Is Fear of Wireless Foreclosure “Speculative?” Depends. Is this About Intent Or Effect?

Recently, the Antitrust Division of the Department of Justice  (DOJ) filed these comments with the Federal Communications Commission (FCC) in the proceeding on spectrum aggregation limits (aka spectrum screen v. spectrum cap). The DOJ comments have some good stuff about the economics of the wireless industry and competition (in a theoretical way), and about why it is important to make sure potential competitors have spectrum, particularly low-band spectrum. Mostly, DOJ’s argument rests on the idea of “foreclosure,” that a wireless firm will bid on licenses at auction just to keep them out of the hands of competitors.

Asked about this on a recent earnings call, VZ CFO Fran Shammo basically said that there is no evidence that Verizon is bidding on licenses just to keep them out of the hands of rivals, so DOJ’s argument is “theoretical” and the FCC should not adopt any limits.

VZ basically argues that we should not worry about possible foreclosure unless there is evidence of an actual intent to foreclose. This treats a spectrum screen (and concern about foreclosure) as a precaution against bad actors. As long as bidding on licenses at auction makes sense for reasons other than foreclosure, and there is no evidence of any intent to foreclose, then everything should be just fine even if the outcome has the same effect as a foreclosure strategy (e.g., competitors don’t have enough spectrum to offer viable competing services.)

But the Communications Act does not work this way. Specifically, Section 309(j)(3)(B). Whether Verizon (or any other carrier’s) intent is as pure as the driven snow, or black as any comic opera villain, does not matter one iota. What matters is whether we avoid a “concentration of licenses” and “disseminate licenses among a wide variety of applicants” so that we “promot[e] economic opportunity and competition and ensur[e] that new and innovative technologies are readily accessible to the American people.”

As I will discuss below, the evidence from the 700 MHz auction and subsequent transactions demonstrates that we are feeling the effects of foreclosure, regardless of whether there was an actual intent to foreclose. As a result, the DOJ concern is not “theoretical,” but very real.

 

More below . . .

 

DOJ provides the standard antitrust reason why the FCC might want to consider adopting a spectrum cap (or tighter screen that differentiates among bands, as my employer Public Knowledge has argued) — something called “foreclosure.” Briefly, a provider values spectrum for how much it increases capacity to provide service. (I’ve talked about how this creates barriers to entry to new entrants and smaller competitors at length here).  But DOJ notes that because the number of licenses is extremely small, it becomes possible for a large enough firm to bid on licenses to keep them out of a rival’s hands. This is called “foreclosure value.” DOJ argues that the FCC needs to consider that in an auction, a large enough firm would value a license as “extractable efficiency value” + “foreclosure value” rather than just “extractable efficiency value” and therefore will pay more than a rational competing firm.

Given the current lack of access to spectrum, especially the importnat “lower-band spectrum” below 1 GHz, the DoJ advises the FCC to take this concern very seriously and put spectrum aggregation limits in place that will level the playing field unless there is evidence that the two largest players are suffering sufficient spectrum-based congestion to warrant giving them access to more spectrum before rivals catch up.

Verizon Responds That It’s All Theoretical.

No one denies foreclosure is possible as a theoretical matter. The question is whether or not it happens enough to worry about. Perhaps unsurprisingly, Verizon COO Fran Shammo expressed skepticism that this explains Verizon’s superor low-band spectrum position relative to its non -AT&T rivals. To quote from the transcript:

So as you know, the DOJ recently this week weighed in on a theoretical concern about the market foreclosure, we believe the concern is really around some who buy the Spectrum to keep others from buying the Spectrum, and I think if you look at history, that has not shown itself.  Verizon has never purchased Spectrum for that reason.

In other words, says Shammo, if we look at Verizon’s actual behavior we can see that Verizon actually uses (or sells off) the spectrum it acquires by auction, we can see that Verizon is quite busy using the spectrum and not sitting on it merely for the value of foreclosure. True, VZ (and AT&T) bid very actively in both the AWS-1 auction in 2006 and the 700 MHz auction in 2008, and have been extremely active acquiring licenses in the secondary market. But if you look at the post acquisition behavior, argues Verizon, you will see that the two largest wireless firms are actually using what they buy. Yes, VZ and AT&T ended up with licenses they didn’t need after all, but they are swapping those around with each other (and occasionally with others) to end up with more efficient holdings. All of which is exactly what we would predict in a market operating under Coasian efficiency rather than mere anti-competitive foreclosure.

Put another way, Verizon’s argument is that the current spectrum market is rather like the cooking contest show Chopped. Anyone familiar with the show knows that some chefs will race into the pantry and gather up every ingredient or piece of equipment they might need and bring it to their station before anyone else can get to it. If other chefs need, say, the fresh basil, the chef who moved slower is forced to wander around saying “anyone have the basil?” Even if speedy chef says “sure, over here,” speedy chef has won an advantage by slowing down rival chef. But speedy chef didn’t cheat and hide the basil just to keep it away from rival chef. Slowing down rival chef is just a (happy) side effect of speedy chef moving first to make sure s/he has everything s/he wants, whether s/he actually ends up using it or not.

 

Does Foreclosure Need Intent To Foreclose?

Proving an intent to foreclose, as you might imagine, is rather difficult. But does the FCC have to prove that licensees intend to foreclose rivals to worry about the impact of foreclosure? Happily, no.

Section 309(j) of the Communications Act, 47 U.S.C. 309(j), gives the FCC its authority to conduct spectrum auctions. The statute also includes a lot of rules for what the FCC is supposed to accomplish with its spectrum auction and how it ought to design the auctions (at least in a general way to achieve the Congressionally mandated goals). Of relevance here is 309(j)(3)(B) requires the FCC to:

promot[e] economic opportunity and competition and ensur[e] that new and innovative technologies are readily accessible to the American people by avoiding excessive concentration of licenses.

So if a practice has the effect of foreclosing rivals (creating an “excessive concentration of licenses” in the hands of the acquiring firm), then the FCC needs to address it and prevent it from happening. that holds true regardless of whether the firm with all the licenses actively intends to shut out its rivals, or whether the firm is just prudently snarfing up all the licenses it can grab and then selling off later what it turns out it doesn’t need.

Also, it is important to note that foreclosure value doesn’t go away, even if the firm does not pursue a deliberate foreclosure strategy. The rational bid on a license for a firm is based on the total value of the license, which is (Extractible Value )+ (Foreclosure Value). Keeping the license out of the hand of the spectrum starved rival has value, regardless of whether the firm capable of foreclosure also plans to extract value by adding it to total capacity. Given that spectrum will just about always have some extractable value in addition to its foreclosure value, it is extremely difficult (if not impossible) to prove that a firm’s acquisition is based entirely on a desire to foreclose.

Happily, the FCC doesn’t need to prove definitively that foreclosure has occurred. We just need to know whether we are in danger of getting an “excessive concentration of licenses.”

 

Regardless of Intent, Do We See The Effect of Foreclosure?

Assuming that foreclosure is the primary reason to adopt a spectrum aggregation limit (I can think of others, but lets stick with fear of foreclosure at the moment), do we see sufficient evidence of the effects of foreclosure (or the likelihood of foreclosure) that we ought to have a spectrum aggregation rule of some kind (whether as a hard cap or a screen)? Alternatively, should we try to have some sort of bidding credit or penalty to offset the foreclosure value winning the license gives the largest firms? Or is the problem still at such a theoretical level that we should take no action?

I would argue that we see some fairly strong evidence of effective foreclosure, regardless of intent. If we look at the conduct of the last two significant auctions, the AWS-1 auction and the 700 MHz MHz auction, we see that AT&T and Verizon were able to effectively capture the majority of the licenses in the top markets either in the auction itself, or subsequently in the secondary market by buying out competitors. More importantly, the inability of rivals to obtain spectrum for expansion at the same time that AT&T and Verizon have adequate spectrum to meet current need appears to be a factor in the willingness of rival firms to exit the market, with AT&T and Verizon acquiring the lion’s share of the licenses when these firms do exit the market.

The 700 MHz auction and its aftermath provides a striking example of foreclosure effect. Alltel, at the time a strong regional player breaking into the national market, had expressed strong interest in acquiring licenses in the auction for needed . In just about all cases it was outbid for licenses in areas it needed to add capacity by AT&T or Verizon. It is noteworthy that AT&T and Verizon could not have been deliberately targeting Alltel because of the “anonymous bidding rules” adopted by the FCC for the auction. But the effect was still the same. Alltel, denied the ability to expand its footprint, sold itself to Verizon a few months later. If the Commission aproves the proposed acquisition of  the last Alltel assets from ATNI by AT&T, just about all the licenses held by Alltel will end up in the hands of either VZ or AT&T — making it’s dissolution almost a textbook example of foreclosure effect without explicit (or exclusive) foreclosure intent.

We see a similar pattern in the divestiture of Verizon’s 700 MHz licenses. By and large, these licenses have gone either to AT&T (in exchange for needed AWS-1 licenses) or to rivals so small they constitute no competitive threat whatsoever. The one notable exception in recent years, Verizon’s sale of spectrum to T-Mo, was the direct result of regulatory intervention (arguably demonstrating the salutary and pro-competitive nature of regulatory intervention to prevent undue concentration of licenses).

The foreclosure effect hypothesis also answers one of the perennial questions of the spectrum secondary market. Why do AT&T and Verizon sell licenses to each other? Given that they are each other’s closest competition, you would expect them to avoid sales to each other.

We can explain this as a difference in the foreclosure value. Consider a sale of a low-band 700 MHz license from Verizon to AT&T as opposed to between Verizon and Sprint. AT&T has substantial low-band spectrum, so the foreclosure value to Verizon (as seller) of denying AT&T this particular license is fairly low. By contrast, Sprint has relatively little low-band spectrum. The foreclosure value of denying the license to Sprint is fairly high. Even better, the foreclosure value of denying the license to Sprint is high to AT&T as well. Arguably, because the value of the license to AT&T is (Extractable Value) + (Foreclosure Value), AT&T will pay a higher price than Sprint (which values the license only for its Extractable Value.

For Verizon, sale of the license to AT&T enhances the value by allowing it to capture the foreclosure value as against Sprint. Put another way, because FVSprint > FVAT&T, Verizon realizes a premium selling to AT&T even if both AT&T and Sprint offer Verizon the same price.

Obviously, this is all a bit rough for a blog post and does not constitute a real honest-to-God analysis. I leave that to the FCC and to others with the skills or resources to hire those with the skills to do such an analysis. I simply note that my very sloppy back of the envelop analysis would seem to suggest that the spectrum transactions of recent years are consistent with a foreclosure effect, even absent an intent to foreclose.

 

Conclusion

My real point here is that Verizon isn’t lying when it says it follows a rational license strategy of buying what it thinks it needs and then selling off what it doesn’t rather than actively trying to foreclose rivals by acquiring licenses it doesn’t need. But this honesty doesn’t change anything. We still see lots of signs in the market of the effects of foreclosure . As DoJ points out, that ought to raise alarm bells with the FCC because foreclosure is bad for competition and thus bad for consumers. As Jon Peha recently pointed out, spectrum policy ought to promote competition. That’s true regardless of whether the largest firms actively intend to foreclose their rivals from needed spectrum, or if foreclosure is just a happy fringe benefit of a rational spectrum acquisition strategy.

Put another way, while it’s legal on Chopped to grab all the ingredients out of the pantry, the stakes here are a bit higher than $10,000 and bragging rights. The FCC needs to make sure all competitors have a chance to get the ingredients they need to compete. Or else competition . . . . will be Chopped.

Stay tuned . . .

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  1. […] change about the nature of the market and the way equipment subsidy is screwing up pricing. Yes, foreclosure is real and yes antitrust and pro-competitive regulation make a real difference. And yes, by enhancing […]

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