Gerald R. Faulhaber, a professor of public policy and management at Wharton, last month was named chief economist of the Federal Communications Commission. In this one-year position, he will be closely involved with critical economic issues and regulatory debates about future trends in telecommunications. Faulhaber, who was director of strategic planning and financial management at AT&T as well as head of economics research at Bell Labs before joining Wharton in 1984, spoke to Knowledge at Wharton about three issues: The future of mobile computing, trends in Internet telephony and new business models in telecommunications.

Knowledge at Wharton: A worldwide battle has been raging over the standard for mobile telephony. Global System for Mobile (GSM), the European wireless standard, has some 300 million subscribers worldwide, while those based on U.S. standards such as Code Division Multiple Access (CDMA) have barely 70 million users. Has the U.S. lost the wireless race?

Faulhaber: That’s a complicated question because the Europeans have made a strong commitment in their spectrum allocation to so-called 3G or third generation platforms. That is going to give them a leg up. In fact, it already has. You always take a risk, as the Europeans have, when you commit to a specific platform, because it might be that 4G is the way to go. I hear from folks in our industry that they believe the Europeans have locked themselves in. I doubt that. I don’t think what the Europeans have done is a bad idea.

I do think that in wireless telecommunications, Europe is in advance of the U.S. I don’t know why the U.S. wireless industry has been a laggard—and it is pretty evident that it has. I don’t know if the U.S. will catch up. There are certainly a lot of plans and interesting pieces of software, but basically whether these get deployed or not depends on the availability of bandwidth and the availability of carriers to start offering services. That is a very different issue than writing cool software programs and great wireless application program protocol apps that do all sorts of cool things. You’ve got to have antennas out in the communities and decent handsets to use them. And I don’t see that coming here in the U.S.

It’s not for want of trying. The FCC is pushing spectrum out the door. Auctions are held on a very regular basis, and these put a lot of spectrum in play. So we will see. It’s a question of U.S. wireless operators stepping up to the plate and whether they will do this or not. Frankly, I would like to see other companies from overseas come in and give our guys a little bit of a challenge.

Knowledge at Wharton: Deutsche Telekom is trying to establish a strong presence in the U.S. wireless market. For example, it recently acquired VoiceStream for more than $50 billion. Do you think this could pose a significant challenge to U.S. companies?

Faulhaber: It’s possible. I don’t view Deutsche Telekom as being one of the more innovative companies on the block, though. I’d even be interested in Nippon Telegraph and Telephone (NTT). So if I were to pick a foreign entrant it would probably not be Deutsche Telekom, but I guess you take what you can get. Opening up our markets would actually be a grand idea, and a big piece of that is, are we going to have enough spectrum available. I hope that U.S. companies as well as foreign entrants will be able to come in and deploy some of the services that we are now seeing in Scandinavia and Japan. It would also be good if we could leap beyond the collection of standards we have right now, so that the industry can coalesce around a set of standards for the next generation. But I don’t see signs of that happening.

Knowledge at Wharton: Another major issue that confronts telecom companies is the future of Internet telephony. How do you see the prospects for those services?

Faulhaber: Internet telephony is an interesting play. It is, for both technical and regulatory reasons, a way to avoid regulation that has traditionally been imposed on voice telecommunications, both local and long-distance. It is at present not a very good substitute for traditional telecommunications. It is generally computer-to-computer, or in some cases, computer-to-phone. But its quality is poor because of the nature of transmission over the IP or internet protocol network. This is a best-efforts network rather than a circuit-switch one, and that does not make it very good for real time transactions. It makes it very good for shipping web pages back and forth, but not very effective for conversations or interactive video. So you get free telephone service if you have voice-over-IP, but it’s not a very good telephone service.

Knowledge at Wharton: Is that changing?

Faulhaber: Yes. There are discussions within the Internet community and also among backbone suppliers about providing what is called quality of service interconnections or QOS. Here the notion is to provide a guaranteed level of service so that we can begin to deploy some of these real-time applications. Many of us see this as the next wave of the Internet. If this happens, we won’t make just a best efforts commitment as backbone networks to carry the traffic. We will make a commitment to provide a certain quality of service to ensure that the packets [carrying voice over the Internet] get there in a specified period of time. This would begin to make the IP network perform more with the reliability and interactivity of the telephone system, which has that quality of service.

Knowledge at Wharton: Do you see much investment by traditional telephone companies in web telephony to protect themselves from being cannibalized in the future? For example, AT&T has just decided to invest in Net2Phone. What do you think?

Faulhaber: Of course, AT&T is well positioned with its cable properties to go head-to-head with the telcos using voice over IP. AT&T has been seeking a way to re-capture customers’ full range of telecoms services that it lost with divestiture and this could be the play that does it. I expect they would seek deals with other cable providers, even non-Bell DSL providers, to be the leading vendor of voice over IP. It’s a new strategy to achieve an old objective: control all the customer’s telecoms pathways.

In general, we are beginning to see some existing telephone companies become much more aggressive about deploying innovative plans to do broadband. They have been hampered by their technical restrictions on doing Digital Subscriber Lines or DSL, but they are beginning to find ways of getting around that now in interesting ways. Would they do voice over IP? They don’t really have to. They do voice over voice–after all, that is their business. Voice over IP, in its present configuration, is nothing more than a way to get around the regulations, and that is not an RBOC (regional Bell operating company) problem. Their real issue is to get broadband out in forward deployment. Some companies have awakened to this and are now beginning their rollouts.

Knowledge at Wharton: How do the efforts of the phone companies compare with those of cable companies in this regard?

Faulhaber: The phone companies are way behind the cable companies. For the next year or two the phone companies and the cable companies will be constrained by just how much broadband stuff they can put into people’s houses, because they don’t have the people to do it. If you want to get a broadband service such as DSL out to someone’s house, it usually means at least one truck roll, and maybe two or three. And these companies don’t have the trucks or the people to do it. This problem should go away in about a year, but right now that is a big problem.

People understand that there will someday be big pipes going into their houses. As for telephony, probably in the long run it is going to be free. Whatever the technology is, it doesn’t matter. It’s all bits, and stuff like telephony, which takes almost nothing, is going to be essentially a free service. That’s where it is heading. People who are paying attention to the market understand that. Even some of the regional phone companies, which can see where this is going, are starting to get really concerned about it.

Knowledge at Wharton: Do you see these companies or others developing new or innovative business models to deal with such threats–or opportunities–in telecommunications?

Faulhaber: This is very exciting. Things are so open that we just don’t know where they are going. One of last year’s debates was, as the cable companies get into the broadband business, what are they going to do? It’s now becoming clear that one of the things they will do is telephony. It might be circuit-switched or IP based. The cable companies could in fact produce very high quality local telephone services. That is part of AT&T’s plan, so that the company, with its cable providers and use of broadband Internet and telephony—local services over the cable and long-distance over its own network—can supply a very integrated working model. The company then has control over its customers for all their telecommunications needs.

If you look at a company like the proposed AOL-Time Warner, there we see a rather different model. It’s a vertically integrated model that is more content-based. You have a content company, an information aggregator and some cable guys—that is a new and different model. However, if you see both AT&T and AOL-Time Warner, their battle last year was over open access.

Now I may be calling this wrong, but it seems to me that that battle is over. The early indications are that both AT&T and AOL are heading this way for business reasons and not for legal or regulatory reasons. They are heading towards a more open model because AOL makes greater use of its flagship service simply by being available on multiple conduit platforms, such as AT&T, Comcast and also Time Warner. And it maximizes the value of its cable properties by having multiple ISPs go across them. It seems pretty clear that they are taking a lot of actions that look like they are headed in that direction. Although AOL Time Warner is vertically integrated, it does not appear at this time—and I emphasize at this time—that they are going to go for a closed, proprietary model. Of course, they are in the middle of a merger negotiation, so they do want to look like they want to play nice.

This is a very different model than cable has ever had before. Cable has not been an open model; it has been a proprietary one. This may be changing, and there is good reason to think that this is the right business model for them.

So I do see new models emerging. One is backbone networks doing quality-of-service type agreements based on performance. That will open up a whole new world of interactive services and impose demands for bandwidth on both cable and DSL operators. For example, you can imagine two-way video between consumers, or the so-called C2C market. That is very bandwidth-intensive. Another bandwidth-intensive C2C market is real-time gaming. I can imagine that being a quality of service game, because it is interactive. It will be interesting to see how these issues play out in the future.