Open access or not, big telecoms still have the advantage

Love ‘em or hate ‘em, cell phones have become an integral part of life for most Americans. As of June 2007, we had 243.4 million wireless accounts active in the U.S., representing an 81 percent penetration rate. We send 28.8 billion text messages monthly, and have spent a grand total of 1.95 trillion minutes on cell phones. To say we use them a lot is an understatement. Yet cell phones run on a finite resource: radio spectrum. Thus, the ability to compete with entrenched companies becomes a vastly difficult endeavor. The auction of the 700 MHz spectrum, which concluded last week, brings this issue to the forefront.

There is only a certain portion of spectrum available for cell phone use. This new spectrum only opened up because TV stations were ordered to abandon it by 2009. After this, there likely won’t be any spectrum available for auction “in the foreseeable future.” In other words, any company that either wanted to enter the cellular world, or beef up their current holdings, would have to get serious about this auction.

There was a significant barrier to most companies and the valuable spectrum. AT&T and Verizon, the nation’s Nos. 1 and 2 wireless carriers, respectively, were/are sitting on billions in capital. Surely, the additional bandwidth — which can cover long distances and penetrate walls — is valuable to these wireless giants. And so, in predictable fashion, they dominated the auction. And this was no subtle domination. Of the $19.12 billion raised, Verizon and AT&T accounted for over $16 billion.

Where’s the competition?

After seeing the numbers, my first reaction was, “Well, that makes sense.” But after that, I wondered how any other company could expect to compete. The Nos. 3 and 4 wireless carriers in the nation, Sprint and T-Mobile, declined to bid. Sprint has enough problems already, with a steady stream of defecting customers. T-Mobile just dropped $4.2 billion on 120 advanced wireless services licenses last year, so their sitting out is also understandable.

There was a portion of the auction that was tailor-made for the big telecoms: The C-Block. Of the 62 total megahertz being auctioned, the C-Block comprises 22 MHz, by far the largest chunk. It was also only broken into 12 licenses, a fraction of the number of licenses in other blocks. The idea was that the big companies could wrestle over these larger licenses, leaving the smaller ones for regional cell companies and new entrants.

Except that’s not what happened. Of the 214 bidders that qualified for the auction, fewer than half actually won spectrum. Alltel, the nation’s fifth-largest wireless carrier, won no new spectrum. Ditto for regional carrier Leap Wireless, which owns the Cricket Communications and Jump Mobile brands. MetroPCS, another regional cell carrier, won just a single license.

So why did these companies — who would have benefited greatly from the powerful 700 MHz airwaves — lose out?

AT&T’s pre-auction deal

AT&T, despite being the nation’s largest carrier in terms of subscribers, did not really compete with Verizon for the C-Block of the spectrum. This might seem strange at first. Why would AT&T let Verizon grab that spectrum for just over $4.7 billion — especially when the reserve price was set at $4.6 billion?

A few months before the auction, AT&T purchased spectrum from Aloha Partners. This was in the lower 700 MHz frequency, and covered 196 million people. In essence, AT&T saw the competition ahead for the 700 MHz spectrum, found a company that already owned spectrum in that frequency, and nabbed it up. This did two things.

First, it allowed AT&T to focus their efforts on the B-Block. They didn’t need the large licenses of the C-Block; they just needed smaller licenses to fill out their network. Of course, this did not bode well for smaller companies looking to buy spectrum, as it was best suited for them — 734 licenses over 12 megahertz.

Second, it allowed Verizon to bid on the C-Block basically without competition. What other company could come close to the $4.6 billion reserve price?

Google’s efforts

Because this was/is the last auction of this type for some time to come, Google saw an opportunity. See, the major cell providers have this practice of locking handsets to their network — that is, if you buy a handset from Verizon, it will work only on the Verizon network. They also tend to restrict third-party applications. This shuts out many small-time software and hardware producers who could otherwise be making a positive impact on the wireless industry.

So Google proposed to include open-access provision on the C-Block. That is, that the winner of the spectrum must allow any non-harmful device or application to function, no matter which carrier actually ended up winning the auction. Google also wanted a requirement that the winning bidder lease portions of the spectrum to smaller, virtual operators. This, they claimed, would give consumers a greater level of choice, and foster a higher level of competition in the wireless industry.

In the end they got open access, though the mandatory leasing provision was shot down. Even so, Google announced that it would bid on the C-Block as a potential new entrant. However, that appears not to have been their actual intention.

Loophole in the open-access rule

In September, Verizon challenged the open-access rules in a federal appeals court. They claimed that the provision “violates the US Constitution, violates the Administrative Procedures Act, and is arbitrary, capricious, unsupported by the substantial evidence and otherwise contrary to law.” This appeal was quickly abandoned, though, when Verizon was denied an expedited schedule.

Strange, though, that the appeal drop came within two weeks of AT&T’s announcing their purchase of Aloha’s spectrum. Could Verizon have seen something here? Particularly, that AT&T likely wouldn’t be bidding on the C-Block, thus greatly reducing their competition. Even further, it was widely speculated that Google wasn’t bidding to win the auction. They were merely there because of their prior involvement, and possibly to create a more even playing field.

But most of all, they were there because failure to reach the $4.6 billion reserve price would mean that the auction would be re-done, sans the open-access provision. AT&T would still likely stay out, or at least not involve themselves to the level that they would have without Aloha’s spectrum. This would create an enormous competitive advantage for Verizon.

This led Google to pus the C-Block over the $4.6 billion mark, with a $4.7 billion bid. Verizon then made a bid to top that, and so ended the C-Block bidding. But some stalling prior to the auction hitting the reserve price made it clear that Verizon would have just as well let the auction end without having met it. And then they would have had a new auction all to themselves, basically.

Where the spectrum went

This map shows the regions that Verizon won with in the C-Block. No, that’s not a joke. They won what amounts to a national license. The only portions of the C-Block they didn’t get were the Gulf of Mexico region, and licenses in Alaska and Puerto Rico. In addition to that, they nabbed 77 licenses in the B-Block and 25 in the A-Block. AT&T bought up 227 licenses total, all in the B-Block.

This didn’t leave a whole lot left for the other 200-some-odd bidders. But they took what they could get. Satellite TV company EchStar, owners of the DISH Network, nabbed 168 licenses, all in the E-Block. However, this spectrum is considered more optimal for broadcast rather than voice conveyance. I think it’s safe to assume they won’t be opening up a nationwide wireless company with this spectrum.

Qualcomm got some B- and E-Block spectrum, likely to enhance their MediaFLO multimedia offering. However, they provide services to cell phone carriers. They are not, and most likely will not become, a cell carrier themselves. Oil company Chevron won some A, B, and E-Block spectrum, but that’s more likely for their own projects rather than a consumer service. A company called Cavalier Wireless won a bit of spectrum, but it was just $61.8 million worth, and in the A and B blocks, so it’s unlikely they’re ready for a nationwide offering.

Really, the only cellular companies other than Verizon and AT&T were MetroPCS, with their aforementioned one license, and U.S. Cellular, who dropped $401 million for 152 licenses.

No greater competition

The sum of all this is that the auction created no new opportunities. The rich got a lot richer, and the poor picked up the scraps. What this auction really accomplished was to allow the bigger carriers to provide more and better services to the masses. While this is a good thing, allowing for the entry of new companies would have achieved the same thing in a more consumer-friendly way.

But there was no real way for a third party to enter, unless that company was Google. And it’s easy to understand why they wouldn’t want to enter the fray. They have their core competencies, and delivering wireless services is not one of them. Not only would it have been an enormous investment, but it would have been very risky, too.

I’ll look forward to Verizon’s open access network. They already started embracing the idea, as they’re beginning their open handset initiative. This will allow third party handset developers to submit phones to Verizon for testing. If they pass the company’s testing procedures, they can be activated on the network, though Verizon will not manufacture or market the devices. That’s up to the developers. These devices will also be free to run third party applications, so long as those applications don’t use a disproportionate amount of the network’s resources.

And actually, this plays into Google’s desire to see the open-access spectrum rented out on a wholesale basis to smaller carriers. In addition to being able to sell their devices to the masses, developers will have the option of buying minutes wholesale from Verizon, thus creating mini Mobile Virtual Network Operators (MVNOs). If one were so inclined, a developer could make an entire line of handsets, load Android on them, and sell them as if they were a brand new company.

Of course, the MVNO model isn’t exactly a stable one. Over the past year and a half, we’ve seen such MVNOs as ESPN Mobile, Amp’d Mobile, Disney Mobile, and XE Mobile go down the chutes. However, there is still hope, as companies like Page Plus, Tracfone, and Virgin Mobile have had varying levels of success with the model. Really, it could work much better if done on a more local level, which is likely how many of these new potential MVNOs would operate.

Even so, we’re still at the behest of our wireless overlords. We’ll still have to sign two-year contracts if we want a discount on a phone. And those contracts will still include mandatory arbitration, which clearly favors companies over consumer.

Free markets or carefully regulated ones?

This issue certainly speaks to the shortcomings of free markets. Ideally, yes, you’d like to see free markets foster competition, thereby bringing down prices for consumers while at the same time raising the level of service. However, this isn’t how it works with finite resources.

Radio spectrum is rare and in demand, so it will command a high price. So high, in fact, that only the top companies in the country can afford to buy it. This was made clear in the 700 MHz auction. Smaller companies and new entrants were all but shut out, because they simply couldn’t afford entry. This lessens competition, since we still have just a few companies covering nearly everyone’s wireless needs.

I’m not sure what to do with this. But I think it’s an important issue that’s not really being addressed by the mainstream. We’ve had problems in this country with just a few companies controlling oil prospects. Why do we insist on going through the same thing with our wireless telecommunications?