May 24, 2011 7:39 PM

A "Leap" in the Wrong Direction: Regulatory Problems Disguised as Merger Concerns

Yesterday, Leap Wireless ("Leap") added its voice to those opposed to the AT&T/T-Mobile merger.  What is interesting about Leap's opposition, are Leap's claimed concerns about the acquisition.  According to Leap's Chairman, Doug Hutcheson, the proposed AT&T/T-Mobile merger:

raises problems of spectrum concentration and impaired access to spectrum by competitive carriers; undercuts access to wholesale voice and data roaming services; and threatens to foster reduced device availability and reduced interoperability of wireless networks and devices, among many other issues.

See Leap Press Release. (emphasis added)

Mr. Hutcheson expresses some important concerns about the future of the wireless industry, although it's unclear how any of these concerns are necessarily exacerbated by the merger, or would be mitigated by cryogenically preserving T-Mobile in its present state.  However, I do sympathize with Mr. Hutcheson's concern over whether smaller carriers have been getting a fair shot at spectrum, and whether things will change for them in the future--though I disagree that the merger is the appropriate target of this frustration.  In other words, there is no immediate solution that could mitigate Leap's concerns, or solve AT&T's capacity crunch.

Unfortunately, the lack of available spectrum--without acquiring it from other carriers--puts Leap and AT&T on different sides of the same coin.  Ideally, the FCC would recognize that smaller carriers (not just unrealistically small "new entrants") should be eligible for "designated entity" ("DE") bidding credits in upcoming spectrum auctions.  Similarly, the Commission should allow these carriers the flexibility to build out their networks by leasing wholesale capacity to whomever they choose, as long as they are building out their license areas.  

The optimal spectrum auction policy would be for the Commission to make room for smaller carriers to grow, and to use the demand of larger carriers to assist in this growth.  Unfortunately, the Commission's existing auction rules foreclose this pro-consumer alignment of incentives between large and small carriers.

The FCC's Auction Rules Harm Small and Large Carriers

In Auction 66 (for AWS spectrum), the Commission adopted rules that limited the ability of incumbent carriers to access "secondary" markets for wireless capacity.  These rules restricted the ability of larger wireless carriers from purchasing/leasing wholesale services from smaller carriers that obtained their spectrum capacity as "designated entities" ("DEs") under the parts of the Act/FCC rules designed to promote access to spectrum by small businesses.  The Commission allowed these rules to remain in place for its 700 MHz auction.

DEs receive bidding credits at spectrum auctions that are designed to put them on more equal footing with larger, incumbent providers of wireless service.  Traditionally, if a DE won an auction, then it could obtain additional sources of funding to build its network by wholesaling excess capacity, to its larger rivals.  This allowed larger firms access to temporary capacity while upgrading their own capacity, and became an indispensable source of capital for DEs from a resource that would otherwise go unused.

The Commission's actions in 2006-2007 virtually foreclosed DE participation in Auctions 66 and 73.  The full history of the FCC's counter-productive restrictions on DE wholesaling (which have harmed both new entrants and incumbent service providers) can be obtained from the Third Circuit's decision vacating two of the three most destructive restrictions on wholesale market participation by DE's.

In its opinion vacating two of the three challenged rules this past August, the Third Circuit admonished the Commission,

we note the Commission's inattention to the nature of the wireless wholesaling business. ... Given the extensive provision of services entailed in wireless wholesaling, it is not at all obvious that the FCC[] . . . should necessarily . . . prohibit[] DEs from engaging primarily in the wholesale business, so long as they do not sell or lease overly large quantities of their capacity to any single lessee or buyer. The FCC appears to have failed to even acknowledge this issue. We commend it to the Commission's attention on remand.

Council Tree Communs, Inc. v. FCC, 619 F.3d 235, 254, n.8 (3d Cir. 2010) (emphasis in original).  The court vacated and remanded the Commission's rules in August 2010, but the Commission still has not addressed this remand--even though it plans to auction 12 MHz of 700Mhz spectrum this coming July.

The Spectrum Conundrum

Prior to introducing the iPhone in early 2007, AT&T had about 61 million wireless customers at the end of 2006. See Chart 1, p.17.  By then end of 2010, AT&T had 96 million customers.  During that time period, AT&T completed 3 smaller, spectrum-motivated acquisitions that probably added, at most, about 5 million customers. See pp. 53-54.  Thus, AT&T--in 4 years--saw its customer base organically grow by more than 50%.  These customers increased wireless data demand by over 8,000% during this same time.  It only makes sense that such an increased production in network output would lead to an increased demand for critical inputs, like spectrum.  

But, even if spectrum were available--which it is not--could Leap expect an opportunity to acquire it at auction on terms that would allow it to build the spectrum economically, through wholesale leasing to any carrier?  The FCC has said "no", by failing to act on the Third Circuit remand.  Saying "no" again, to the AT&T/T-Mobile merger, does not help smaller firms like Leap Wireless.

As Congress conducts its hearings on the merger, it should be careful to listen to problems raised by competitors.  Congress should also keep in mind that it's easier for competitors to attack a merger than their regulator.  Thus, Congress must keep an ear out for problems that are likely to be industry-wide regulatory issues disguised as merger complaints

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