A week later, Sprint got half of what they were looking for when the DoJ filed suit to challenge the proposed AT&T/T-Mobile acquisition. Yesterday, if there were any doubters about Sprint's optimal outcome, Sprint announced its intention to keep those gains by filing their own private antitrust suit to enjoin the merger. Copy of Complaint here.
To hear Sprint's CEO talk, or read their pleadings, Sprint is very small in the marketplace. But around here, they call Sprint the "Whale", because they're a big boy in Washington. Everything they do is CRAZY BIG!! When they heard Justice was suing to enjoin the AT&T/T-Mobile merger, Sprint went all in. You know what I'm talking about, right Coco?
Let's take a look at what Sprint's "won" so far, and the risks that they still face before entering the capacity-constrained "promised land" of 4G with the largest cache of excess capacity.
The Beautiful Genius of Sprint's Gambit
The Guidelines are designed to limit "artificial" output restrictions by firms with market power, but Sprint has successfully convinced the government that the concentration figures in the Guidelines should be applied rigidly (in this instance) to prevent any of the largest 3 firms from quickly expanding capacity by purchasing it from the 4th largest firm (which is both capital and spectrum constrained).
In other words, Sprint understood AT&T's data capacity constraints in a much more real sense than any regulator could possibly understand. Consequently, by persuading the government to challenge the merger, Sprint can possibly compel an output restriction by one, if not two, of the remaining firms providing advanced wireless data services.
By persuading the government that "raw", undeveloped spectrum (which could hit the market in several years) is interchangeable with "working capacity", which can be easily diverted to address present excess consumer demand. Said differently, the beauty of Sprint's advocacy was that they have commandeered the tools of the Guidelines to defeat the purpose of the Guidelines.
How Justice Advanced Sprint's Gambit
First, the one big advantage Sprint gained was moving the merger decision out of the hands of the FCC, and into court with the Antitrust Division. This is important, because the only winner in Sprint's Gambit is Sprint. When other merger opponents realized this, they would have been arguing for merger conditions that allowed smaller, regional firms to become more powerful competitors to Sprint.
Approval of the proposed merger, subject to significant divestitures is a threat to Sprint. Not only is it possible that many markets would "de-concentrate" and become more competitive due to acquisitions by known participants, but large divestitures might open the door for another large telco (for example, a CenturyLink type company) to gain a toe-hold in wireless.
Second, Sprint wins by getting the DoJ to commit to its 2010 Guidelines concentration numbers for purposes of analyzing this, and perhaps future wireless transactions. This represents a potentially significant departure from past analyses, because it has the effect of making the smaller competitors acquisition targets (because they have limited growth ceilings), rather than marketplace threats. For Sprint, the oligopoly is the finish line--it doesn't matter who's left in the market, as long as existing firms will be leaving, and new firms won't be entering.
Third, Sprint--through the DoJ--has succeeded in reducing competition by creating artificial exit barriers. In other words, firms that invest, obtain a measure of success, and then seek to leave the market would now be required to "pay" a "penalty" (accept less than the fair value of their enterprise) in order to get their investment out. So, assuming there is a firm large enough to buy T-Mobile as an ongoing competitor (say China Mobile), and continue to invest in T-Mobile, the Department would minimize that risk for Sprint by declaring T-Mobile to be a "liquidity trap."
The Risks: The Whale No Hesitate--Sprint Goes All-In
Why did Sprint file its own, almost identical, antitrust case? We know that it won't be consolidated with the DoJ case, because--as noted in the 8/23 post--only the Government represents consumers and competition. Sprint, unlike the Government, needs to allege a Sprint-specific injury, which it makes only the vaguest attempt at asserting in a scant, vague 5 paragraphs at the end. Sprint's goal is not to win, but to have a voice in the settlement of the case.
First, Sprint needs this litigation to have a zero-sum outcome, and they've drawn a judge that is known for moving the litigation along. So, the worst case for Sprint is that Justice settles. Why? Because the likely result would be a stronger T-Mo/AT&T competitor plus amped up competition from U.S. Cellular, Metro PCS and Leap who would likely be the beneficiaries of significant divestitures. So even though Sprint's complaint will eventually be dismissed for lack of standing, the presence of the complaint is designed to put added pressure on DOJ not to settle.
Remember, if Justice wins the case, they only enjoin the deal as structured. AT&T can withdraw its existing merger application at any time and come back with a new deal with DT. Because of this omnipresent possibility, it may be the case that, paradoxically, the best outcome for Sprint would be to keep the litigation going if it looks like AT&T will "win." In that sense Sprint's filing is tactical, not substantive.
Second, Sprint's interest foreshadows that Sprint sees a significant role for itself in any Tunney Act proceedings to evaluate any settlement of the DoJ/AT&T litigation. (The Tunney Act requires the DoJ to put out all DoJ antitrust settlements for public comment and that a court review the settlement to ensure that it adequately addresses the concerns identified in the complaint.) This is the big risk that Sprint has overplayed its hand and will provoke a "fix it first" solution wherein the litigation is dismissed, the transaction is restructured so AT&T gets the capacity it needs, and DT gets a fair price for the assets that will go to strengthen smaller competitors.
Virtually from the announcement of the AT&T/T-Mobile merger, both Sprint's advocacy and Sprint's ultimate goal in its opposition to the merger (blocking the merger outright) have been a puzzle to me. Specifically, Sprint's categorical opposition to the merger makes me wonder: "why the opposition?" and "what are they really looking for here?"
Sprint's superficial, substantive arguments against the merger are a fairly generic, typical "Guidelines" style analysis from a consumer welfare (rather than Sprint-specific) perspective. Coming from a competitor, these arguments invite suspicion.
In fact, the Supreme Court has been extremely skeptical of competitors seeking to block mergers on the grounds that "competition" will suffer as a result of the merger. See, e.g., Brunswick Corp. v. Pueblo Bowl-O-Mat, Inc., 429 U.S. 477 (1977)(rejecting antitrust standing of competitors seeking to block an acquisition on the basis that it would concentrate the market, and leave the post-merger firm with lower costs, creating a potential threat to plaintiff competitors).
Regardless, it makes little difference whether Sprint's opposition is motivated more by self-interest than the public interest. However, Sprint has been quite clear in its advocacy before the FCC and the Congress that the objective of its advocacy is to see the proposed transaction blocked.
The Puzzling Perplexity of Sprint's Advocacy Goals
If Sprint's preferred outcome is for the proposed transaction to be completely blocked, then we have to ask, how does this outcome maximize Sprint's self-interest? This is the question that is so vexing to me. After all, if a market becomes more concentrated, and leads to price increases and less innovation, one would expect that the last party to complain would be a competitor remaining in the post-merger market.
It seems obvious that Sprint will only benefit from higher retail prices. Less innovation, as well, would have its rewards in terms of reduced capex pressure, and reduced pressure to constantly roll out new bandwidth-gobbling devices. These are real benefits, so why does Sprint want the merger blocked (vs. "conditioned")?
A true "gambit" requires that a player sacrifice something of value to gain a greater strategic advantage. In this gambit, there are at least two very obvious sacrifices that Sprint is willing to accept from the outset.
The first sacrifice is that Sprint will not seek merger conditions, because (according to Sprint) there are no conditions that could mitigate the consumer harms created by this merger. This is a "real" sacrifice, because Sprint could have reasonably expected to extract some valuable concessions.
The other sacrifice is much more significant, but has gone completely ignored by the industry insiders and press. The fact is that Sprint, through its advocacy, has disqualified itself from acquiring T-Mobile. So Sprint is not seeking to disqualify AT&T from acquiring T-Mobile, so that it may subsequently acquire T-Mobile for a lower price.
This sacrifice is an unequivocal and inseparable part of its economic analysis of the merger. As Sprint explains, the current proposed merger allegedly increases the HHI by 700 points, based on market share numbers listed. On the other hand, a Sprint/T-Mobile merger would move the same "highly concentrated" baseline HHI up by 500 points. See Table 4 ("postpaid only" column) in the economics declaration in Sprint's Petition to Deny (p. 257 of 377).
It is, therefore, quite clear that Sprint's analysis--if accepted by the government as a basis to block the merger--would also disqualify Sprint and Verizon as subsequent bidders for T-Mobile, thus "cementing" the "national wireless market" (if you buy this definition) as a 3 firm market. Why do I say 3 carriers when we are left still with 4 "national" providers? Because in that world, T-Mobile is fundamentally crippled from a competitive standpoint and that, in essence, isthe big win.
The Gambit Payoff
Consider the advantages to Sprint of a capacity-constrained 3 firm oligopoly market structure.
1) Customer Share/Acquisition. Constructively, T-Mobile will be an island, cut off from ready access to capital from its parent, Deutsche Telecom. Without a "true" 4G network, T-Mobile will gradually lose customers to other carriers in the market. Many would argue that Sprint is the next best substitute for T-Mobile, so Sprint may gain disproportionately from T-Mobile customer defections.
2) Accelerated Growth in Data Services. Let's assume that Sprint (rationally) believes the fact that AT&T is very data capacity constrained. If the government successfully blocks AT&T's proposed acquisition of T-Mobile, the remaining three 4G carriers (remember, under the Sprint theory we virtually ignore other competitors like Metro PCS who may have 4G networks, too) have no real means to acquire additional spectrum capacity.
The number one provider of wireless data service--AT&T--will be supply inelastic in most cities for the foreseeable future (no capability to acquire sufficient spectrum). This puts AT&T in a "shortage" situation, where it must set prices not to maximize profits, vis-à-vis costs, but to increase prices, and reduce output, in an effort to ration service consumption.
Once AT&T is forced to implement "congestion pricing", it is logical to expect that Verizon, the number two wireless data provider, will adjust its own prices in order to preserve its network capacity in a spectrum-constrained market (it can't acquire spectrum either). The only party that "wins" in this scenario is the firm with the largest excess capacity--Sprint--which through its and Clearwire's holdings has more spectrum, and more capacity than anyone else in the market, including AT&T or Verizon. See FCC's 15th Wireless Competition Report, at Table 28 (Sprint/Clearwire has a weighted avg. of 184.4 MHz of spectrum vs. a combined weighted avg. of 173 MHz for AT&T and Verizon Wireless combined)
3) Peace of Mind. Can you ever really put a price on it? With a tight 3 firm oligopoly, characterized by high barriers to entry, Sprint no longer has to "watch its back" as the undisputed "national" value brand.
The Beautiful Genius of Sprint's Gambit
Sprint's analysis virtually ensures a 3 firm oligopoly going forward, because every potential bidder with the experience and financial capacity to acquire T-Mobile is eliminated. T-Mobile lacks the resources to build out a 4G network, and no other carriers have the kind of money they would need to buy T-Mobile, at their present size, and then upgrade T-Mobile's network to being 4G capable. Finally, if T-Mobile has to continue as an independent carrier, their only realistic alternative for offering "national" 4G services is through . . . Sprint's majority-owned wholesale carrier, Clearwire. This is a brilliant gambit.
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.
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.
Yesterday, NAB President Gordon Smith speculated that the proposed AT&T/T-Mobile mergercould reduce the amount of money the Treasury might have previously expected to receive from voluntary auctions of unused broadcast spectrum. Mr. Smith, a former U.S. Senator from Oregon, theorized that if he were still in the Congress (which must authorize any re-purposing of spectrum from broadcast to mobile wireless) he would have second thoughts about the proposed voluntary auction, based on the amount of money it would produce with one potential bidder removed.
Mr. Smith reasoned that an auction with one fewer bidder would, necessarily, yield lower prices for the auctioned commodity--in this case, spectrum. But, here's where it helps to better understand that spectrum is unique, scarce, and owned by a monopoly--the United States Government.
Chairman Genachowski, to his credit, has been earnestly and convincingly explaining at every opportunity--from the White House Spectrum Summit to the NAB Show--the importance of voluntary auctions to relieve the impending spectrum shortages facing the country. The facts are stark. Wireless broadband demand is quickly out-stripping spectrum capacity in the aggregate.
So, what about Mr. Smith's observation? In an auction for goods that have substitutes, Mr. Smith's auction theory has some merit. In an auction for antique furniture, for example, the removal of one bidder (who might uniquely value one item over another) might well affect the total auction value. However, that's not the situation here.
The spectrum market, as Chairman Genachowski has effectively explained, is characterized by a type of market failure known as "shortage", or a situation where demand for the available quantity of a product exceeds the available supply. Those of you old enough to remember can recall the Arab Oil Embargo.
In this situation, a cartel controlling a significant portion of the world's available oil decided to refuse to supply oil to the United States. Demand for oil could not be quickly displaced to another substitute. As a result, the price of oil quadrupled and gas prices increased daily, resulting in long lines at the pump and gasoline rationing.
Now, imagine you were a trucking firm at that time. Supply of an indispensible input has been constricted for all firms. Let's say some trucking companies merged, so that there were fewer colors of trucks waiting in the gas lines. But, there wouldn't be fewer trucks, because consumers still demand transportation for all the same products. Will the price of gas really change just because there are fewer colors on the trucks in the gas line?
Of course not; and this is the fallacy of Mr. Smith's argument, which--if taken to its rational conclusion--contradicts itself. Anyone that has ever played the game Monopoly understands that the hypothetical monopolist is willing to pay the highest price for scarce property. Like Boardwalk and Park Place, a spectrum monopoly is very valuable--and would garner the highest revenue for the government.
In the case of additional spectrum, the government is the monopoly supplier in a shortage environment. If it simply wanted to capture the greatest amount of money, it would sell the spectrum in one big block to the highest single bidder--in effect auctioning off market power.
Fortunately, the Communications Act requires the FCC to structure its auction rules in a way that allows the most participation by the most firms. Do the provisions of the Act, which requires small firms to be able to compete for spectrum with large firms, reduce the government's returns from an auction? Probably, but the public benefits from the vibrant competition produced by these auction rules. As a former Senator, Mr. Smith should understand this.
Before I talk about some else's "ugly"--I'll 'fess up and say that last post was dry as dirt. You know what's worse? "The Ugly" isn't going to be any less ugly!
So, let's just move through it. The "ugly" part of the Wireless Competition Report is the adjacent market analyses--the "downstream" and "upstream" markets information. While some of this data--meticulously compiled as it was--is . . . well . . . interesting, but its relevance to the state of competition in the mobile wireless services market is questionable.
Simply put, the adjacent market analyses were superfluous, almost by definition. Why? Because, strictly speaking, the statutory language that mandates the preparation of the Report requires the FCC to report on the state of the mobile services market and the service providers that comprise that market--period. This means that the market for which Congress seeks information on is the market to be isolated. Congress did not require the Commission to Report on "downstream" markets, or any other ancillary markets.
Strictly speaking, the "downstream" markets for devices, operating systems, and mobile applications seem almost too integrated with wireless service to be considered "downstream" in the production/distribution chain. This is because it is not possible to receive any wireless mobile service without some sort of device. Semantics aside, though, the Commission's data seems consistent with healthy competition in the wireless market--that is to say that output of handsets is increasing by number of manufacturers (which have doubled from 8 to 16 in the past 3 years), Report, ¶300, and the prices of handsets and smart phones have decreased dramatically in the past 3 years, Report ¶310.
But, the chicken-egg problem still exists, with respect to being able to make any inferences regarding the state of mobile wireless service competition based on the "downstream" market data. The largest carriers offer consumers the greatest choice of handset and smart phone models. Report, ¶308, Chart 43. However, one cannot say what this information means vis-à-vis the competition for mobile wireless services. Do the largest carriers have the most customers because they offer the most handsets? Or, can the carriers with the largest number of customers offer the greatest choice in handsets because they have diverse enough customer bases to support the most diverse number of handset models? Is there another, more anticompetitive, theory to explain the relationship between "downstream" market devices and mobile wireless service competition? We don't know. No correlation between handsets and service competition is ever offered. This is the "ugly." Informative? Sure. Probative? Of what? Not clear.
The "upstream" market section of the Report suffers from the same problem--the difficulty of drawing a correlation between mobile wireless service competition and the "input" markets of spectrum, access to tower sites, network equipment costs, and backhaul costs. As noted in one of the previous posts, I did "kind of" like the effort to look at inputs. . . at first . . . until I thought about it more. On deeper consideration, it seems unlikely--given the economies of scale and scope that characterize wireless mobile networks--that this exercise is ever likely to produce any information that would not be potentially misleading. Rather, it would seem that the large economies of scale and scope in the wireless network services market would simply indicate that (other things being equal) the carriers that serve the largest number of users (either directly, or through MVNOs) will have the lowest costs per user.
Also, the Report failed to describe to what degree, if any, these costs were competitively significant. In other words, to some degree or another, all carriers must deal with the "role of spectrum", obtaining tower space, network equipment, and backhaul from their cell sites or other points of aggregation. It was unclear from the Report whether any carriers face input costs that cannot be overcome by superior competitive performance.
Role of Spectrum. Here the Commission posits that some firms (the first movers on cellular spectrum in the 1980's, and the winners of the 700 MHz auction) have better spectrum than others, in that it is cheaper to build out--due to its superior propagation properties. However, the Commission also notes that this "lower build-out cost" spectrum costs more to buy than the more expensive to build-out, higher frequencies. Report, ¶271. This seems like the classic "operating leverage" concern confronting all firms in all industries.
A higher initial fixed cost, can frequently yield very high profits--past a given output level. Conversely, a lower initial cost of entry is often associated with higher variable costs. Neither is necessarily best. For example, many MVNOs probably outperformed many facilities-based networks over the past few years. Will MVNOs, with their low cost of entry and high variable costs, always outperform the same facilities-based carriers? Who knows?
Other Infrastructure Costs. Costs associated with tower site acquisition, and associated network equipment, seem to favor the firms with the largest established customer bases. This is because it costs less to incrementally add sites than it is to build a network starting with a low customer base. Again, while this suggests that the wireless mobile market is characterized by high fixed costs, it does not explain whether "newer" entrants--with less investment in legacy network design, equipment, and reliance on traditional forms of backhaul (copper DS1s and DS3s)--are able to compensate for these higher costs of initial entry with greater capacity, lower operating costs for a given number of subscribers, and greater revenue opportunities (for example, through offering higher-speed broadband services through newer network design).
Backhaul. It is, likewise, unclear to what degree backhaul costs effect competition in the mobile wireless industry, or the degree to which wireless demand affects competition in the backhaul market. The Commission notes that "traditional" copper backhaul is quickly losing ground to fiber-based backhaul. Report, ¶294. However, the Commission also suggests that "unaffiliated" (with an incumbent LEC) wireless carriers may be at a disadvantage to "affiliated" wireless carriers, due to the costs of special access backhaul (traditionally provided by the incumbent LEC). Report, ¶¶ 295-296. On the other hand, given that the largest two wireless networks are also the largest purchasers of "other" incumbent LEC backhaul, it would be helpful to know whether these two carriers have a greater incentive/propensity to differentiate their costs by devoting more "spend" to out-of-region competitive fiber providers--thus promoting backhaul competition.
Another problem with the "backhaul" section is that it never attempts to quantify backhaul costs in absolute terms, or as a percentage of annual costs or revenues. The only reference it makes is to a study in Verizon Wireless' NOI Comments, stating that backhaul was expected to increase from a $3 billion market now (2008 total mobile wireless revenues-$150 billion (Report, ¶201)) to an $8-10 billion market in the next 5 years). Report, ¶296, n.785. Assuming an industry cost of backhaul at $3 billion, this would put backhaul costs at slightly less than advertising costs, at around $3.4 billion for the most recent year. Report, ¶128.
It might be the case that backhaul costs, and the other "upstream" input costs discussed in the Report, are a competitive concern, but the Commission didn't support this rhetoric with data. Again, misleading, and, therefore a little "ugly" . . . .