Arguments for Bidder Exclusion Rules Remain Weak and Inconsistent…

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Last week, the Phoenix Center released my Perspective entitled Will Bidder Exclusions Increase Auction Revenue?  A Review of the Arguments, which assessed the arguments being made about the revenue consequences of excluding AT&T and Verizon from the upcoming broadcast spectrum incentive auction.  While a number of parties have claimed that such exclusions can enhance auction revenues, I show in my Perspective that the economic theories they rely upon do not support the claim. 

In fairness, Sprint, T-Mobile, and others are quick to note that they are not proposing to exclude the two most successful carriers completely, but rather are proposing they be subject to a 30% spectrum cap on spectrum below 1 GHz.  This response to criticisms of exclusions is not compelling, however. 

First, such claims fail to recognize that a 30% spectrum cap could be an effective exclusion if the amount of spectrum proffered by the broadcasters is low. 

Second, economic theory indicates that the revenues from (and efficiency consequences of) an auction are typically very sensitive to the specific rules applied.  Importantly, no party calling for exclusions or limitations on bidding has presented a theoretical argument suggesting that their specific proposal for manipulating the auction has a chance of increasing revenues. While some particular manipulations may increase revenues (and it’s always “may”), this possibility does not imply that any and all auction limitations will increase revenue in every type of auction.  As I see it, the burden is on the companies calling for restrictions to show that the restrictions will more efficiently reallocate broadcast spectrum and increase revenues raised.  Keep in mind that AT&T and Verizon are not bidding only against other mobile broadband providers, but also against broadcasters that may prefer to keep their spectrum (and choose their own minimum acceptable bid in the reverse auction).  Further, the companies calling for bidding restrictions should be required to show that such regulations will increase consumer welfare and the efficiency with which spectrum is deployed and used.  The fact that the companies have not demonstrated either effect is a strong indicator that the proposal simply won’t produce either outcome.

Third, as noted in our recent Policy Bulletin entitled Equalizing Competition Among Competitors:  A Review of the DOJ’s Spectrum Screen Ex Parte Filing, the DOJ’s argument for steering spectrum to T-Mobile and Sprint, and specifically away from AT&T and Verizon, rests on a theory of foreclosure value.  As the Agency notes:

The Department is concerned that carriers may have incentives to acquire spectrum for purposes other than efficiently expanding their own capacity or services[,] pursuing spectrum in order to prevent its use by a competitor, independent of how efficiently the carrier uses the spectrum.  Indeed, a carrier may even have incentives to acquire spectrum and not use it at all (DOJ Ex Parte, at 10).

Thus, the DOJ reasons,

Absent compelling evidence that the largest incumbent carriers are already using their existing spectrum licenses efficiently and their networks are still capacity constrained, the Department would normally expect the highest use value for new spectrum that is in the public interest to come from rivals to the leading firms (DOJ Ex Parte, at 12).

So, the DOJ’s argument hinges on AT&T and Verizon paying a mint for spectrum and then not using it to provide service.  The theory ignores the FCC’s elaborate rules requiring build-out deadlines, adopted specifically to preclude spectrum hoarding.  Further, economic theory suggests that the largest carriers are likely to have the highest use value, as shown in our Bulletin.)

Let’s turn to why Sprint and T-Mobile don’t want to fully exclude AT&T and Verizon from the auction.  As T-Mobile explains in its recent June 10, 2013 Ex Parte filing (and here too),

… it would be against the interest of competitive carriers to exclude AT&T and Verizon from the bidding: given the realities of the global wireless market, carriers such as T-Mobile need AT&T and Verizon in the 600 MHz band ecosystem. Without the purchasing power of these two carriers, commanding attention from the global supply chain of manufacturers would prove difficult, and competitive carriers would be left facing significant challenges in acquiring affordable devices for the new band (T-Mobile Ex Parte, p. 2).

Let this soak in a minute, and then consider this:  if AT&T and Verizon do not plan on using the spectrum as the DOJ suggests, then how does their ownership in the 600 MHz band affect the global supply chain of manufacturers?  Clearly, Sprint and T-Mobile expect AT&T and Verizon to use the spectrum they obtain in the auction, and use it sufficiently so as to impact the global market for equipment.  In other words, AT&T and Verizon will use the spectrum to serve millions of customers.  In effect, Sprint and T-Mobile’s argument acknowledges that AT&T and Verizon have a high use value for the spectrum, and this admission sinks the DOJ’s argument. 

This same statement is also a blatant admission to the superior efficiency of AT&T and Verizon.  Presumably, AT&T and Verizon’s acquisition of more spectrum is likely to improve their services to the detriment of Sprint and T-Mobile’s businesses, but the two still want the larger carriers to get some of the spectrum so they can benefit from the socialized scale economies in the equipment market.  The smaller carriers’ policy preference indicates that the relative efficiencies of the larger carriers is quite large—large enough to overwhelm the competitive effects of the additional spectrum in the larger carriers portfolio. 

Also, the DOJ argues that the auction should “serve the dual goals of putting the spectrum to use quickly and promoting consumer welfare in wireless markets (p. 1).”  Obviously, Sprint and T-Mobile (among others) recognize that only with AT&T and Verizon’s help can that happen.  In addition, the DOJ argues that the FCC should ensure that “the largest firms do not foreclose other rivals from access to low-frequency spectrum that would allow them to improve their coverage and make them stronger, more aggressive competitors (p. 18).”  But here we see that the smaller carriers can’t be “strong, more aggressive competitors” without the help of AT&T and Verizon’s superior efficiencies, and that help only arises if the two have a use value for the 600 MHz spectrum.   

Furthermore, those favoring limits on the largest carriers argue that such limits will “inspire wireless innovation, and accelerate broadband deployment.”  Yet again, the argument is that innovation and deployment are the consequence of the larger carriers owning 600 MHz spectrum and bringing their relative efficiencies to bear.

Obviously, the argument for limiting the participation of the largest mobile wireless carriers in the upcoming incentive auction requires more thought than the idea has thus far been given.  Perhaps the solution is to just forgo the revenue argument altogether and hook the proposal to equalizing competition among competitors, though putting it so bluntly runs afoul of legal precedent.   In fact, we’ve already seen some movement in this direction in T-Mobile’s critique of the recent study by Holtz-Eakin and Bazelon, where they state:

… even under the extreme strawman of a complete ban on AT&T and Verizon participating in the 600 MHz auction, the authors conclude that the auction would still generate $19 billion in revenues, which is more than one-third of the revenue of all other spectrum auctions combined. As Holtz-Eakin and Bazelon concede, this “worst case” $19 billion revenue projection is more than sufficient to cover the nearly $2 billion to reimburse broadcasters for relocation costs and the $7 billion for purposes of funding the nationwide “First Responder Network Authority,” while still leaving $10 billion to compensate broadcasters for relinquishing their spectrum.

T-Mobile thus claims that even if auction revenues may be $12 billion lower without AT&T and Verizon’s participation, there’s still plenty of money to go around.  One has to ask, however, what society is getting in return for giving up the $12 billion.

The auction rules are still not formalized.  It will be interesting to see how they develop.