How the Dying Landline Business Fuels Opposition to Net Neutrality

Remember Qwest? It's now officially gone, absorbed by CenturyLink (CTL). This combination of the former number 3 and number 4 landline carriers has only a fraction of the market cap or revenue of either Verizon (VZ) or AT&T (T). But more intriguing is a different measure: the two put together now have as many landline customers as Qwest alone did in 2005.

That's a surprising testament to how quickly the old landline business is dying off. For years it was highly profitable, running on infrastructure long paid for. As people shift their conversations to Internet-based telephony and wireless, many neither need nor want the old cash-cow service. And that helps explain why the telcos have pushed so hard against net neutrality.

To understand how the carriers are behaving, you have to look at their historical business strategies:

1. Set service levels in ways that push most consumers to buy more voice or data capacity than they will actually use
2. Control all relationships with customers, even when all the carrier does is provide a conduit for third-party services.
3. Crowd out competitors to reduce consumer choice.

Why do carriers use pricing to change consumer behavior by encouraging them to use less capacity, rather than to recover actual costs? Because they don't want anyone to actually use the capacity they pay for, as doing so makes the carriers less profitable. A graphic example is AOL, whose old dial-up Internet access business delivers nearly all the company's profits from people who continue to pay for subscriptions they no longer need because they have broadband access.

Things have been going in the wrong direction for the telcos. Look at AT&T's earnings report for 2010. Even as total revenue was up slightly over the year before, operating income was down, as the graph from the earnings release shows (click to enlarge):

That's a continuation of a longer trend, as these numbers from AT&T filings show (click to enlarge):

Verizon has a similar pattern:

Although wireless is responsible for revenue growth, the companies have had to invest in their networks to meet customer demand -- think AT&T and the iPhone -- which reduces operating income. Furthermore, as software, service, music, and media sales increasingly move through ecosystem owners like Apple (AAPL) and Google (GOOG), carriers have fewer opportunities to make additional sales that would turn into almost pure margin. In short, the operating income trend is in the wrong direction.

To become fatter and happier, the telcos have to again create an artificial shortage of capacity. That's why they want to put limits on data use and, if possible, to favor their own service offerings over those available from third parties to pump up those pure margin injectors. And that's why, to the telcos, net neutrality must go.

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