Convergence 2.0

With the notable exception of video programming, the FCC has traditionally focused its regulatory efforts on certain portions of our communications infrastructure: The public switched telephone network, the coaxial cable plant, the cellular network, broadcast towers, and satellite space and earth stations. To the extent computing capability and devices (though arguably inappropriate, let’s call computing capability and devices “nodes”) have been considered by the FCC at all, it has targeted the treatment of nodes by the operators of certain portions of the Internet’s infrastructure rather than the manufacturers and distributors of nodes themselves. The FCC has also regulated various portions of the Internet’s infrastructure using separate regulatory regimes based on their technical characteristics.

Convergence 1.0 – the convergence of communications and computing capabilities – began disrupting this “stovepiped” regulatory model in 1966 when the FCC began is Computer Inquiries. Convergence 2.0 – the complete integration of computing, networks, nodes, software, services, and content – is now rendering the model hopelessly obsolete:

• Computing capabilities have become inseparable from network infrastructure;
• Different network infrastructures (e.g., mobile and fixed) are beginning to provide integrated services;
• A single type of node can access different network infrastructures (e.g., a smartphone can access a fixed or mobile network);
• Multiple types of nodes can use the same operating systems and software (e.g., a converged OS X and iOS are expected to power the Apple iPhone, iPad, Apple TV, Apple laptops, and Apple desktop computers with in the next two years);
• Multiple network and node types can provide the same type of services; and
• Content can be created and distributed by anyone using any combination of service, software, node, network, and computing capabilities.

The convergence of networks, nodes, software, services and content into platforms offering seamless communications experiences is already driving disruptive competition in the communications sector. I expect it will soon be driving disruptive regulatory change as well.

Cloud Computing

Cloud computing isn’t new. It’s on the list because it is only now beginning to impact end-user behavior – the issue at which the FCC tends to target its regulation.

As cloud computing matures, it is making users truly node and location independent. Services like Dropbox and Evernote synchronize all of a user’s files across all their nodes and the nodes of others with whom they wish to share. Automatic syncing of files and preferences is making it easy for families to share nodes. If I need to work with image files, I might take my 17-inch laptop on the road while other family members use the desktop and iPad. When I return and want to use the desktop, they can use the laptop knowing that all the files and preferences they’ve changed while I was away will be there waiting for them. Although smartphones are still generally tied to particular users based on phone numbers, services like Google Voice are rendering this limitation on node sharing less relevant. All nodes are becoming capable of providing both phone and computing capabilities that differ primarily in form factor rather than use.

Cloud computing is also proving to be one of the “killer apps” driving the mobile data explosion and spectrum crunch. When the “need for speed” was debated in the National Broadband Plan proceeding, many assumed additional capacity would be needed to accommodate future applications with high peak or sustained throughput. Greater capacity is needed right now due to the use of existing applications that are leveraging the capabilities and convenience of the cloud. “Applications” that once required little or no Internet bandwidth at all – e.g., transferring a file from home to the office using a thumb drive – now generate Internet traffic multiple times per day to access the cloud’s enhanced capabilities. Cloud computing also generates traffic by making current applications more convenient to use. Recent reports indicate that Apples’s cloud-based Siri application has already doubled data use on the iPhone.

As these shifts in usage become more prevalent, the FCC’s current approaches to many issues will have to shift as well. I never thought I’d say this, but it’s time the FCC put its head in the cloud.

Hotspot 2.0

Wi-Fi is increasingly being used to offload data traffic from mobile networks, but generally doesn’t provide as seamless an experience as a mobile network, primarily due to authentication and security issues. Hotspot 2.0 promises to bring the mobile network’s end-user experience to Wi-Fi through a standards-based approach. A complementary initiative, the Next Generation Hotspot, is addressing interoperability between Wi-Fi and mobile network operators and service providers on the backend. Together, these two initiatives could break down the walls that currently divide licensed and unlicensed networks.

The integration of unlicensed spectrum into mobile networks raises several questions at the FCC. If these initiatives are successful, should unlicensed spectrum be included in spectrum aggregation analyses (i.e., the spectrum screen)? If enterprise vendors of unlicensed networks using new Wi-Fi technologies are able to successfully compete with licensed mobile network operators, should the FCC attempt to address the potential regulatory disparities between licensed and unlicensed networks? I expect these questions won’t be easy to answer.

Small Cells

Small cells are like Wi-Fi hot spots that use licensed spectrum and are already integrated into mobile networks. Some argue that the spectrum crunch can be solved by increasing capacity with small cell deployment. However, there are both economic and regulatory barriers to widespread deployment of small cells. According to a Gartner report, global mobile data traffic is expected to grow 26-fold between 2010 and 2015, while revenue is expected to double. The gap between data revenues and traffic will tend to limit the availability of capex for extensive small cell deployment.

The regulatory barriers are actually more daunting. Operators often are required to reach agreements with municipalities before deploying small cell networks. AT&T initially submitted an application to the City of Palo Alto on January 14, 2011, to build a small cell network, but is still awaiting a decision more than a year later. The availability of backhaul is also a significant problem. Laying fiber to thousands of small cells mounted on light poles is cost prohibitive and impractical. Wireless backhaul solutions will likely work in many situations but may be unable to handle large numbers of small cells. Cable plant may offer the most practical solution in many instances, but now that cable is entering the mobile space through its relationship with Verizon, cable may not be willing to share its plant with potential competitors. The FCC has taken steps to lower regulatory barriers to antenna siting, but it may need to move faster and go further before we see widespread deployment of small cells.

Not so fast. The Chairman also said “getting it right is as important as getting it done.” By “getting it right,” he means doing it the FCC’s way rather than the way Congress has proposed. Chairman Genachowski took issue with provisions in the House bill that would prohibit the FCC from allocating cleared spectrum bands for unlicensed use by companies that didn’t pay the price required to clear those bands, and would prohibit the FCC from rigging the auction results by limiting the ability of certain companies to win. Even assuming the FCC would do a better job making such decisions, I can’t agree that doing it the FCC’s way is more important than doing it at all when the FCC Chairman says doing nothing would kill jobs, harm consumers, and hurt our global competitiveness. (For a more detailed look at the substantive issues, see posts here and here.)

As AT&T said on its policy blog last week, “it would be a disservice to the Nation if the FCC is so adamant about preserving and enhancing its own power that it would risk killing this crucial legislation.” The House and Senate have already compromised on the key issue that held up the legislation last year, which was the reallocation of the D Block to public safety. We can’t afford to further delay the deployment of a nationwide, interoperable public safety network or the availability of more mobile spectrum while we argue about the extent of the FCC’s regulatory authority. It’s time to embrace the public safety compromise forged in Congress and declare victory.

The key phrase in the letter is the desire to “set aside” spectrum for unlicensed use. Once spectrum is set aside for use on an unlicensed basis, that set aside is permanent – as a practical matter, alternative uses of the spectrum become impossible. I acknowledge that the FCC’s rules say that unlicensed uses are not entitled to protection from interference, which in theory means that unlicensed spectrum could easily be converted to other uses. But when the FCC has been confronted with proposals that would result in interference to unlicensed devices, the FCC has chosen to protect the unlicensed use no matter what its rules say. If the FCC sets aside more spectrum for unlicensed use, it would preclude other potential uses of the spectrum for the foreseeable future.

Limiting the use of cleared spectrum solely for unlicensed devices would also fundamentally change our current approach to spectrum policy. Congress and the FCC have been moving away from prescriptive spectrum policies for more than a decade. The result has been an explosion in wireless innovation and consumer demand. The current FCC, however, has begun to reverse course. It has shown a tendency to impose its own views regarding optimal spectrum use via government fiat rather than allow the high tech industry to balance the tradeoffs inherent in wireless network design. Congress is more than justified in limiting the ability of the FCC to return to more prescriptive spectrum policies.

The letter says government-mandated use of spectrum for unlicensed devices is the “truest form” of free markets. In a free market, economic intervention and regulation by the state is limited to tax collection and enforcement of private ownership and contracts. The House bill would provide market participants an opportunity to decide whether spectrum should be used for unlicensed devices (a private commons) or for some other purpose, and if it were used for unlicensed devices, how the potential for interference would be avoided. The letter advocates government-mandated use of the spectrum by unlicensed devices pursuant to mandatory technical requirements. That is not a free market approach to spectrum policy.

The letter closes with an ironic appeal to “suppress our desire to be overly prescriptive” and allow the FCC to set the course because technology is “ever-changing.” The House bill would allow the high tech industry – the experts most capable of adapting to changing technology – to decide how spectrum is used. If the market is allowed to decide, it is possible the high tech industry will determine that the spectrum is best put to licensed use. The statements of FCC Commissioners leave no doubt, however, that if the FCC were allowed to decide, it would mandate some portion of the spectrum be put to unlicensed use irrespective of market forces. The fundamental choice before Congress is whether it believes the high tech industry or the FCC is better positioned to decide how spectrum should adapt to a rapidly changing technology environment. With due respect to the FCC, history suggests the high tech industry is the better choice.

Although I appreciate the FCC’s desire for unlimited authority, it isn’t surprising that the House has proposed to limit the scope of the FCC’s delegation over spectrum policies granting special market privileges to favored technologies, services, or industry groups. Rather than make things better, FCC attempts to fine tune the market through government privilege typically result in unintended consequences that make things worse.

Spectrum Cleared at Auction Should Not Be Allocated on an Unlicensed Basis

Although the FCC’s policies authorizing the use of encumbered spectrum bands on an unlicensed basis have generally proven successful, the FCC’s attempt to make cleared spectrum available for unlicensed use in the PCS band was largely considered a disaster. Unlicensed advocates are nevertheless urging that Congress permit the FCC to authorize unlicensed use of TV band spectrum that has been cleared through an incentive auction – spectrum that would otherwise be ideal for licensing by auction.

Harold Feld recently extoled the ability of unlicensed devices in the TV bands to work “really well for mobile broadband” and send signals “up to 60 miles.” If Harold is right, such devices could be used to provide mobile broadband services that compete directly with services provided by operators who paid for spectrum licenses at auction. Why should the FCC use the proceeds from the auction of one block to clear another spectrum block and authorize its use for free when both blocks will be used to provide competing services? The FCC hasn’t attempted to answer that question. In the absence of an FCC analysis supported by persuasive evidence demonstrating that the proposed unlicensed approach would be preferable to proven spectrum policy, unlicensed advocates are asking Congress to take a leap of faith. Congress should not accept an invitation to yell “Geronimo” when the U.S. is in the midst of a spectrum crisis that is threatening its competitiveness.

The Case for Unlicensed Spectrum (“Milgrom”) offered by unlicensed advocates asks more questions than it answers. Unlicensed advocates say “the primary benefits of unlicensed spectrum may well come from innovations that cannot yet be foreseen.” (Milgrom at p. 2.) They rely on the “story of Wi-Fi” to provide evidence that unlicensed spectrum increases the “pace of innovation.” (See Milgrom at pp. 9-11, 15.). Wi-Fi is an innovative technology, but it took longer to develop and deploy than mobile technologies. The FCC first set aside spectrum for cellular services in 1981 and spectrum for unlicensed use enabling Wi-Fi in 1985. The first Wi-Fi standard (a spread spectrum technology) wasn’t finalized until 1997, and the first Wi-Fi capable laptop wasn’t released until 1999, almost twenty years after unlicensed spectrum was first made available for spread spectrum technologies. (See Carter, Lahjouji, and McNeil here at pp. 23, 28-29.) By 1999, spread spectrum technology was already widely deployed in licensed mobile networks, and in 2000, the 3GPP standards body released its third-generation standard for mobile networks. Unlicensed advocates don’t attempt to explain why unlicensed and mobile technologies developed at such different rates.

Unlicensed advocates also argue that free access to unlicensed spectrum “encourages a more competitive market structure” because the cost of deploying an unlicensed network is “extremely low” and the “services that operate on unlicensed spectrum increasingly compete with services offered by operators that rely on license spectrum.” (Milgrom at p. 15.) Fair competition benefits consumers, but promoting competition through disparate regulatory treatment of competitive services distorts economic incentives and outcomes. (One of the FCC’s fiscal year 2010 performance goals is to “ensure harmonized regulatory treatment of competing broadband services.”) The low cost of deploying unlicensed networks is in part explained by such regulatory disparity. Unlike licensed spectrum users, unlicensed network operators have no build out requirements and aren’t subject to government oversight of their deployments. They also are not subject to other public interest obligations generally imposed on licensed mobile service providers (e.g., hearing aid compatibility requirements). Given these advantages, operators using TV band spectrum to support mobile services would be free to cherry-pick the most valuable customers while leaving costly deployment in rural areas and lower income communities to licensed operators who are subject to greater regulatory scrutiny. Unlicensed advocates do not attempt to address the competitive or public interest impact of such a policy regime.

Finally, unlicensed advocates argue that using an auction to determine the relative allocation of licensed and unlicensed spectrum would be untenable. (See Milgrom at p. 24-26.) The advocates recognize that the “beneficiaries of unlicensed spectrum are the manufacturers of all these devices,” but then make the mistake of assuming that these manufacturers would be unable to compete in an auction. (See Milgrom at p. 15.) Device manufacturers know how to form consortiums that value and monetize usage rights made available for collective use: They are called patent pools. Google was willing to pay $12.5 billion for Motorola’s patents in order to protect the open use of Android, Google’s mobile operating system. That’s more than double what Verizon Wireless paid to outbid Google for a nationwide spectrum license in the 700 MHz auction. If unlicensed use of cleared, nationwide spectrum in the TV band were as valuable as unlicensed advocates suggest, Google would have had an incentive to actually win the spectrum and make it available on an open basis (known as a “private commons”) similar to its practices with Android. Google could have recouped its investment through fees assessed on other device manufacturers (akin to patent royalties), fees to end users, or a dynamic auction mechanism. Alternatively, a consortium of manufacturers could have bid on the spectrum and made it available to its members as a private commons (akin to a patent pool or the work of the Open Handset Alliance). Unlicensed advocates don’t explain why manufacturers can form consortiums to pool patents or develop a mobile operating system (the Open Handset Alliance is comprised of 84 different companies), yet it is untenable for them to form a consortium to bid on a spectrum license.

If auctioning unlicensed spectrum is possible and unlicensed spectrum provides as much value as licensed spectrum, why do unlicensed advocates so strenuously oppose unlicensed auctions? I can think of at least two reasons. First, if a manufacturing consortium buys spectrum at auction and makes it available as a private commons, the consortium’s use of the spectrum would be subject to the public interest obligations applicable to licensed spectrum (e.g., build out obligations). Second, the manufacturers would have to invest their own capital to buy the spectrum and bear the risk that use of the spectrum on a private commons basis proves less valuable than projected (it is the taxpayer who bears that risk if the spectrum is made available for free). Why should manufacturers pay for spectrum subject to costly public interest obligations and market risk when they can try to convince the government to give them unregulated spectrum for free through the art of political compromise? Congress doesn’t need unlicensed advocates to answer that question.

Auctions Should Not Be Subject to Eligibility Restrictions

The FCC’s attempt in the mid-1990’s to implement policies restricting auction eligibility proved disastrous. In so-called “entrepreneur auction” completed in 1996, the FCC restricted the bidding to small businesses and allowed them to pay 90% of their winning bids through installment payments over ten years. Less than one year after the auction was completed, it was apparent that many bidders would be unable to raise enough money in the private capital markets to meet their obligations to the government, so the FCC suspended their payment obligations. (See CBO Report here.) It took nearly ten years to resolve the legal issues plaguing these licenses and reassign them to operators capable of providing service to the public. Rather than create additional competition, the FCC’s eligibility restrictions deprived the mobile industry of approximately 30 MHz of nationwide bandwidth for close to a decade at a cost to society of $65 billion. (See Hazlett, Porter, and Smith here at pp. 16-18.)

When the 700 MHz auction closed in 2008 (Auction 73), the FCC noted the auction had produced approximately as much revenue for the U.S. Treasury as all other previous auctions combined (excluding the 2006 AWS-1 auction (Auction 66)). (See exhibit here.) Auction 73 generated approximately $19 billion in net winning bids while all other FCC auctions (sans Auction 66) generated approximately $45 billion in net winning bids. (See FCC auction results here.) Although those auctions raised $45 billion on paper, the U.S. Treasury only received approximately $19 billion. Where did the other $26 billion go? It was lost through defaults, bankruptcies, and other licensing debacles enabled by the auction policies Chairman Genachowski wants authority to implement. Twenty-six billion dollars in lost revenue is more than enough evidence to justify limiting the FCC’s authority on this issue.

The House Bill Offers Significant Compromises to the Senate

Those who disfavor Congressional limits on the FCC will try to use the reconciliation process to force “compromise” on these issues. The problem with that approach is that the House bill already offers significant compromises to the Senate. House Republicans initially opposed the Senate’s proposal to reallocate the D-block to public safety, but embraced it in the bill as passed. The House bill also preserves the white spaces concept in the TV band and provides for additional unlicensed allocations in other bands. If the unlicensed and auction eligibility issues ultimately bring the entire spectrum reform bill down, it won’t be due to the unwillingness of House Republicans to compromise. It would be a sign that real compromise was never possible.

That changed a few weeks ago when Dish Network unveiled its own plans to build a terrestrial LTE network using MSS spectrum. Dish Network is buying both DBSD North America and TerreStar, who together hold 40 MHz of MSS spectrum in the 2 GHz band. In its recent application seeking approval for the Terrestar transaction and waivers to provide terrestrial service (available here), Dish Network says that, if its requests are granted, it will make “substantial terrestrial network deployment commitments intended to increase wireless broadband competition, including in rural areas.” (Application at 48.) These commitments include deploying an LTE Advanced network pursuant to a “reasonable, attainable buildout schedule keyed to commercial availability of the LTE Advanced Standard.” (Application at 48.)

Dish Network’s plan to build a new 4G broadband network offers the potential for significant competitive disruption in both the mobile broadband and MVPD markets, especially when combined with the retail and streaming video assets Dish Network acquired from Blockbuster earlier this year. Due to capacity and other limitations inherent in satellite broadband services, satellite TV providers don’t currently offer broadband services capable of competing in urban and suburban markets with the cable modem, DSL, and fiber offerings of other multichannel video programming distributors (MVPDs). The inability of satellite TV providers to offer competitive broadband services in urban and suburban markets is in part why cable operators have maintained approximately 70% market share while Dish Network has competed primarily on price. With its planned 4G deployment, Dish Network could compete on quality of experience by offering video, broadband, telephone, and mobile services on integrated service platforms through Blockbuster’s virtual and retail stores (imagine mobile devices that access a Blockbuster apps store with streaming content, a TV device that seamlessly combines Dish Networks satellite programming with streamed wireless services, etc.). For the first time, Dish Network would be able to compete across the entire value chain.

Dish Network is also well positioned to quickly become a formidable new competitor in the mobile broadband market. Unlike a typical new entrant, Dish Network already has significant brand awareness and customer relationships, existing retail networks, and an industry partnership with Frontier Communications. Dish Network could leverage its 14 million MVPD subscribers, 4 million Frontier Communications customers, and Blockbuster retail stores to quickly generate a nationwide presence in the mobile market and substantially lower its customer acquisition costs. Because Dish Network does not have an embedded base of devices that depend on earlier generations of wireless technology, it would be able to deploy and maintain a single, cost effective LTE Advanced network. Its spectrum would also enable the use of spectrally efficient 20 MHz channels – a channel size some incumbent mobile operators cannot deploy due to the limitations of their spectrum holdings. (For example, Verizon’s current generation LTE network is limited to 10 MHz channels based on its available spectrum.) Although Dish Network may eventually need more spectrum, as a new entrant with no legacy technology concerns, Dish Network wouldn’t face a capacity crunch anytime in the near term.

Given the potential for Dish Network to increase competition in both the MVPD and mobile markets, I expect the FCC to grant the application. It would be difficult for the FCC to deny Dish Network’s application after granting similar relief to LightSquared. Even if the FCC would have preferred to reassign the 2 GHz MSS spectrum using an incentive auction, Dish Network’s commitment to “creating a competitor against the mobile broadband incumbents” (Application at 22) is an offer the FCC is unlikely to refuse.

The FCC’s new interest in legitimizing the distribution of signal boosters without licensee consent or control is perplexing. Given the FCC’s ongoing existential crisis, it’s not surprising that its signal booster proposal lacks any market analysis justifying regulatory intervention (e.g., there is no evidence that consumers lack access to signal boosters authorized by licensees). What is surprising is that legitimizing third-party signal booster sales would be flatly inconsistent with the regulatory approach the FCC adopted last year in its net neutrality order. In the net neutrality order, the FCC recognized the wisdom of affording network operators “the latitude they need to effectively manage their networks.” (Net Neutrality Order at paragraph 86.) Network operators are thus able to “implement reasonable practices to ensure network security and integrity, including by addressing traffic that is harmful to the network.” (Net Neutrality Order at paragraph 88.) Signal boosters implicate the same reasonable network management concerns the FCC address in the net neutrality order, but, inexplicably, the FCC wants to specify detailed network management practices for signal boosters.

By their very nature – their purpose is to “boost” the power of a radio signal – signal boosters present a risk of harmful interference to the network (either by completely blocking other customers’ signals or degrading data rates). This risk must be balanced against the potential coverage benefits signal boosters provide. Operators have strong incentives to balance these risks in an effort to maximize overall network performance. Operators reduce the risk of harm to the network through careful selection of signal booster features and quality, and by maintaining control over their deployment and use, i.e., through reasonable network management. In economic terms, operators internalize the harms caused by signal boosters.

Manufacturers of unauthorized signal boosters do not share operators’ incentives to maximize network performance. The Manufacturers’ incentives are to maximize signal booster revenue and profits irrespective of signal boosters’ impact on the network as a whole. They maximize revenue by offering consumers signal boosters that can improve the experience of their individual customers at the expense of other consumers. Manufacturers maximize their profit by producing signal boosters at the lowest cost, which results in the sale of low feature, low quality signal boosters that cause harmful interference to operators’ networks.

The individual consumer’s incentives are similar to those of the manufacturers. Consumers want to maximize their connectivity at the lowest cost, irrespective of the impact on others using the network. Consumers’ lack of incentive to avoid harmful interference to the network is coupled with an inability to remedy such harm if it does occur. The average consumer doesn’t have the technical knowledge or resources to know that interference to other users is occurring, let alone determine that they are the cause. Even if they did, consumers whose connectivity is improved by their signal boosters would have an incentive to remain silent (a free-rider problem).

In economic terms, the harm caused by the sale of signal boosters to consumers without licensee consent or control is a negative externality, i.e., a harm incurred by a party (in this case, consumers adversely affected by harmful interference with their use of the network) who did not agree to the action causing the harm (i.e., the use of a signal booster by their neighbor). “Externalities are a type of market failure.” By codifying this negative externality, the FCC’s proposed signal booster rules would codify a market failure. Regulation is typically justified by the desire to correct a market failure, not create one. But that is what the FCC would do if it proceeds to take reasonable network management out of the hands of network operators and put it into the hands of manufacturers and consumers who have no incentive to be reasonable.

Given the relatively straightforward economic incentives involved, it is obvious that network operators are in the best position to reasonably manage the use of signal boosters within their networks. The FCC is nevertheless proposing to insert itself directly into the network management process through inflexible, prescriptive regulations specifying detailed technical parameters for signal boosters. Even assuming the FCC could find the optimal balance between the potential harms and benefits of signal boosters today, the prescriptive nature of the regulations would prevent operators from adapting signal booster technology and uses to innovative network technologies and topologies in the future. The result would be less innovation and unhappy consumers.

Potential Winners

Googorola: If Google’s stock price is any indication, it looks like the market thinks the deal is a mistake. In think the alternative – failing to even try to monetize Android’s 40% market share – would be a much bigger mistake. Although some analysts believe Google should stick to its core business, which is selling advertising, the total market for mobile advertising in 2010 was only about $877 million. That is miniscule compared to Apple’s Q2 2011 revenue of $24.67 billion, which was largely driven by its iOS business model. If Google wants a winning hand in the mobile OS game, it can’t afford to stand pat – it needs to up the ante by expanding its core business. The Motorola acquisition gives Google an opportunity to compete by offering an end-to-end mobile device platform capable of generating significant returns on Google’s Android investments. An integrated mobile device platform could be far more profitable for Google than Android is now, even if Android loses market share and support among other manufacturers. Apple has already proven that iOS’s 18% market share coupled with a vertically integrated product portfolio generates at least an order of magnitude more revenue than Android’s 40% market share coupled with a mobile advertising model. If Googorola can produce a new integrated mobile device platform, it would be a significant win for Google.

Motorola’s mobile devices are only a part of Googorola’s upside. Motorola’s set top boxes may be even more important to Google. Because I think this issue deserves a more in-depth discussion, I’m writing about it in a separate blog post that will be coming soon.

Mobile Competition & Consumers: The deal, which is itself the result of heated competition, will likely enhance competition in the mobile device segment. Apple became the most valuable company in the world by offering the only vertically integrated, end-to-end mobile device platform. If I’m right about Googorola, Apple won’t have the mobile device platform market to itself much longer. A fully integrated Googorola mobile device platform capable of competing in the same arena would be a significant win for mobile competition and consumers.

Sprint: Sprint’s inability to offer the iPhone has been a thorn in its side. Although it is already rumored that Apple is making an iPhone for Sprint, the possibility of a Googorola mobile device platform will put additional pressure on Apple to broaden the iPhone’s availability through Sprint’s customer base. Because Google is in a unique position to cross-subsidize advertising for a Googorola mobile device platform, it has less economic incentive to enter into exclusive deals than other device manufacturers, which also means it has stronger incentives to seek the broadest possible distribution of Googorola products. These factors could lead to the availability of the iPhone and a Googorola mobile device platform on Sprint’s network, which would be a double win for Sprint.

webOS: It’s a nifty OS, but Hewlett-Packard’s webOS hasn’t lived up to its potential in the market. To increase webOS visibility and market share, Hewlett-Packard has been trying to license webOS to other companies. The threat Googorola poses to other device manufacturers who rely heavily on Android may increase pressure to license webOS as a hedge against a potential Googorola mobile device platform. The potential licensees include Amazon, who would give “HP much-needed marketing and distribution for its products.” An Amazon deal would be a huge win for HP and webOS.

Potential Losers

“Openness” & the PC Model: Advocacy groups like Public Knowledge have argued stridently against Apple’s end-to-end approach to the iPhone. They wanted the mobile device market to mimic the market for Windows PCs, with completely separate vendors for OS, chipsets, devices, and software. They argued that Apple’s business model was holding “the iPhone back,” and asked the rhetorical question: “If Apple’s goal is to increase market share for the iPhone . . . why not sell the iPhone 3G like Macs or any other computer without subsidies?” The market has provided the answer, and Googorola confirms it: The PC model doesn’t work well in the mobile environment. The Nexus One proved consumers don’t want to pay full-price for mobile devices, and the results of the OS wars have repeatedly proven that higher market share (see Symbian and Android) doesn’t necessarily mean higher revenue or increased consumer satisfaction. The PC model was driven by enterprise customers, who enlist the help of in-house IT departments to deal with the PC model’s downsides. Consumers drive the mobile device market, and consumers don’t have in-house IT departments to deal with problems like Android fragmentation. Google’s apparent bow to this market reality is a big loss for advocates of PC-style “openness” in the mobile market.

Android Partners: Although manufacturers of Android-based devices issued statements supporting the deal, they are entering uncertain territory. Google says Android will remain open, but it can’t exactly say anything else without jeopardizing regulatory approval of the deal as well as its current Android partnerships and market share (a lesson learned the hard way by Nokia, whose market share fell off a cliff after it made the mistake of announcing the abandonment of Symbian before Nokia was ready to ship Windows smartphones). Once the deal is approved and Motorola is fully absorbed, however, Google will have strong incentives to provide Motorola with preferential or exclusive access to Android code and applications. If it does, Google’s Android partners would end up losing.

Neutral

Microsoft: The deal cuts both ways for Microsoft. Microsoft is a potential loser to the extent it lost in a bidding war for Motorola. It’s also a potential winner to the extent it can leverage uncertainty about Android’s future to increase market share for Windows Phone 7. When the set top box market is taken into account, I think the deal is neutral to negative for Microsoft.

Coming soon: Googorola and your TV.

A comparison of smartphone OS market shares and revenue reveals a much stronger motivation for acquiring Motorola. When I wrote about the smartphone OS wars last August, Q1 2010 data indicated that Android held less than 10% of the global smartphone market. By the end of 2010, Android held over 22% of the global market (with an overall 888% growth rate in 2010), making it second only to Nokia’s Symbian operating system. Android now leads all smartphone operating systems with more than 43% of the global smartphone OS market, whereas Nokia has announced plans to abandon Symbian. In the space of two years, Android’s market share has gone from a baby gorilla to an 800 lb silverback.

Although Google denies it, the deal is a competitive reaction to the success of Apple’s iOS business model.

Significant market share usually means significant revenue, but Google hasn’t been able to cash in on Android’s impressive growth. Despite Android’s number one market share, Android’s advertising-based business model doesn’t generate anywhere near as much revenue as Apple’s vertically-integrated iOS business model. Even though the iPhone’s global market share is only 18%, Apple reported record second quarter revenue of $24.67 billion. Just three iOS products (the iPhone, iPod, and iPad) account for 66% of Apple’s revenue. Although Google doesn’t regularly publish numbers for Android, its global mobile advertising revenue in Q3 2010 was only about $1 billion. To put things in perspective, Apple’s Q2 revenue was close to triple the $9.03 billion in total revenue reported by Google in Q2 2011. As a result of its success with iOS, Apple is now the world’s most valuable company.

Although Google denies it, the deal is a competitive reaction to the success of Apple’s iOS business model. To compete with Apple, Google needs to monetize Android in the same way Apple monetized iOS: by controlling the entire mobile device platform. Although Google could theoretically do this on its own, Motorola’s engineering resources, manufacturing expertise, and product distribution chains will allow Google to emulate Apple’s vertically integrated mobile device platform far more quickly. That’s the real reason Google is buying Motorola.

Coming soon: My take on the deal’s impact, including potential winners and losers.

“People love to categorize.” Categorization helps us make sense of a complicated world. But, when categorization doesn’t reflect substantial similarities, it obfuscates as much as it illuminates. So it is with communications policy, which is categorized primarily by the technologies used to deliver communications services (“stovepipes”) rather than their impact on consumers. This approach to categorization obfuscates the relevant question – whether a particular regulatory approach maximizes consumer welfare (rather than the prospects of particular competitors).

If the government subsidizes universal broadband, it would render government subsidization of over the air broadcast duplicative.

The ongoing debates about broadcast incentive auctions and universal service reform offer a poignant example of such obfuscation. Because the services that are the subjects of these debates use different technologies, and are thus categorized separately, these debates are being conducted independently. When viewed from the perspective of consumer welfare, however, these debates are inherently interrelated. They both involve regulations that are intended to address the same concern – the widespread dissemination of information to consumers from a multiplicity of sources.

The core question in both debates is to what extent the government should subsidize consumer access to information. Because broadband service provides access to far more information than is possible through over the air broadcast, answering this question in the universal service debate informs the incentive auction debate: If the government subsidizes universal broadband, it would render government subsidization of over the air broadcast duplicative.

The Government Subsidizes Both Universal Service and Television Broadcast

The government subsidizes universal telephone service through mandatory fees. As I explained in a previous post, the broadcast industry is subsidized by the government through the imposition of must-carry obligations on cable providers:

As a result of the success of cable television, it had become clear by 1992 that broadcasters lacked a viable business plan. Because fewer and fewer people were watching broadcast television over the air, broadcasters were having a more difficult time selling advertisements. To prop up the dying broadcast industry, Congress decided to force cable providers to carry broadcast channels on their cable systems. Forced cable carriage ensures that broadcasters reach enough “eyeballs” to satisfy advertisers, which is how broadcasters make money.

Because only about 10% of the population actually watches television transmitted over-the-air, without government mandated must carry, most broadcasters couldn’t sell enough advertisements to survive. Forced cable carriage of broadcast signals is thus an indirect government subsidy financed by cable consumers. (For a detailed must-carry discussion, see Turner Broadcasting System, Inc. v. FCC, 512 U.S. 622 (1994) (Turner I).)

Television broadcasters also enjoy subsidized use of radio spectrum worth up to $33 billion. When Congress provided the FCC with auction authority in 1993, it required that FCC auctions promote multiple purposes (see 47 U.S.C. § 309(j)(3)), including:

• development and rapid deployment of new technologies, products, and services;
• recovery for the public of a portion of the value of the public spectrum resource and avoidance of unjust enrichment; and
• efficient and intensive use of the electromagnetic spectrum.

Auctioning broadcast spectrum would support all of these Congressional objectives. For that reason, during the debates that preceded the 1996 Act, multiple bills were introduced proposing to auction digital broadcast channels. (For a detailed history, see Ellen P. Goodman, Digital Television and the Allure of Auctions: The Birth and Stillbirth of DTV Legislation, 49 FED. COMM. L.J. 517 (1997).) But Congress ultimately bowed to broadcast industry pressure and exempted from auction “initial licenses or construction permits for digital television service given to existing terrestrial broadcast licensees to replace their analog television service licenses.” (See 47 U.S.C. § 309(j)(2).) As a result, broadcasters lacked economic incentives to transition to digital technology more quickly or use their spectrum more efficiently, and the public didn’t recover any of the value of the public spectrum resource the broadcasters squatted on for over a decade.

These broadcast subsidies remain in place today even though “the social opportunity cost of using the TV Band for television broadcasting . . . is conservatively estimated to exceed $1 trillion (in present value).” (Thomas W. Hazlett, Unleashing the DTV BAND: A Proposal for an Overlay Auction (2009) at p. 5.) This opportunity cost dwarfs the benefits of over-the-air broadcast television. Only about 10% of the population actually watches television transmitted over the air and there is little evidence all of these viewers actually need subsidized television. Because over the air broadcast subsidies are not targeted to lower income Americans, the 10% of over the air TV watchers includes middle-class and wealthy Americans who have no need for government subsidies. Given the high opportunity costs and limited benefits of over the air broadcasting, it’s hard to understand why there is any interest at all in subsidizing television.

Both Universal Broadband Service and Television Broadcast Serve the Same Purpose

Preservation of free over-the-air broadcasting was originally intended to promote the widespread dissemination of information from a multiplicity of sources. (See Turner Broadcasting System, Inc. v. FCC, 520 U.S. 180 (1997) (Turner II).) In the Turner decisions, the Supreme Court upheld must carry legislation because broadcasting was “a principal source of information and entertainment for a great part of the Nation’s population.” When the Turner II decisions were issued in the 1990s, 40% of American households still relied on over the air signals for television programming. Although consumption of programming over the air had declined by the 1990s, broadcasting was still a significant source of information.

Over the last decade the facts have changed dramatically. As noted above, broadcasters now serve only about 10% of the population over the air. At the same time that over the air viewership has declined, broadband availability and subscription rates have exploded. Approximately 95% of the U.S. population has access at home to broadband service capable of delivering high quality video (4 mbps downloads) (see sixth broadband deployment report, available here), and approximately 66% of Americans use a high-speed connection at home. Because universal service reform would ensure that all Americans – regardless of their income – have access to broadband offering high quality video capabilities (just like TV), there would no longer be any rationale for subsidizing over the air television. The purpose served by over the air television – the widespread dissemination of information from a multiplicity of sources – would be served by universal broadband access.

Although government subsidies can promote consumer welfare, “[i]t is widely acknowledged that subsidies are generally economically inefficient.” (Erwin H. Bulte, Richard Damania, and Ramón López, On the Gains of Committing to Inefficient Production: Corruption and Low Land Productivity in Latin America (2004) at p. 2.) Subsidizing duplicative programs that serve the same purpose would be blatantly wasteful. Such waste would be particularly egregious in this context due to the high opportunity cost of using spectrum for over the air television. Television programming can be (and primarily is) delivered via the wired Internet, cable, and fixed satellite systems; but the wired Internet, cable and fixed satellite systems cannot provide the mobility that broadcast spectrum can enable.

When universal service reform and incentive auction policies are viewed holistically, the best course of action is clear: enact both policies this year. Universal broadband service would give every American consumer access to more information from more sources than could ever be made available via broadcast television, and freeing broadcast spectrum for mobile use would help the United States meet its goal of leading the world in mobile broadband. The resulting win-win would boost the U.S. economy, create jobs, and spur innovation.

They note that the FCC’s analysis eschews direct evidence of the state of competition based on consumer behavior in favor of reliance on indirect evidence. The FCC ignored the direct evidence it collected in favor of market share measures, even though the FCC itself admitted that measures of market share are not synonymous with market power. Messrs. Faulhaber and Singer generally reached the same conclusion I did in my previous posts: the FCC intends to rely its mobile wireless competition reports to further regulate the wireless industry.

They take particular issue with the FCC’s implied intent to limit the ability of larger mobile wireless service providers to acquire spectrum via auction. They then note that, in this circumstance, the only viable solution for larger service providers is to acquire additional spectrum in the secondary markets. If the FCC wants to have a competitive mobile wireless industry, it can’t have its cake and eat it too. The FCC needs to release more spectrum immediately and allow larger mobile service providers to access it, or the FCC needs to speed its review of secondary markets transactions. If the FCC instead does neither, the mobile wireless industry and consumers both will suffer.