Wireless competition turned upside-down — In theory

Are fewer competitors better for mobile broadband customers? Yes, according to the Phoenix Center for Advanced Legal & Economic Public Policy Studies, which says that when spectrum is used up, fewer firms lead to lower prices.

The February study “turns the conventional view of wireless competition on its head,” according to its authors. It does so, however, by seemingly ignoring trends in mobile network architecture that intended to address the capacity crunch the author’s see, thus undermining the assumptions on which the theory is based.

The study raises questions.

The conventional view of more wireless providers as better for competition — and consumers– is based on the Cournot competition model, under which prices and profits intuitively decline as the number of firms increases. The authors start with this and make some tweaks for the wireless case.

First, they assume the amount of capacity is not linearly related to the amount of spectrum an operator has — capacity is assumed to increase at a greater rate than spectrum is added. This can be seen as an economy of scale.

Second, the authors look at what happens when all operators in a market have reached the point of so-called “spectrum exhaust” — when they’ve maxed-out spectrum use and are running at maximum capacity. Under spectrum exhaust, according to the theory, the operators with the largest spectrum assignments enjoy the largest economies of scale, which become even bigger if they can get more spectrum. These economies, ideally, make their way to the customer in the form of lower prices.

Split the exhausted spectrum up among more operators and economies of scale go down, prices go up. The authors give this example in an accompanying blog post:

Say you have 100 MHz of spectrum and you divide it among 4 firms so that each gets 25 MHz. Say this generates 100 units of capacity. If instead you divided 100 MHz among two firms, so that each gets 50 MHz, then the amount of total capacity would be something like 150.

Why 150 instead of, say, 105 or 200? We aren’t told. How few operators are optimal? We aren’t told that either:

We cannot and do not reach conclusions about how many competitors is the right number under existing market conditions. What we do demonstrate is this: if it is true that there is spectrum exhaust, then the argument that more competitors leads to lower prices is not true.

Again we’re left with a question: More than what? Though they don’t reach conclusions about the right number of competitors, they present a model that happens to show two as optimal, for what they say is an arbitrary set of input assumptions. Presumably a different set of assumptions, equally arbitrary, could indicate a higher or lower number than two.

What about the new wireless reality?

In light of their findings, the authors say the U.S. Department of Justice’s and the FCC’s reliance on traditional market concentration measures, such as Cournot model and the Herfindahl-Hirschman Index, is misplaced.

It’s encouraging to see some fresh, thought-provoking thinking on mobile competition analysis. One concern I have with the study, however, is the need for there to be a condition of “spectrum exhaust” for the model to work. Does an operator ever reach the point where it “runs out” or is exhausted of spectrum? I think not.

This is because capacity — what the operators are really selling, not spectrum — can be increased without using new licensed spectrum through a variety of techniques including Wi-Fi and small-cell offloading, or increased antenna sectorization at the base station. What happens to this, or any other, competition analysis when the customer can access an operator’s network using no licensed spectrum, or bypass that network completely for some services?

Some other concerns:

In setting the background for the report, the study invokes a discredited FCC technical report that uses invalid assumptions and is reported to be disowned by the FCC staff that prepared it.
After relying on the Cournot model, the authors caution that it has several practical defects.
The authors say some analysts think there’s too much competition “today,” citing articles that are two or more years old.

I don’t doubt the authors’ belief that mobile-broadband competition analysis can be improved, but I don’t think this analysis, in its present form, is ripe for influencing policy. Perhaps the research could be extended to take into account the move toward heterogeneous networks, severing the notion of spectrum and capacity, and looking at the issue as an optimization problem in terms of size and location of licensed spectrum, number of operators, and use of unlicensed spectrum and other techniques to increase capacity. Then we may have a better handle on what is the optimal number of mobile broadband operators.

In one study of 40 international markets, 36 have three operators that control 85 percent of their market. That same study observes that this follows the Rule of Three, which states that there are three significant competitors for any mature market. Maybe two, as shown in the Phoenix Center model, isn’t that far off. In the face of disruption from offloading, heterogeneous networks, and over-the-top content, however, the mobile-broadband market is losing its mature status. The Rule of Three may become less applicable as traditional notions of a mobile-broadband industry fade.

Steven Crowley is a consulting network engineer, who blogs here. He can be found on Twitter @stevenjcrowley

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