Response to Fransman's Paper
Comments on "The Evolution of the Telecommunications Industry into
the Internet Age," by Martin Fransman, at the MPI/LINK Workshop on "Cognition
and Evolution in the Theory of the Firm," September 25-27, 2000, Jena, Germany
by Richard N. Langlois
Professor of Economics The University of Connecticut Storrs, CT 06269-1063 USA
Let me begin by saying how much I like this paper. It is a comprehensive
account of the evolution of the telecommunications industry seen through the
lens of industrial structure and industrial dynamics.
In many ways, this paper is the untold story. The conventional account
of deregulation in telecommunications focuses much more on government
regulation and the political (and politico-economic) forces that (partially)
undid regulation. These stories could be combined, of course, to produce an
evolutionary account of institutional change in the manner of Ruttan and Hayami
(1984). (For an attempt to apply this theory to regulatory change in electric
power, see Kench (2000).) The conventional story in the U. S. goes something
like this. AT&T was always a political animal, from the days of Theodore
Vail, who embraced regulation in the name of maintaining a unified "system" as
the key to AT&T's growth and dominance. As part of this process, AT&T
engaged in cross-subsidy of products for political reasons. In particular, it
subsidized below-market rates on local phone service (used by the voting
masses) at the expense of high rates on long-distance service (used by
businesses). This created a profit opportunity for firms that could enter only
the long-distance business underneath AT&T's price umbrella. Firms
initially began doing this through the reselling of service on leased copper
lines, but the development of microwave technology enhanced the profit
opportunity, since those with rights of way for line-of-sight microwave towers
(like the Southern Pacific Railway - hence Sprint) could create a network
without investment in copper wires. But large-scale entry meant altering the
regulatory structure that gave AT&T exclusive rights. Through intensive
lobbying efforts led by MCI, the authorities yielded, and the profit
(rent-seeking) opportunity had given rise to institutional change. (One could
tell a similar story about terminal equipment both before and after the Federal
Communications Commission's 1968 Carterfone decision.)
This is where Fransman comes in, suggesting that the resulting change
in industrial structure influenced future change (both industrial and
institutional) by changing the technological regime guiding innovation. The
industry became more "horizontal," with R&D and innovation removed from the
"vertical" structure of telecom monopolists and into a network of specialized
suppliers to whom all comers had access. The distinction between the old
vertical and the new horizontal structure comes from Andy Grove's (1996)
analysis of the computer industry, which had for analogous (if less political)
reasons decentralized away from the "vertical" mainframe paradigm. In both
cases, internal coordination had given way to specialized players at distinct
levels who are coordinated by technological standards and other anonymous
interfaces. Both industries had become more "modular." There are some
differences between the two industries, of course. In telecoms, even though
old-fashioned vertical integration is dead, many corporate players have stakes
at multiple levels, something that is less typical in computers. For example,
AOL-Time Warner is a content provider as well as an owner of infrastructure
(cable networks). Raghu Garud and his coauthors (1996) have suggested a reason
for this consistent with Fransman's emphasis on Knightian uncertainty: because
everyone's "vision" of the future of telecoms is so cloudy, companies find it
desirable to take positions in a wide variety of technologies and at several
"levels" in the telecom food chain.
These positions are experiments, in effect, analogous to - and
sometimes literally constituting - options in the financial sense. The notion
of options helps explain why the transformation to a horizontal structure in
both computers and telecoms spurred innovation and created profit
opportunities. To a large extent, as I've suggested, these industries became
modular systems; and coordination in such systems requires technical and
procedural standards. Standards are interpersonally shared pieces of knowledge;
they are public institutions that guide action. Neoclassical theory has focused
on the demand-side effects of adopting a uniform set of standards, but it has
neglected what are perhaps the most significant benefits of creating a modular
system. Paul Robertson and I (1992) have argued that the Schumpeterian benefits
of unleashing a diverse pack of "external capabilities" can lead to faster
innovation by taking advantage or rapid trial-and-error learning (Nelson and
Winter 1977). Recently, Baldwin and Clark (2000) have translated this argument
into the language of options theory. Opening up the component parts of a system
in a modular way creates greater option value, since modularity allows direct
access by investors to technological experiments rather than limiting investors
to the experiments chosen (as Fransman explains) by vertically integrated
suppliers. And, as options theory teaches, a portfolio of technological options
can be worth significantly more than a single option on a portfolio of
technologies.
References:
Baldwin, Carliss Y., and Kim B. Clark. 2000. Design Rules: the Power
of Modularity. Cambridge: MIT Press.
Garud, R., A. Kumaraswamy, and A. Prabhu. 1995, "Networking for Success
in Cyberspace" IEEE Proceedings of the International Conference on
Multimedia Computing and Systems, 335-340
Grove, Andrew S. 1996. Only the Paranoid Survive. New York:
Bantam Doubleday.
Kench, Brian T. 2000. "Induced Regulatory Change in the Electric Power
Industry," paper presented at the Annual Meeting of the International Society
for New Institutional Economics (ISNIE), Washington D.C., September 15-16,
1999.
Langlois, Richard N., and Paul L. Robertson. 1992. "Networks and
Innovation in a Modular System: Lessons from the Microcomputer and Stereo
Component Industries," Research Policy 21(4): 297-313.
Nelson, Richard R., and Sidney G. Winter. 1977. "In Search of More
Useful Theory of Innovation," Research Policy 5: 36-76 (Winter).
Ruttan, Vernon W., and Yujiro Hayami. 1984. "Toward a Theory of Induced
Institutional Change," The Journal of Development Studies 20(4): 203-22.
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