Wireless competition under spectrum exhaust.

• Author: Beard, T. Randolph

Table of Contents I. Introduction II. Background III. Cournot Competition under a Capacity Constraint A. Supply Side B. Demand Side C. Equilibrium D. Jobs and Investment E. Spectrum Technology F. The Asymmetric Case G. Caveats IV. Conclusion I. INTRODUCTION

Spectrum is an essential input for providers of mobile wireless voice and data service. Indeed, without spectrum there can be no service at all, and the more spectrum that a provider has, the better the services it can provide. (1) Unfortunately, as Americans continue to consume mammoth amounts of data with their smartphones and tablets, the united States is rapidly exhausting the capacity available from the existing supply of viable commercial spectrum. The National Broadband Plan, released in 2010, concluded that the present inventory of commercial spectrum represents "just a fraction of the amount that will be necessary to match growing demand." (2) Echoing that concern, Federal Communications Commission ("FCC") Chairman Julius Genachowski cautioned, "[w]ithout action, demand for spectrum will soon outstrip supply.... If we don't tackle the spectrum crunch now, network congestion will grow, and consumer frustration will grow with it." (3) The White House is also concerned, concluding that there is a "spectrum crunch that will hinder future innovation." (4)

As a result, both the FCC and the White House express the need "to free up [more] spectrum" and make it available for broadband use. (5) The National Broadband Plan called for the assignment of an additional 500 Megahertz ("MHz") of spectrum for broadband use, a portion of which is expected to come from spectrum currently used for broadcast television and a portion to be reallocated from government use. (6) Many praised the FCC's plan to increase the stock of spectrum for mobile broadband services, and a report by the National Telecommunications and Information Administration ("NTIA") outlined some ideas for this significant reallocation of spectrum. (7) To help facilitate the reallocation of spectrum, this past February, President Obama signed into law the Middle Class Tax Relief and Job Creation Act of 2012, which provides the FCC with the authority to hold voluntary incentive auctions to repurpose television spectrum for mobile broadband use. (8) However, by the FCC's own admission, the reallocation of spectrum has historically taken several years. (9) Therefore the reallocation of broadcast spectrum and government spectrum to higher-valued uses could take years to fully implement and, even then, provides only a portion of the needed spectrum. (10) Accordingly, a "spectrum crunch" may be the market reality for the foreseeable future. As such it is important to understand what effects a binding spectrum constraint has on the nature of market performance in mobile wireless communications and how policy must adapt to this reality.

In this article, we shed some light on this important policy issue by formally modeling wireless competition under a spectrum constraint. Our findings reveal that while some in Washington policy circles increasingly view rising industry concentration (i.e., rising values of the Hirschman Herfindahl Index or "HHI") in the mobile wireless industry as a bellwether of poor market performance, the addition of a spectrum crunch to standard models of competition turns this standard, textbook view of market structure and performance on its head. Indeed, our analysis finds that under a binding spectrum constraint, competition among few firms will produce lower prices than competition among many firms, and will possibly increase sector investment and employment. As a result, given spectrum exhaust, policies that aggressively seek to engineer entry into the mobile market--such as efforts to impede incumbent carriers from acquiring more spectrum via either auction or acquisition--may do harm rather than good.

Our article is outlined as follows. First, we present some background material describing the looming spectrum exhaust, the government's expressed concerns about rising industry concentration, and the relevance of such details for antitrust and regulatory policy. Second, we present our theoretical model, which extends the Cournot framework to incorporate a special type of input which is limitational for the production of output (e.g., spectrum exhaust). Firms are taken to be capacity-constrained by their holdings of this input, and they use ordinary capital and labor inputs to produce output at or below their effective constraint. We assume that the maximal output rate of any firm is a convex, increasing function of its holding of the limiting factor (i.e., spectrum). That is, twice the spectrum holding permits more than twice the service to be delivered to consumers. We then analyze Cournot equilibria for key industry configurations, and demonstrate that under such plausible circumstances, industry output rates and consumer welfare may be increasing in the level of industry concentration. This result is counter to the standard view of competition in that under spectrum exhaust we find that few firms produce more output and sell that output at lower prices than do many firms. Concluding comments are provided in the final section.

2. BACKGROUND

   In the coming decade, the federal government expects mobile wireless communications services to "be a key pillar of U.S. economic policy" and "a significant contributor to U.S. economic growth." (11) Certainly, consumer demand for mobile broadband services is rapidly growing, and mobile computing platforms are forecast to replace the desktop computer for many Americans. (12) As the demand for mobile data grows, however, so grows the capacity requirements of mobile broadband networks, and this capacity is closely linked to the amount of spectrum available to commercial wireless carriers. (13) By most measures, domestic mobile wireless carriers, today, fall short of their spectrum needs. According to the FCC, the estimated amount of additional spectrum needed per operator ranges from 40 to 150 MHz. (14) CTIA, an association of wireless carriers, forecasts that the industry will need an additional 800 MHz to satisfy rising demand. (15) In 2009, the total amount of auctioned spectrum was only 361 MHz. (16) The FCC estimates that there are 547 MHz of spectrum "currently licensed under flexible use rules, which allows for mobile broadband and voice services." (17) Thus, the near-term spectrum needs of wireless carriers well exceed the current total stock of spectrum assigned to commercial services. In the FCC's latest CMRS Report, the agency states the problem plainly:

   ... the current spectrum forecast demonstrates that the amount of mobile data demanded by American consumers is likely to exceed the capacity of wireless networks in the near-term, and that meeting this demand by making additional spectrum available is likely to create significant value for the mobile economy. Specifically, ... mobile broadband growth is likely to outpace the ability of technology and network improvements to keep up by an estimated factor of three, leading to a spectrum deficit that is likely to approach 300 megahertz within the next five years. (18) The shortage of spectrum is also acknowledged by the industry's financial analysts. (19) Notably, the spectrum crisis is not limited to the U.S., and several international organizations have also expressed concerns about a looming spectrum crunch, and have done so for many years. (20)

   In light of rising demand for mobile data and a limited inventory of available commercial spectrum, many believe that the most significant recommendation of the National Broadband Plan is to "[m]ake 500 megahertz of spectrum newly available for broadband within 10 years, of which 300 megahertz should be made available for mobile use within five years." (21) Where this spectrum will come from remains unclear to this day, and finding large swaths of quality spectrum may prove more difficult than the authors of the National Broadband Plan predicted. (22) Many hope that some television broadcast spectrum, which is in the highly valued broadcast spectrum band, can be repurposed for mobile broadband use. (23) However, even though legislation was passed to give the FCC the authority to hold voluntary incentive auctions, history has shown that the bureaucratic implementation process is often slow and cumbersome. (24) Even optimistic estimates of the amount of spectrum that will be freed up by such plans falls short of industry requirements. (25) Thus, as the exact amount and delivery date of new broadcast spectrum in the auction pipeline is still very murky, acquiring spectrum resources by merger and acquisition through private transactions has become widely recognized as a sensible option for operators. (26)

   However, the merger option as a solution to the spectrum shortage has been difficulty to pursue. Due to the high fixed and sunk costs of providing mobile wireless communications services, the industry has expectedly morphed into a relatively concentrated equilibrium industry structure (albeit with government approval every step of the way). (27) As a result, the question of who gets to acquire new spectrum, whether incumbent spectrum users or new entrants, is the subject of fierce political debate. (28)

   According to FCC statistics, at the end of 2009, the HHI for the U.S. mobile wireless industry stood at about 2,800. (29) By the government's Merger Guidelines standards, the industry is classified as "Highly Concentrated," which is a label reserved for industries with an HHI exceeding 2,500. (30) That said, when talking about "concentration," it is also important to keep things in perspective. For example, an HHI of 2,500 equates to 4 equal-sized firms, and the FCC's most recent CMRS Report reveals that, by Census Block, 94.3% of all Americans have access to at least four or more mobile wireless providers, and 89.6% of all...