Wholesaling Wireless Capacity: A Simple Fix For A Consumer-Unfriendly Problem

Includes: S, T, VZ
by: Dana Blankenhorn

The whole problem with the U.S. Internet market, which underlies the U.S. Justice Department's case against the AT&T-T-Mobile merger, comes down to one word: Incentives.

Because of their vertical structures, U.S. Internet Service Providers serving retail consumers have no incentive to invest in their networks, whether wired or wireless. They have no incentive to increase speeds or lower prices.

Yet that's what tablet and phone makers like Apple (NASDAQ:AAPL), Google (NASDAQ:GOOG) and Amazon (NASDAQ:AMZN) most want, and what they are promising their customers with visions of “taking your Netflix subscription with you.”

AT&T (NYSE:T) was able to overcome the 1996 Telecommunications Act and control its customers because of regulatory decisions taken in the last decade. Those decisions can be undone: Simply issue an order requiring all wireless and wired Internet carriers to allow wholesaling, or resale, of their capacity.

The Internet is not a series of tubes. It's connectivity. The speed at which data travels is determined by the slowest link in the chain between your home or device and the Internet core, which remains competitive.

The last mile is the bottleneck. Control of the last mile means control of the customer, of you. The owner of the last mile can make the customer pay whatever they want, for as little as they want to give. The incentive, then, is to limit choice, control the last mile, and limit connectivity.

The phone companies' broadband answer, ADSL, is much slower than what cable offers, but cable has an incentive for upgrades in its basic TV service, and so it has taken that market. The only response, by Verizon (NYSE:VZ), is FIOS, bringing fiber closer to the customer, essentially overbuilding the TV plant to enable faster Internet speeds. But that's not working for its bottom line.

Control of the customer is also the key to wireless profit. AT&T and Verizon use new phones to sign multi-year contracts with customers, then go about increasing their average revenue per user in any way they can. This isn't done with network upgrades; it's done with marketing -- and by adding charges where charges didn't exist before, and where costs don't exist, as with AT&T's flat $20/month SMS charge.

In both these cases, increasing profits for Verizon and AT&T require they deliver fewer choices to the customer, not more connectivity. Their vertical integration has skewed their profit incentive toward scarcity, not abundance.

But what if they were required to wholesale their capacity to others? The UK requires this, and even controls what British Telecom can charge its rivals. The result is a competitive market with lower prices and higher speeds than U.S. consumers get.

The same should be true in wireless. AT&T and Verizon refuse to wholesale their capacity. Sprint (NYSE:S), T-Mobile, Clearwire (CLWR) and LightSquared do. Why not? Because they don't make as much money (per bit) from wholesaling as they do from customer control. This is what poker players call a “tell.” What they're saying is that their incentive is to limit the bits they deliver and get more for each bit, not deliver as many bits as possible.

So the answer to me is clear. Require all carriers, wireless and wired, to wholesale their capacity. Demand competition in the retail market, and you'll provide traffic, which creates incentives for carriers to deliver more bits.

Once this happens, the promise of all these wireless commercials, from both the ISPs and the equipment makers, can start to come true. Once the carriers' incentives favor abundance, they will deliver it. But not until then.

Disclosure: I am long GOOG.