Assessing competition in U.S. wireless markets: review of the FCC's competition reports.

• Author: Faulhaber, Gerald R.

1. INTRODUCTION II. DIRECT MEASURES OF MARKET POWER ARE PREFERABLE TO INFERENCES BASED ON MARKET SHARES III. DIRECT EVIDENCE OF WIRELESS PRICING DOES NOT SUGGEST MARKET POWER IV. DIRECT EVIDENCE OF ENTRY BY NEW SUPPLIERS DOES NOT SUGGEST MARKET POWER A. Clearwire B. Leap Wireless (Cricket) C. MetroPCS D. LightSquared E. Super Regional Carriers (U.S. Cellular, Cellular South, and Atlantic Tele-Network) V. MARKET STRUCTURE ANALYSIS PRESUMES A STRICT RELATIONSHIP BETWEEN PRICES AND NUMBER OF PROVIDERS VI. VERIZON AND AT&T DO NOT APPEAR TO POSSESS A "MUST-HAVE" INPUT A. The Nextel Re-Banding Process B. Spectrum Is One of Several Inputs in the Production Process C. The Requisite Level of Spectrum Below-1000 MHz VII. ARE WE MISSING SOMETHING? VIII. POLICY IMPLICATIONS A. Handset Exclusivity B. Spectrum Policy IX. CONCLUSION I. INTRODUCTION

   Last year's Annual Report and Analysis of Competitive Market Conditions with Respect to Mobile Wireless ("14th Wireless Report"), issued by the FCC, broke new ground compared to prior reports. (1) The FCC should be commended for its willingness to expand the scope of its competition report, for example, by including related markets such as handsets and applications as part of its analysis. (2) The report also broke new ground by not concluding, as it had in prior reports, that the wireless services market was effectively competitive. (3) This year's report ("15th Wireless Report") followed suit and refrained from making any competitive assessment. (4) This retreat from the FCC's earlier competitive assessments suggests a change in the FCC's outlook on this market. In addition, the omission of a statement on competition in this market appears to directly contravene Congress's mandate to the FCC to produce annually a Competition Report that "shall include in its annual report an analysis of. .. whether or not there is effective competition." (5)

   A key issue in reaching a conclusion about effective competition is how to interpret the evidence. The 14th and 15th Wireless Reports review a wide variety of evidence, both direct (how firms and customers behave) and indirect (industry concentration measures). (6) The reports are silent, however, on how to interpret this evidence. In contrast, modern antitrust analysis tends to rely far more on direct evidence and less on indirect evidence. Ironically, at least one highly influential reader (7) of the reports focuses entirely on the indirect (less relevant) evidence to draw a strongly negative assessment, which we think is unwarranted. We are concerned that this apparent refusal of the FCC to follow modern competitive analysis standards bodes ill for future regulatory decision making (in this as well as other markets).

   In failing to put more weight on the relevant direct market evidence to reach a more informed competitive assessment, the 14th and 15th Wireless Reports invite erroneous conclusions about the real state of competition in wireless markets. Stated differently, the FCC's purpose should be to directly assess performance. To be fair, in the introduction to its 15th Wireless Report, the FCC acknowledges that "market performance metrics provide more direct evidence of competitive outcomes and the strength of competitive rivalry than market structure factors, such as concentration measures." (8) Yet the 15th Wireless Report begins with an analysis of market structure--suggesting that market structure provides an important barometer of wireless competition--and its Herfindahl-Hirschman Index ("HHI") calculations are highlighted in the Executive Summary (which precedes the Introduction) without the aoppropriate disclaimer that concentration may not indicate market power. (9) We are concerned that the FCC's undue emphasis on indirect evidence could eventually adversely influence regulatory policy in wireless markets. (10)

   Economists generally believe that competitive analysis should be about satisfying customers. If firms exercise market power, customers may suffer through higher prices, reduced quality, and foreclosed entry of new competitors. If firms are not exercising market power, the market will have strong competition, customers will get what they want, and regulators do not need to intervene in the market. Traditionally, competitive analysis was not based on measuring what is happening to customers. Because economists did not have the tools to adequately measure this effect, they relied on indirect measures, such as market share in the relevant markets, the HHI, and market definitions. (11)

   The approach to market analysis changed substantially with the landmark Staples-Office Depot proposed merger. The Federal Trade Commission ("FTC") employed a new standard of direct evidence, examining whether the merger would actually raise prices to customers instead of using indirect measures. It found compelling direct evidence that in markets without the presence of both firms, prices were significantly higher. (12) Accordingly, the agency denied the merger. Since then, this direct approach has become the modern standard for conducting competitive analysis.

   To determine whether firms are exercising monopoly power, one looks directly at the conduct of the firm: Does the firm in question behave like a monopolist? This direct approach has been widely embraced by academic economists, (13) and in 2010, the federal antitrust agencies revised the Horizontal Merger Guidelines to reflect this new thinking in competition analysis. (14) A review of the 14th and 15th Wireless Reports reveals that the FCC considered in great detail (but did not rely upon) this direct evidence of market power. (15) For example, in Table 19 of the 14th Wireless Report, the FCC chronicles the downward trajectory of average revenue per voice minute from 1993 through 2008 ($0.44 to $0.05) and the upward trajectory of minutes of use per month over the same period (140 to 708), (16) but fails to attribute these massive consumer welfare gains to enhanced competition. (17)

   The Reports critically ignored the continuing downward trajectory in wireless prices. Despite its June 2011 release, the 15th Wireless Report tracks the Bureau of Labor Statistics' ("BLS") Cellular Consumer Price Index ("CPI") and industry average revenues per user ("ARPUs") only through 2009. (18) According to the BLS, wireless prices decreased by 3 percent from January 2008 to December 2010. By comparison, the CPI for all goods and services increased by nearly 4 percent over the same period. (19) Thus, by failing to extend its time series through December 2010, the 15th Wireless Report missed an important price decline (of nearly 3 percent) from December 2009 through December 2010 and focused instead on the nearly constant prices from December 2008 through December 2009. Indeed, the same series shows wireless prices falling by another 3 percent from December 2010 through May 2011. Falling prices and market power usually do not coexist; this secular price decline is far more likely to signal effective competition, not market power.

   The 14th and 15th Wireless Reports ignored this and similar direct evidence of competition--namely, aggressive pricing behavior, robust entry, and continued long-term reduction in prices, all of which strongly support a conclusion of "effective competition." (20) Instead, the FCC focuses on inferences of market power based on market shares. For example, in the 14th Wireless Report, the FCC makes much of the combined share of the top four wireless providers (21) generally, and of the top two wireless providers, AT&T and Verizon, in particular. (22) Tellingly, the FCC admits that "[s]hares of subscribers and measures of concentration are not synonymous with market power--the ability to charge prices above the competitive level for a sustained period of time."(23) The 15th Wireless Report repeats this warning nearly verbatim. Despite the direct evidence of the lack of pricing power that the report presented, the FCC was unwilling to conclude, as it had in the prior six reports on this subject to Congress, that the U.S. wireless market was "effectively competitive." Although the FCC correlated HHI in a local geographic area with population densities in both reports, (25) it failed to correlate HHI with wireless prices in either report. Had it done so, it would have discovered that as the nationwide average HHI increased from 2,151 in December 2003 to 2,848 in June 2010 (depicted on the first Y axis), and wireless prices as measured by the Cellular CPI were falling (depicted on the second Y axis).

   [FIGURE 1 OMITTED] (26)

   In this report, we suggest how the FCC can improve its competitive analysis for future mobile wireless competition reports to be more consistent with modern economic analysis. Part II explains how direct evidence of market power has supplanted inferences based on market shares of some relevant market. In Part III, we assess the direct evidence of pricing power (or lack thereof) in the wireless services industry. We examine the direct evidence of exclusion (or lack thereof), the other hallmark of non-competitive markets, in Part IV. Entry by Clearwire, Leap, MetroPCS, the cable television providers, and LightSquared is inconsistent with any claim of monopolization. In Part V, we explain that a market structure analysis presumes a relationship between prices and the number of providers, when such a relationship does not always exist. Part VI investigates whether Verizon or AT&T possesses a "must-have" input that, if withheld from rivals, would impair their ability to compete effectively. In Part VII, we ask whether we are missing something critical to the competition analysis. Part VIII reviews the policy implications of our findings with respect to handset exclusivity and spectrum allocation.

2. DIRECT MEASURES OF MARKET POWER ARE PREFERABLE TO INFERENCES BASED ON MARKET SHARES

   As a general matter, direct evidence of monopoly power or anticompetitive...