Wednesday, July 11, 2007

A little competition goes a long way

Today the Wall Street Journal had a flurry of pieces about the potential for “wireless net neutrality” for at least some of the next round of the FCC's spectrum auction. The planned auction will parcel out the UHF channels 52-59, analog channels being surrendered by broadcasters (nominally in February 2009) with the conversion to HDTV.

Of course, “net neutrality” is anathema to the Journal. (For those who slept through religion class, anathema is a Greek word adopted by the early Christian church to cut off heresies such as Arianism).

This all was stirred up by an interview with FCC chairman Kevin Martin that ran in Tuesday’s USA Today, in which he said:

“Whoever wins this spectrum has to provide … truly open broadband network — one that will open the door to a lot of innovative services for consumers,” Martin said in an interview Monday.

What this would mean in practice: “You can use any wireless device and download any mobile broadband application, with no restrictions,” Martin explained. The only exceptions would be software that is illegal or could harm a network.
In response, the Journal had not one! not two! but three! articles on the subject — a news piece on page A2, an op-ed column and an official editorial. The editorial blamed the plan on former Clinton FCC micromanager (now lobbyist and regulatory arbitrageur) Reed Hundt.

In Tuesday’s article, Martin had use locked iPhone was held up as a representative example. The every same day, Hundt’s company, Frontline Wireless, took a full page ad in the Capitol Hill newspaper which seems to imply that a lack of net neutrality (locking the iPhone to AT&T) is depriving voters in 13 states of their Darwin-given right to use an iPhone.
The op-ed column, by respected Brookings economist Robert Crandall, was a little more measured and rational in its criticism of the Martin plan. However, his defense of vertical integration (and thus attacking measures helping VoIP providers) seems early 1960s, i.e., pre-MCI, pre-Carterfone, pre-Execunet.

Martin’s plan is consistent with the use of regulation to promote competition. This apparent paradox captured by the book published on 1990s financial and telecom liberalization by my friend and mentor, Steve Vogel; he called the book Freer Markets, More Rules.

Net neutrality — like earlier decisions such as Carterfone and Execunet — means that restrictions are levied on one part of the value chain (PSTN, wireless access) in hopes of increasing competition on another level (handsets, value-added services). In this case, the goal is to prevent use of vertical integration as a barrier to entry and comeptition. In free markets, such regulation is only justified by a presumed market failure, such as the “last mile” monopoly of wireline telecom, or the oligopoly (three national carriers with 77% market share).

It remains a question of fact (not of economic theory) whether the potential benefits of one outweighs the potential risk of the other. However, there are plenty of complaints by startup entrepreneurs that it’s impossible to offer new applications (particularly on Verizon) without getting the carriers’ cooperation; this certainly seems to be stifling the rate of innovation, even if Crandall were right that a lack of regulation would lead to the optimal economic efficiency.

Meanwhile, the WSJ news article, like the hundreds of other articles this week (as in Information Week), note that Internet services like Google and Skype would benefit from FCC rules guaranteeing access to wireless data networks. Of course, Skype stirred up the whole idea of wireless net neutrality with its FCC filing in February.

The carriers’ lobby group, CTIA, claimed the plan was tailored to benefit Google and called it “Silicon-Valley Welfare”: CTIA president Steve Largent clamed:
Crafting special rules for a company with a market cap of $170 billion to address problems that don’t exist in our competitive market makes absolutely no sense whatsoever.
Of course, the claim of "Silicon Valley welfare” is drek. Of course, imposing restrictions on some spectrum would reduce the value of that spectrum to operators that don’t want “net neutrality” — such as those using “walled gardens” — potentially reducing the number of bidders and certainly the amount paid for the spectrum. If the FCC goes ahead, it means that it believes the benefits of competition at one level outweigh the reduced auction price (and potentially reduced investment) by the carriers. Given last year’s legislators are more politically like Hundt than ex-Rep. Largent, Martin is likely to get enthusiastic support from a less-than-free-market Congress.

Beyond that, the CTIA’s Chicken Little claims are completely implausible. Hundt makes it clear that he thinks only one of the six bands should be auctioned with the open access mandate. That means three national carriers (five if you buy the CTIA math) plus five new spectrum owners would be without net neutrality, but an 11th owner would be so restricted.

Such apocalyptic rhetoric seems like a really stupid strategy by the carriers and CTIA, on two fronts. First, if net neutrality is limited to just this one new band, that would likely reduce the pressure for the existing carriers to open up their networks. Carriers would be free to offer better (albeit non-neutral) solutions and customers would decide whether (or if) neutrality was something that they valued. Hey, Steve, what’s more free market than that?

Second, the US carriers — unlike those in Europe — have been shooting themselves in the foot by blocking Wi-Fi enabled handsets, as when Cingular requested Nokia drop Wi-Fi from the E61 so they could sell it as the E62. Wi-Fi calling is inevitable, but for a long while it will be difficult to use, so the carriers should let it happen and spend some time figuring out (as the European carriers seem to think) there’s a way to make money off of it. Last week, David Pogue reviewed a cool home Wi-Fi hotspot for your cell phone which (not surprisingly) is being offered by the #4 US carrier, Germany’s T-Mobile; they even get an extra $10/month for all the resulting “free” calling.

If the wireless carriers really can’t cope with this limited competition, then their anguished wails mark the death cries of soon-to-be-extinct dinosaurs. If it’s not that serious, they’ve shot their credibility by crying “wolf” one time too many, undercutting their influence on other issues of importance.

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1 comment:

Peter Cramton said...

Very well argued. One point: You state that an open access provision on one sliver of spectrum (the E Block) potentially may reduce the number of bidders and certainly the amount paid for the spectrum. This is an issue that I have studied extensively, and my conclusion is that the open access provision would increase auction revenues, likely substantially. The theoretical argument and empirical facts are presented in "Revenues in the 700 MHz Spectrum Auction" (with Andrzej Skrzypacz and Robert Wilson), Working Paper, University of Maryland, 27 June 2007. The paper was filed with the FCC on behalf of Frontline Wireless, and is also available at www.cramton.umd.edu/auction-papers.htm.

The argument is quite simple. First consider the outcome without the open access provision. Verizon and AT&T currently earn rents from the coverage advantage they have as a result of holding nearly all the low-frequency cellular spectrum. Verizon and AT&T have a strong incentive to foreclose entry in order to protect their duopoly rents. The FCC's simultaneous ascending auction makes it easy to foreclose entry, especially of a nationwide bidder if a nationwide license is not offered. Potential investors of new entrants know that Verizon and AT&T have this incentive to foreclose entry and therefore they rationally expect that participation in the auction is futile. Verizon and AT&T will ultimately win, so there is little point in incurring the cost of participating in the auction just to be a loser. Verizon and AT&T thus win the spectrum and pay little for it, since the new entrants that would push prices up do not participate.

In contrast, the open access requirement prevents Verizon and AT&T from winning all the spectrum (assuming they choose to continue with their current business models). This motivates participation by new entrants, since investors know that at least one new entrant will be successful. This participation increases auction prices on all the spectrum. A crystal clear example of this is the UK 3G auction, in which a single-license set aside for a new entrant motivated substantial non-incumbent participation and generated record-setting auction prices. Other countries, such as the Netherlands, made the mistake of having the same number of licenses as incumbents, resulting in the predictable outcome in which incumbents win all the spectrum at low prices.

As you say, “a little competition goes a long way.” Many thanks for your insightful analysis.

Peter Cramton
Professor of Economics
University of Maryland
and economist for Frontline Wireless.