DOJ Spectrum Plan Is Not Supported by Economic Theory or FCC Findings

Posted by | May 15, 2013 | Public Safety, Wireless | One Comment

Frontline relied on the DOJ foreclosure theory to predict that the lack of eligibility restrictions in the 700 MHz auction would “inevitably” increase prices, stifle innovation, and reduce the diversity of service offerings as Verizon and AT&T warehoused the spectrum. In reality, the exact opposite occurred.

The DOJ recently recommended that the FCC rig the upcoming incentive auction to ensure Sprint Nextel and T-Mobile are winners and Verizon and AT&T are losers. I previously noted that the DOJ spectrum plan (1) inconsistent with its own findings in recent merger proceedings and the intent of Congress, (2) inherently discriminatory, and (3) irrational as applied. Additional analysis indicates that it isn’t supported by economic theory or FCC factual findings either.

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The Phoenix Center published a paper with an economic simulation that exposes the fundamental economic defect in the foreclosure theory underlying the DOJ recommendation. The DOJ implicitly recognizes that the “private value” of spectrum (the amount a firm is willing to pay) equals its “use value” (derived from using spectrum to meet consumer demand) plus its “foreclosure value” (derived from excluding its use by rivals). In its application of this theory, however, the DOJ erroneously presumes that Verizon and AT&T would derive zero use value from the acquisition of additional spectrum – a presumption that is inconsistent with the FCC findings that prompted the auction.

The Phoenix Center notes that all firms – including Sprint Nextel and T-Mobile – derive a foreclosure value from the acquisition of spectrum due to its scarcity. When considering the benefits to consumers, it is the comparative use value of the spectrum for each provider that is relevant. If the use value of the spectrum to Verizon and AT&T exceeds that of Sprint Nextel and T-Mobile, economic theory says Verizon and AT&T would maximize the potential consumer benefits of that spectrum irrespective of its foreclosure value.

Of course, determining the differing use values of spectrum to particular firms is what spectrum auctions are for, which brings the DOJ’s argument full circle: If government bureaucrats at the DOJ and the FCC could accurately assess the use values of spectrum, we wouldn’t need to hold spectrum auctions in the first place.

The circularity of the DOJ theory explains its reliance on an unsubstantiated presumption that Sprint Nextel and T-Mobile have the highest use value for the spectrum. If the DOJ had instead (1) conducted a thorough factual investigation, (2) analyzed the resulting data to assign bureaucratic use values for the spectrum to each of the four nationwide mobile providers, and (3) compared the results to determine that Verizon and AT&T had lower use values, the DOJ would have engaged in the same failed “comparative hearing” analysis that Congress intended to avoid when it authorized spectrum auctions. Given the Congressional mandate to auction spectrum yielded by the broadcasters, the FCC cannot engage in a comparative process to pick winners and losers, and it certainly cannot substitute an unsubstantiated presumption for an actual comparative process in order to avoid the legal prohibition.

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The foreclosure theory and DOJ presumption are also inconsistent with the auction experience and current factual findings of the FCC. The DOJ foreclosure theory has been presented to the FCC before and has proved invalid by the market.

When the FCC was developing rules for the 700 MHz auction in 2007, Frontline Wireless sought preferential treatment using the same foreclosure theory as the DOJ. Frontline submitted a paper (prepared by Stanford professors of economics and management) that relied on the same types of information and reached the same conclusion as the DOJ – that Verizon and AT&T were dominant “low-frequency” wireless incumbents with “strong incentives” to acquire and warehouse 700 MHz spectrum, and that their participation in the 700 MHz auction must be limited in order to “promote competition” and prevent “foreclosure.” Frontline predicted that, if Verizon and AT&T were not prevented from bidding in the 700 MHz auction, it would “inevitably lead to higher prices, stifled innovation, and reduced diversity of service offerings.”

The FCC rejected Frontline’s foreclosure theory. The FCC concluded that, “given the number of actual wireless providers and potential broadband competitors, it [was] unlikely that [incumbents] would be able to behave in an anticompetitive manner as a result of any potential acquisition of 700 MHz spectrum.”

The last five years have proven that the FCC was correct. Though Verizon and AT&T acquired significant amounts of unfettered 700 MHz spectrum, the auction results have not led to the “higher prices, stifled innovation, and reduced diversity of service offerings” predicted by Frontline. In its most recent mobile competition report, the FCC reported that:

  • Verizon used its 700 MHz spectrum to deploy a 4G LTE network to more than 250 million Americans less than four years after Verizon’s 700 MHz licenses were approved (i.e., it didn’t warehouse the spectrum).
  • Mobile wireless prices declined overall in 2010 and 2011, and the price per megabyte of data declined 89% from the 3rd quarter of 2008 – a few months before Verizon received its 700 MHz licenses – to the 4th quarter of 2010 (i.e., industry prices decreased).
  • The number of subscribers to mobile Internet access services more than doubled from year-end 2009 to year-end 2011 (i.e., industry output increased).
  • Prepaid services are growing at the fastest rate, and new wholesale and connected device services are growing significantly (i.e., providers continued to provide new and diverse service offerings).
  • Market concentration has remained essentially unchanged since 2008 (the population weighted average of HHIs increased from 2,842 in 2008 to 2,873 in 2011 – a change of only 1 percent).

Remember: Frontline relied on the DOJ foreclosure theory to predict that the lack of eligibility restrictions in the 700 MHz auction would “inevitably” increase prices, stifle innovation, and reduce the diversity of service offerings as Verizon and AT&T warehoused the spectrum. In reality, the exact opposite occurred. Verizon and AT&T did not warehouse the spectrum, industry prices decreased while output increased, diverse new service offerings exhibited the strongest growth, and market concentration remained essentially unchanged. And, while competition thrived, consumers reaped the benefits.

So, why would the DOJ make the same failed argument for the 600 MHz auction (other than crony capitalism)? Some might say, “Even the boy who cried wolf was right once.” But, even if one were inclined to give the DOJ the benefit of the doubt, the theoretical possibility that the foreclosure theory could adversely impact the 600 MHz auction must be weighed against the potential harm of limiting participation in the auction.

The harm is well documented and could prove particularly problematic in this auction. A paper coauthored by Leslie Marx, who led the design team for the 700 MHz auction when she was the FCC’s Chief Economist, demonstrates that excluding Verizon and AT&T would have even more severe consequences in the incentive auction than in previous auctions.

A paper published by economists at Georgetown University’s Center for Business and Public Policy attempts to quantify the severity of these consequences. It estimates that excluding Verizon and AT&T from the auction could reduce revenues by as much as 40 percent ($12 billion) – a result that would jeopardize funding for the nationwide public safety network, reduce the amount of spectrum made available for wireless Internet services, and adversely affect more than 118,000 U.S. jobs. That is a steep price to pay for the privilege of seeing whether the boy is crying wolf again.

One Comment

  • Alton Drew says:

    Mr. Campbell’s economic argument is spot on. I would add that since AT&T and Verizon have a higher use value for spectrum, they will submit bids that equate to this use value, thus resulting in more revenues for the Treasury and an accurate signaling of the value placed on spectrum by the market. The FCC has been saying that the auction will be market based. The FCC should put its money where its mouth is and allow for a true market-based spectrum auction.

    It also appears that by doing what it is supposed to do, that being ensuring that natural capital such as spectrum gets to carriers that show they value spectrum via bids, the FCC has indirectly contributed to lower wireless prices. The FCC should, as Mr. Campbell has shared, continue with the precedent it set in Frontline.