Use of designated entity preferences in assigning wireless licenses.

• Author: Hazlett, Thomas W.

1. INTRODUCTION

   The Federal Communications Commission (FCC or Commission) was granted the power to auction licenses for use of the electromagnetic spectrum in the 1993 Omnibus Budget Reconciliation Act in which Congress added section 309(j) to the Communications Act.(1) Congress mandated the new auction policy on the grounds that new telecommunications services were to be deployed quickly, but also that licenses be assigned to "a wide variety of applicants, including small businesses, rural telephone companies, and businesses owned by members of minority groups and women."(2) In general, auctions have been a faster and less costly means of license assignment than previous FCC methods. As the auction process has progressed, however, it is apparent that the mandate for speed and efficiency has clashed with the preference programs established to facilitate the diversity mandate. Specifically, in some instances, the very structure of the preference programs has encouraged entry of comparatively inefficient telecommunications providers. In turn, this has led to delay in the provision of telecommunications services to consumers.

   This Article attempts to isolate the delays in license allocation and in the provision of consumer services that are directly associated with the FCC preference programs for small, woman, and minority-owned businesses. This Article then estimates the consumer costs associated with those delays and compares those costs to the quantifiable benefits of the preference programs--such as subsidies to producers and enhanced auction revenues for the government. In other words, the Article constructs the framework for a social welfare analysis to assess changes in both producer and consumer welfare as well as the amount of deadweight loss--the amount that is not captured by either telecommunications producers or consumers--associated with the preference program structure.

2. GENERAL FRAMEWORK OF THE FCC DESIGNATED ENTITY PREFERENCE PROGRAM

   The FCC adopted its initial regulations governing general auction structure on March 8, 1994. To meet its mandate of assigning licenses to a wide variety of applicants, the FCC structured the auction under the assumption that the primary impediment to participation by small businesses and minority or woman-owned firms was their lack of access to private capital markets.(3)

   To compensate for this lack of access, or more precisely the inability of small start-up firms to obtain low-interest financing, the FCC established a program of multitiered benefits--consisting of various combinations of government financing programs and bidding credits--for "designated" bidders. To be designated for a particular benefit package, the potential bidder had to meet certain criteria based on firm size and ownership status. A few subcategories of the designated entity status were fairly consistent across auctions. The FCC categorized designated entities by average revenues over the three years preceding the filing for auction eligibility. The most widely used categories were very small business, for those firms with average revenues of $15 million; small business, for those with revenues not in excess of $40 million; and entrepreneur, for those with revenues in excess of $40 million and not in excess of $125 million.(4) Entrepreneurs were to have no more than $500 million in gross assets.(5)

   This Article highlights only two of the several auctions with designated entity programs: the Regional Narrowband Personal Communications Services (RNPCS) and the Personal Communications Services (PCS) C block auctions.(6)

3. DESCRIPTION OF DELAYS ASSOCIATED WITH DESIGNATED ENTITY PREFERENCES

   By examining the performance of the designated entities versus their nondesignated counterparts, one can compare the delays from license allocation until market deployment associated with the various program structures. Specifically, this Article examines the licensing and subsequent performance of the RNPCS firms and the licensing and subsequent performance of the designated entities in the C block versus the nondesignated entities of the A and B block auction.

   1. The Auction Process Versus Previous Methods

      Auctions were intended to correct problems associated with lotteries and comparative hearings--the previous FCC license assignment procedures. It was argued that auctions would reduce rent seeking, speed licenses into the marketplace, capture license rents for the Federal Treasury rather than "squander" them on lucky or politically connected applicants, and enhance performance because the auction winners would be most likely to implement services most efficiently.(7)

      When comparing the time delays associated with various assignment methodologies, it is important to be precise in setting the end points. While the evidence indicates that, on average, auctions reduce the time between license application and license grant, it is more difficult to determine differences in time from license grant to time of market deployment. It must be noted that this analysis does not measure the total "regulatory lag," which would include the time delay associated with FCC spectrum allocation. Licenses to operate wireless businesses are issued by the FCC only after a rule making has established how a given block of radio spectrum is to be utilized by private parties. The FCC's block allocation function remains intact across all three license assignment methods and, hence, is not the subject of this inquiry.

      The average number of days between the application for, and the grant of, an auctioned license is approximately 233 days for all licenses auctioned and 276 days for broadband PCS excluding C block. That is 136 to 179 days faster than license distribution under the lottery system. The differential between auctions and comparative hearings is greater still, with auctions averaging between 444 and 487 days faster.(8)

   2. Designated Entities Versus Nondesignated Entities in the Regional Narrowband Personal Communications Services Auctions

      1. From License Allocation to License Grant

         In analyzing the use of designated entities, one can compare two distinct preference structures because of the Supreme Court's landmark decision in Adarand Constructors, Inc. v. Pena.(9) The decision cast doubt on the FCC's authority to single out minority-owned firms for bidding preferences. The only observable use of designated entity versus nondesignated entity status before Adarand was the RNPCS auction.

         There, the FCC auctioned thirty licenses--six blocks with five licenses each. The licenses allowed the awardee to provide advanced paging and data services. Any firm, regardless of size, could participate in the auction, but where nondesignated entities had to pay their full bid price upon completion of the auction, designated entities--or more precisely, small businesses--were eligible for a highly favorable payment plan. Those that qualified for the preference were required to make a down payment of only 20 percent of their bid at the time of license grant, with the remaining 80 percent, plus interest set at the Treasury Bond rate of 7.5 percent, to be paid over ten years. Payments on the bid principal were deferred until years three through ten.(10) Assuming that the cost of capital for firms qualifying for designated entity status was 14 percent, the implicit subsidy embedded in the financing package constituted over 20 percent of the net--after credit--price bid.(11)

         In addition to the installment plan, a bidding credit of 25 percent was awarded to any small business that bid on one of the ten licenses in blocks two and six--that is, for each dollar bid a small business paid only $0.75. Small businesses that were also owned by women or minorities(12) received an additional 15 percent, a total bidding credit of 40 percent, in blocks two and six. These credits effectively reserved blocks two and six for designated entities.

         It took 105 rounds of bidding to determine the final nine winners. Of this group, four designated entities won a total of eleven licenses, and five other bidders won a total of nineteen licenses. The government's net revenue for the RNPCS auction was posted at $394 million.(13)

         Of the twenty-eight bidders to qualify, twenty had some form of preference, and those preferences significantly influenced the outcome of the auction. The incentives attracted many bidders to the set-aside licenses, and competition among designated entities was intense. Aided by bidder's credits and installment payments, designated entities bid up the prices paid by nondesignated entities in blocks one, three, four, and five. The designated entity demand was so strong that even taking account of both the bidding credit and the installment subsidy, the designated firms paid more for blocks two and six than the nondesignated firms would have been willing to pay.(14) Only one small business won a license outside of blocks two or six. However, that small business still qualified for the installment plan.

      2. From License Grant to Market

         As of July 1998, all designated entity RNPCS licensees have developed services, either on their own or through resale contracts as quickly, but not as fully, as their nondesignated entity counterparts.(15) The only designated entity to have a national footprint, Conxus, is currently operational in ten major markets. Of the other three licensed designated entities, at least two are reselling within their license area. These ratios are quite favorable to those of the nondesignated businesses. Only one of the five nondesignated entities, SkyTel, is currently operational. The other four are reselling the services of the two facilities-based providers.

         However, future plans for deployment sharply separate the two groups. Whereas four of the five nondesignated entities expected to have their own systems deployed by the end of 1998, only one designated entity, Conxus, has plans to expand its system.

   3. The A and B...