From Herding Sheep to Herding Cats: Balancing Compliance and Innovation in the Modular Age of the Internet

Abstract

This paper analyzes how a telecommunications regulator can balance regulation with innovation, at a reasonable cost. The existing U.S. telecommunications regulations were created in the integral age. In that paradigm, functional components that constitute a service compliant with regulation resided inside the network core; each operator was vertically integrated and controlled the total functionality necessary to deliver a service; a few such operators controlled the industry; they faced low competition and were under limited pressure to adopt innovation; and consumers had limited choice. The Internet has introduced a polar opposite paradigm — the modular age. In this paradigm, functional components that constitute a service are dispersed across the network core and edges; each firm controls only a subset of the total functionality necessary to constitute a service; many modular firms interoperate to deliver a service; firms compete fiercely and are under great pressure to innovate; and consumers enjoy far greater choice due to the multi-modal competition among multiple technologies. Although transitioning from an integral to a modular age dramatically flips the environment, the current regulatory response to this dramatic shift has been hesitant to shift its intellectual roots. Consequently, this paper describes and analyzes the new telecommunications paradigm and explores its implications for an appropriate regulatory paradigm. The research uses the regulation of voice communications in the United States as a representative case. To carry out this research, we have developed a system-level dynamic feedback model.

As modular entrants of Internet-based technology disrupt integrated incumbents of traditional technology, bewildering dynamic complexity complicates decision-making by policymakers, managers, consumers, and technologists alike. Our model makes understandable the emergent behavior amidst the uncertainty that surrounds such a disruption phenomenon. The model formulations are behavioral. They are derived from the existing theories of technology and industry disruption, where possible. Alternatively, where theories have a gap, the decision processes of stakeholders, gleaned from unstructured interviews, are mathematised as the basis for the model formulations. The resulting structure is a fully endogenous systems model of regulation, competition, and innovation in telecommunications.

Through model analysis, we demonstrate how achieving such a balance in a modular structure is not trivial because of several natural tendencies. First, achieving high compliance at low cost is difficult because in highly modular architectures and industries, coordination costs, such as the time to build consensus, can be inordinately large. Second, keeping the innovation-level high is difficult because it requires fighting the natural tendency of modular firms to gain and abuse market power. We propose a combination of two policy levers — Limiting Significant Market Power (SMP) ccumulation and Building Broad-based Consensus around Regulatory Issues — that most effectively achieve the desired balance and remain inadequately explored in the United States.

We contend that implementing these policy levers will require a more broadly construed antitrust regulation in the United States that will ensure higher modularity, and a telecommunications regulatory agency that is empowered and organized to pursue objectives at the societal level and to build broad-based consensus among divergent interests in a highly modular structure.