Telecom: Where the Antitrust Investigation of U.S. Carriers Will End

Given given the recent antitrust rumblings against the carriers, I wanted to talk a bit about a few elements of the decision:

• the potential to spur innovation and a renaissance in technology equipment companies in the space. Will there be a new wave of venture and technology investment in the space as a result of another "reform" act?
• The potential end game for the carriers in terms of what the competitive landscape may look like
• Steps the FCC could take to alleviate lack of innovation and competition without a big over regulatory clampdown.

In BlindReason's 2009 surprise list we had a prediction that an antitrust investigation would be launched on the carriers (AT&T (T), Sprint (S), T-Mobile and Verizon (VZ)) and the groundwork for that appears to be starting.
See #30-

30. The FCC launches a major investigation into monopoly like practices of AT&T and Verizon. The stocks do incredibly well despite this.

The DOJ and FCC are starting to look at the carriers' "exclusivity periods" in the contracts for special handset deals. These really aren't the deals that bother me too much because typically, exclusivity contracts don't last very long and eventually handset manufacturers migrate to wider deals to grab share. To be fair, my prediction really hasn't come true yet and my intent is to describe a broader look at how telecom reform is being implemented and whether it is inhibiting competition and innovation.

The relevance of this is a big anti trust effort would likely spur technology and new services in an otherwise dormant sector. While the excitement out of the IPhone is game changing, the sector outside of this is anemic.

Generally, management at carriers tends to be relatively slow moving and excessively controlling. They want to control everything on your phone and figure out a way to bill for it. This has represented a bit of a clash of wills as the carriers have offered internet services where the mindset is totally different. Take my favorite example which is Twitter / SMS. Twitter's 140 character limit comes from wireless SMS messages. By allowing this service to be free from carrier controls it's turned into one of the most vibrant social media businesses out there. Why couldn't a carrier figure this out? It's because the carriers are caught in an oligopolistic tango that retards their own innovation and growth. Steve Jobs had to pull out every trick in the book just to hammer open AT&T's network, and Verizon outright refused.

In terms of the exclusivity deals being anti competitive, I think this is a regulatory straw horse. In the case of the iPhone, only now are they rumored to be developing an air interface other than GSM (Verizon and Sprint use CDMA). While T-Mobile uses GSM as well, only recently has it rolled out a decent data network. Once LTE is rolled out nation wide, and most probably before that, Apple (AAPL) will introduce the device for multiple carriers. In fact, I wouldn't be surprised to see an air interface agnostic Media Tablet from Apple well before that. The exclusivity with Apple has dragged on awfully long but that's mostly because Apple has had no real alternative in data network unless it wanted to produce a CDMA version of its phone.

AT&T, which is going to report this week, has only got about 1 year of exclusivity left in my view. It simply is not good business to keep that deal going any longer. Verizon wants a piece awfully badly and you've seen them make some "fake" moves to curtail their own exclusivity deals to show contrast to their competitors. Verizon has one of the most cynical policy groups out there, and in my view, their intent is just to put pressure on Apple and AT&T so they can grab share and end AT&T's lock down which is a huge thorn in Verizon's side. I wouldn't be surprised if Verizon is one of the companies that complained about carrier exclusivity to Congress.

To gain some perspective, it helps a bit to take a step back to the Telecommunication Reform Act of 1996 which ostensibly was designed to increase competition and spur innovation. If we've learned anything, it's that government is very good at creating bubbles whether they are in technology IT, health care, financial services / Banks, real estate or in telecommunications. Do you think that the big telecom bubble that hit after the 1996 act was coincidence? In practice, it temporarily moved AT&T into disparate parts and created a huge investment bubble as capital rushed into CLECs (new competitive baby bells).

So here we are again, back where we started. Eventually, the constituent parts of AT&T mostly just merged back into each other and we are left with a competitive environment that's pretty much the same as it was in 1996. AT&T has been fairly successful in swatting away most competitive challenges by hook or by crook. Other than Sprint, and T-Mobile (formed by Omnpoint and Voicestream), there really were very few carriers that successfully challenged the status quo. These guys use every trick in the book from delaying interconnect installs or using regulatory levers to slow down competitors.

In some parts of the country, the competitive landscape is actually worse. A lot of people only have the one choice or a second choice of carrier really. In some regions, because of negotiated contracts done on a by building basis, your television, voice and if you want an iPhone only have one choice.

"Thank you for choosing AT&T". As if you had a choice.

The most unfortunate thing about this is that it has allowed AT&T to drastically curtail capital investment in its wireless network and in other businesses as well.

It's finally caught up with them as they are trying to furiously upgrade their GSM network now because they have been so surprised with a device that people actually want to use on their network. Their engineers never planned for that kind of data usage because previous limits on devices have been so stringent nobody wanted to try.

With the iPhone launch and the marketing damage being done in the mean time they have to upgrade their network even faster. A lot of the social media outlets have just got some terrible reviews of AT&T's network, particularly in high density areas like Manhattan or in San Francisco. Dropped calls, people not getting voice mails for weeks, and terrible data coverage make it probably the most unreliable network in the country right now in many regions.

So the question is, will we see a resurgence of innovation in telecommunications services and equipment and how can we reform existing regulation to make competition more vibrant? Here are some thoughts:

• While the exclusivity agreements are "interesting", the real issue is getting more nation wide broadband licenses out of the hand of the incumbents. One of the most valuable pieces of spectrum was auctioned off too long ago and the most valuable nationwide band of high propagation, higher value spectrum went to Verizon. Google (GOOG) played a pretty good game of chicken but in the end the license isn't going to do much as long as an entrenched incumbent holds it no matter what FCC regulations say. In a test of IQ points between Verizon and the FCC, the record is pretty clear.
• We need not one, but two of these licenses to be in the hands of new entrants like Clearwire (CLWR) or brand new entrants all together. Some sort of negotiated divestiture by Verizon here would do wonders for competition.
• Competition in fixed broadband services (DSL, etc), can be augmented by fixed wireless solutions. The cost for this type of services are coming down dramatically. With Wi-Max and LTE the data rates here are adequate to provide a competitive alternative to broadband DSL and cable data services. Not too far off from a UVerse like wireless video.
• Wireless voice will eventually migrate to an all you can eat pipe. Much as home broadband evolved, wireless voice will fold into one big data package. Right now carriers overcharge for services like "SMS" and "Voice". Voice takes up minimal bandwidth compared to data services. Eventually, you'll just be charged for one big pipe, especially if competition is allowed to brew.
• Node devices like wi-fi 3g hubs will allow more substitution out of fixed broadband. You may no longer be constrained by the infrastructure in your neighborhood. You may buy a node from your wireless services provider who gives you video and data through a node in the home and mobile services off their network nationwide all as one big bundled pipe.
• Evolutions in data rates will allow substitution in video as well, allowing for more competition against cable, telecom and satellite. Two broadband nationwide licenses would allow robust competition in video, internet, and wireless.

As an aside, the strategic choice that both AT&T and Verizon made has got to be a Harvard Case Study if it isn't already. On one hand you have Verizon with a large capex, huge fiber build outs with its TV service as well as probably one of the more Capex intensive Wireless networks. In contrast you have AT&T who has dramatically under-invested in its wireless network because of lack of competition as well as its UVerse service, which is the least capital intensive choice. Instead of Fiber to the home, UVerse uses existing infrastructure.

The bet by AT&T has turned out to be the right one so far. UVerse is turning out to be a rather dynamic service. They are only a few iterations away from a relatively stable and reliable video service using relatively little bandwidth. The technologist in me would have suggested that Verizon's early choice to get long on technology and big capital intensive fiber builds would be the right one. Verizon has also got the most capital intensive wireless network.

Let me be clear. I'm certainly not arguing for some kind of big regulatory clampdown. Competition is the answer here. I don't even think that the exclusivity deals should be touched. Instead, the FCC should offer up two big Nationwide 4g licenses for fixed and wireless broadband pipes. This is the best way to spur innovation and reintroduce dynamism into what is a relative corpse like sector. Competition is the best cure for what we've seen and offering up these licenses to existing incumbent carriers isn't going to serve anyone's interests. Those Verizon C Band licenses should be the first ones to be set free.

Disclosure: No positions

Comments

[Steve Biren...:]

Good points all around, John. Well done. Not to nitpick but as you know CLWR is in cahoots with the cable companies so I am not sure it will prove to be a real alternative to cable internet. And while cable companies would like to offer wireless, I don't think they will be overly aggressive. Telcos have not been unusually aggressive on pricing in TV and internet given the evidence of stable ARPUs. Cable will likely just push hard enough to remind telcos not to be too aggressive. The oligopoly is working well for both sides.

Jul 22 09:48 AM