence of rural economics; it has been the policy of the federal government.

First, a little history. In 1996, Congress adopted a sweeping overhaul of federal telecommunications laws and established competition as the overriding principle of federal policy. Except in rural America, where Congress established incumbent protection as federal policy at service levels comparatively lower than those available in competitive areas.

In 2010, following the publication of the National Broadband Plan (NBP), the FCC established the broadband digital divide as federal policy. For the nation, the FCC set a goal it believed would be achieved without any government intervention: 100 Mbps speeds to 100 million homes by 2020. With respect to rural areas, the NBP recommended the FCC pursue policies to make available 4 Mbps downstream and 1 Mbps upstream by 2020. The FCC then budgeted, collected and spent $45 billion over ten years to achieve the goal of 4/1 Mbps in rural America.

By establishing low, soft targets, the FCC took an incremental approach, which both was costly and left the nation unprepared for COVID-19. Yet, Congress, the FCC, state governments and the Administration are taking the same rear-view mirror approach once again. The government is again defining broadband as a speed, and a speed that is already slower than the services widely available in the marketplace.

Broadband is not simply a speed at a point in time. Rather than focus on a short-term goal of attaining any particular speed, public funding is better spent on long-term infrastructure, best defined as assets with a life of at least thirty years.

Lesson Number 2: Restricting funding to incumbents is a good way to protect incumbents and a bad way to do anything else.

In public policy, incumbent protection goes by the simplistic catchphrase: no overbuilding. There are already companies providing internet access or receiving public funds, so the argument goes, and it would be wasteful to spend public money on two companies in the same geographic areas.

In 2011, the implementation of the FCC’s broadband plan started by dividing the country into geographic areas based on the type of regulation of the telephone company that had historically served the area: Price Cap and Rate of Return carriers.

Price Cap telephone companies were given a Right of First Refusal (ROFR) for funding of $1.8 billion per year to improve their networks to make 4/1 Mbps available to 99% of their service territories. (The remaining 1% were to be left even further behind as a matter of FCC budgeting.) If a telephone company turned down the ROFR, funding would be held for a future auction of funds. And, following the ROFR period, the FCC was to establish a competitive bidding mechanism, an auction, for funding to further improve the networks.

The Rate of Return telephone companies would never face competitive pressures for their funding. Instead, the FCC decided to use $2.2 billion of annual funding to encourage such companies to improve their networks. Eventually, the FCC made an offer to the Rate of Return carriers that was far more generous than the offer to Price Cap carriers to provide a combination of 4/1, 10/1 and 25/3 Mbps. The $2.2 billion annual expenditure has never been part of the auctions of funds.

In addition, Competitive Eligible Telecommunication Carriers (CETCs), which is a closed group consisting mostly of mobile operators who applied for funding twenty years ago, would continue to receive over $500 million based on the cost of copper network telephone service in rural areas in the 1990s. Those funds would be doled out to AT&T, T-Mobile, and many small cellular operators until the establishment of an auction for funding to improve rural mobile service. After an experiment called the Mobility Fund 1 auction, no such large-scale national auction has occurred, and the spending continues in a way that is obviously unrelated to the provision of mobile service in rural areas.

Public funding should be open to competition. More important, government policy should be designed to promote competition in high-cost areas even after networks are built. The best way to do so would be through the provision of portable consumer-based subsidies.

Lesson Number 3: Proprietary tools and decisions by two or three people should not be the basis to determine how public funding will be spent across the nation. It’s time to open up the mapping, modeling and funding mechanism to the public.

Over the past decade, the FCC has devoted considerable time and resources to develop three key tools to be used for broadband policy: the National Broadband Map, the Connect America Cost Model (and its close cousin, the Alternative Connect America Model), and a reverse auction mechanism for assigning funds in rural high-cost areas.

The FCC staff work on these three tools has been superb. Unfortunately, a series of poor decisions by FCC Chairmen undermined some of the best work done anywhere on broadband.

The National Broadband Map: The American Reinvestment and Recovery Act funded the creation of a National Broadband Map. The work was divided between NTIA and the FCC, with NTIA administering a program to work with states to collect data (called the State Broadband Initiative) and the FCC producing the map itself. Later, when the SBI funding well ran dry, NTIA handed everything over to the FCC, which used the only data it had at its disposal, the 477 data submitted by internet service providers every six months. It has been common to criticize the FCC for relying on self-reported data but credit the FCC for keeping the map running when the funding stopped.

The Connect America Cost Model: When the FCC needed to calculate the cost of building, maintaining and operating a broadband network, it decided that the basis for the costs would be a greenfield fiber-to-the-premise Gigabit Passive Optical Network. It then worked with a company called CostQuest to model the cost of a fiber network built to every rural home and small business. The FCC chose this type of network over copper, over hybrid fiber coax, over fixed and mobile wireless, and over satellite networks. The reason then is the same as it would be today: a fiber network is the best long-term investment of public or private money if the goal to meet the needs of consumers today and for decades to come. The fact that the FCC uses funding based on fiber construction for other transmission media, including copper, coax, and spectrum, is an error made by those policymakers who can’t distinguish between spending and investment.

The CAF II and RDOF auction mechanisms: The FCC’s work on auctions generally is world renowned, and the broadband reverse auctions, like the spectrum auctions, were groundbreaking as matters of government policy. It is surprising that the Commission made such amateurish mistakes, ones that despoiled the otherwise novel, extraordinary work by the FCC auction staff. The mistakes were in both auction design and implementation. First, treating different transmission media with different capabilities as if they were functionally equivalent is not a technologically neutral decision; it is a technologically and economically ignorant decision. Second, vetting bidders before the auction is more important than vetting after the auction. The essence of a winning bidder’s obligation is to build networks. To treat all manner of companies as if they were capable of managing multi-billion construction projects was a grave vetting mistake. Rural areas will pay dearly for these mistakes for years to come.

The country should not rely on one agency’s mapping, modeling or auction processes. We believe there should be an open, public system for broadband mapping, high-cost modeling and auction design.

If anyone would like to join us in establishing an open source process for mapping, modeling and funding decisions, let us know.