Knowledge Problem

Lynne Kiesling

Yesterday’s announcement that the US DOJ would challenge the merger of AT&T’s wireless business with T-Mobile’s was surprising, and their approach to the merger seems to be more conventional and rooted in old HHI-market share and price effect metrics. Their analysis suggests that due to the substantial overlap in the existing separate AT&T and T-Mobile networks, the merger would lead to higher HHIs and larger market shares, and most national consumers would experience higher prices; therefore the merger would have anti-competitive effects.

The complaint has more depth than that (separate analysis for business markets and consumer markets, for example), but that seems to be the core of the argument. I think that argument misses a few important points in such a dynamic market.

The first important point is the quality dimension of the wireless service, and the costs associated with providing quality service(s). In this market some of the most important categories of quality are speed, signal strength, lack of latency, and lack of dropped calls. Providing such quality means building bandwidth and more dense network towers. In a lot of locations, building more towers is increasingly costly due to siting, zoning, permitting costs and lags. Building more bandwidth to add to existing capacity is also not cheap. Thus both AT&T and T-Mobile have been suffering in quality comparisons to their largest competitor, Verizon (I don’t know much about Sprint’s quality, or the smaller regional providers), and are looking at substantial investments and time lags to expand and improve their bandwidth capacity and other features that contribute to quality services. I’ve seen a couple of commentators point to the challenges both companies face as stand-alone competitors if they are going to upgrade their networks from 3G to compete with Verizon’s 4G LTE; in fact, Deutsche Telecom has been trying to sell T-Mobile for a while and has balked at the costs of these investments. In this cost environment, the lower-cost way to increase quality is likely to be the merger, which would allow the merged firm to combine their bandwidth and towers to get that capacity without additional siting, permitting, etc. Thus on a cost basis there’s room to argue that prices could fall for higher-quality (LTE) services, and there’s also room to argue that if prices do go up, it’s a reflection of the consumer demand for high-speed LTE service for their smartphones. It’s hard to capture that quality dimension, and how rapidly it can change in such a dynamic technological environment, when your definition of anti-competitive focuses primarily on the effect on prices. This is a very Schumpeterian point.

That point leads to the second point not to overlook: market definition. Every antitrust challenge of a merger is going to hinge in some way on market definition. If you define the market as national wireless telephony, then the merger would create essentially a duopoly with Sprint as a small third firm. But, as Geoff Manne points out, there are two dimensions on which that’s not the correct market definition — there are regional competitors, and there are other competitors in the broader market, the more relevant market, which is broadband:

Meanwhile, even on a national level, the blithe dismissal of a whole range of competitors is untenable.  MetroPCS, Cell South and many other companies have broad regional coverage (MetroPCS even has next-gen LTE service in something like 17 cities) and roaming agreements with each other and with the larger carriers that give them national coverage.  Why they should be excluded from consideration is baffling.  Moreover, Dish has just announced plans to build a national 4G network (take that, DOJ claim that entry is just impossible here!).  And perhaps most important the real competition here is not for mobile telephone service.  The merger is about broadband.  Mobile is one way of getting broadband.  So is cable and DSL and WiMax, etc.  That market includes such insignificant competitors as Time Warner, Comcast and Cox.  Calling this a 4 to 3 merger strains credulity, particularly under the new merger guidelines.

Yes, particularly the point about how this merger, and the broader evolution of the industry, is about broadband. The distinctions among wireless telephony, satellite, and cable are diminishing as we see convergence across the communications platforms. This is another Schumpeterian point.

Which leads to the final point that cannot be overlooked in analyzing this merger and the DOJ’s challenge of it. It’s about broadband, and thus in large part given the wireless companies involved, that means it’s about spectrum. As I argued in one of the first Knowledge Problem posts back in 2002, federal spectrum policy of the past 75 years has led to distortion, delay, rent-seeking, and political manipulation by incumbent rights holders.

Because of the politics of spectrum rights and the lack of private spectrum ownership, resources might not get to move to higher-valued uses. The FCC is not going to be as impartial a rights arbiter as the combination of well-defined spectrum ownership and a court system using the rule of law. The absence of spectrum privatization may slow or deter potentially beneficial technological change, and leaves in place a political process more prone to financial and other manipulation than one based on markets and law.

If we had alienable spectrum property rights, as Ronald Coase laid out in his spectacular 1959 article on the FCC and spectrum policy, then it’s highly likely that AT&T and T-Mobile would have alternative investment opportunities to gain more spectrum to increase their wireless broadband capacity in their stand-alone networks. Failing that, as a consequence of our turgid spectrum policy, their most attractive feasible alternative for acquiring more spectrum rights is to merge. Do not overlook the effects of poor spectrum policy on the business models of these companies. This is a Coasian point. And, to make a related Doug North point, institutions matter. I made this point initially in March when the merger was first announced.

Being an optimist, let me invoke Jerry Ellig’s point about the DOJ challenge:

For once, the high-profile action everyone pays attention to will occur in an antitrust forum where the decision criterion is the effects of the merger on consumer welfare, period. Regardless of what one thinks about the merger, it’s nice to see that we’ll finally have a knock-down, drag-out fight based on whether a big telecommunications merger harms consumers and competition.  That’s the antitrust standard the Department of Justice has to satisfy in order to prevent the merger.

And to do that it’s going to have to engage these spectrum policy issues, which it has thus far not done.

I am far from expert on all of these issues, so for more I commend to your attention this post from Josh Wright on how the DOJ challenge affected Sprint’s share price yesterday, in addition to Geoff’s post above. Our friends at Truth on the Market and The Technology Liberation Front will be worth reading regularly as this unfolds.