The AT&T deal drew the wrath of both the Justice Department and the FCC, which ultimately proved fatal. Does a similar fate await Verizon?

Ah, you say – there’s no real comparison. Unlike the proposed AT&T/T-Mobile merger, Verizon’s acquisition doesn’t involve the acquisition of millions of subscribers from a competitor, increasing market concentration in the wireless market.

But the deals do have one big thing in common: In both, the primary objective was to cope with the looming scarcity of spectrum. For without more bandwidth, neither carrier will be able to deliver on the promise of whiz-bang wireless broadband services such as high definition movies anytime, anywhere.

To be sure, the problem here is not precisely a shortage of spectrum per se, but a shortage created by the wasteful allocation of spectrum today. If Washington were so inclined, it could free up a ton of spectrum for more valuable uses. That includes spectrum now warehoused by government for low-value tasks and spectrum assigned to commercial interests – notably local TV stations – that no longer make much use of it. The process would be pretty simple: auction the spectrum to the highest bidders (perhaps with a share of the proceeds going to legacy holders), and then allow it to be traded like any other valued resource.

This is an old, but important, idea, one first suggested by Nobel economics laureate Ronald Coase back in 1959. And it’s one that has taken on greater urgency in recent years, both because the technology of spectrum-hungry broadband mobile has arrived in the form of tablets and smartphones, and because Washington desperately needs revenue. (We’re talking tens of billions here.) But the politics of spectrum allocation remain gridlocked, as competing interests push and shove for advantage.

So AT&T and Verizon, the number one and two players in the American wireless market, resorted to end-runs around the problem – that is, to buying spectrum from other carriers or merging to make more efficient use of the partners’ combined holdings. If the AT&T/T-Mobile combination had survived the legal gauntlet, it could have become the largest U.S. wireless provider, with as much as one-third of the market. But the emphasis here is on the word “theory.” The merger might or might not have reversed T-Mobile’s sinking fortunes – which is why its parent company, Deutsche Telekom, has signaled its intent to leave the U.S. market, with or without a merger deal.

The upshot is that it’s far from self-evident that AT&T would have remained first in subscribers for long in a post-merger market. Verizon’s rollout of 4G, the holy grail of mobile excellence, is expected to cover more than 200 million Americans by the end of this year — compared with roughly 70 million for AT&T. Moreover, the proposed Verizon deal includes cross-marketing with the cable companies’ retail stores, yet another advantage in this most visible of consumer markets.

But the merger succumbed to implacable opposition from the trustbusters at Justice and the micromanagers at the FCC. Both agencies argued that the merger would give AT&T more latitude to raise prices. And neither apparently put much weight on AT&T’s need for additional spectrum if it is to offer viable competition for Verizon in a 4G world.

If this were 1951 instead of 2011, a time when self-satisfied American mega-companies like GM set the pace for global industrial innovation, we’d have more sympathy for the government’s tilt against market concentration. But as the Verizon gambit makes clear, this is anything but a static contest. AT&T and Verizon are living in uncertain times in which they must run to stay in place. That doesn’t mean the risk of monopoly power is as dead as the Oldsmobile. But it does mean that discretion in managing markets really has become the better part of valor.

As we see it, Washing has three options. The first is to drastically limit what firms like Verizon and AT&T can do to improve their service offerings, with obvious short-term consequences in terms of slowing the roll out of 4G. The second is to break through interest-group gridlock and leaven competition in the wireless market with a lot more spectrum – the best option, surely, but probably a political non-starter at the moment. The third option, and the probably the best under the circs, is to look favorably upon telecom deals that promise more efficient use of currently available spectrum on the premise that the vitality of innovation means more to consumers than the potential downside of greater market concentration.

Does that mean giving free passes to the telecom giants? Hardly. But it would mean a change in priorities at Justice and the FCC in which the agencies used their legal leverage to minimize concentration in regional wireless market without undermining the potential for more efficient use of spectrum.

Heard about Viber yet? It’s an app for the iPhone and for Android smartphones, the neatest means yet for making virtually free phone calls and sending free text messages to anyone, anywhere, anytime. Oh, and did we mention that the voice quality is typically superior to that of the mobile phone networks? The only catch is that both parties need to install the software.

Well, not quite the only catch. If Viber and similar mobile phone applications from Skype and others are widely adopted – and we can’t imagine why they wouldn’t be – their use will significantly erode the revenues of the wireless telecom networks. This would bring into sharp focus an issue that neither the telecoms nor their regulators are eager to confront: Should the carriers be allowed to decide which applications can be used on their systems, and on what terms?

Viber is not a technological breakthrough. Dozens of companies offer ways to take advantage of the somewhat arbitrary distinction between voice and data communications built into the wireless carriers’ price plans. But Viber is the slickest, most seamless way to date to use so-called voice over Internet protocol technology on popular smartphones.

So what’s the problem here? Thanks to pricing structures going back to a time when the only wireless application that really mattered was voice communications, the voice “tail” still wags the data “dog.” Voice and text messaging use a small and rapidly diminishing share of wireless bandwidth, but generate much of the wireless telecoms’ revenues.

That is likely to force wireless telecoms to change the way they price services. They could switch to plans in which smartphone users were simply charged for their use of the networks, however they chose to use them. Indeed, since voice and text use so little network capacity compared to, say, video streaming, one could imagine plans that threw in unlimited voice minutes as a “free” bonus. Alternatively, they could maintain the voice-data distinction, charging fees for access to Viber-like voice applications – or simply bar access to services that competed directly with their own.

Now, from an economist’s perspective, there’s nothing wrong with charging according to use – especially since the FCC has muscled the big wireless carriers to provide advance notification when customers’ usage exceeds their plan limits. The second approach, controlling access to applications, is more problematic.

We all think it’s OK for a movie theatre to bar patrons from bringing their own popcorn. Isn’t that the same as a wireless carrier barring use of a competing service on its network?

Maybe. In a competitive market, wireless customers who don’t like the restrictions imposed by one telecom are able to shop for another more to their tastes. (Right now, for example, T-Mobile and a number of regional carriers are trawling for business by offering flat-fee unlimited data plans.) If there isn’t much competition, though, it’s the job of the antitrust agencies and the FCC to prevent the carriers from protecting their own services at the expense of competitors by assuring that Viber and its ilk can be used on the networks on reasonable terms.

We think the wireless carriers deserve the benefit of the doubt (at least in markets with several carriers), because there is evidence of robust competition specifically aimed at enticing the tens of millions of Americans who still use plain-vanilla cellphones to step up to broadband Internet access.

But everybody needs to remember there’s no free lunch here – that, one way or another, the telecoms need to cover the costs of subsidizing smartphones and expanding their wireless networks to meet the exploding demand for bandwidth. And that’s probably going to mean bigger bills (along with bigger benefits) for customers who dive into the astonishing world of high speed wireless.

(This post was also published on Forbes.com.)

The Department of Justice has come out with guns blazing in an effort to stop the $39 billion AT&T/T-Mobile USA merger. But is it really in the interest of either the antitrust bureaucracy—or the consumers they are supposed to represent—to put the kibosh on this one?

There’s a legitimate dispute here. On one side are folks (like us) who believe that the merger’s likely benefits—faster introduction of new technology to meet the exploding demand for mobile broadband—far exceed the risks associated with greater market concentration. On the other side are those who believe that moving from four big national carriers to three would mean the end of serious price competition in the wireless industry.

Before engaging in a full-blown legal battle, we think it would serve the interests of the Justice Department to see if its concerns could be met without a trial. For one thing, there’s a real possibility that the trustbusters could lose —the judge in the case has shown in the past that she is no rubber stamp for the government. For another, a trial means that both company’s plans will be put on hold, a prospect that could prove costly to consumers, workers and the telecoms.

T-Mobile USA is running just to stay in place. It lost almost a half-million contract customers in the first quarter of 2011. And though it managed to replace most of them, the bulk of the newcomers were less lucrative subscribers recruited though resellers. Moreover, T-Mobile’s corporate parent, Deutsche Telekom, isn’t about to bankroll a rescue. The German communications giant has made it plain that it won’t invest more to sustain its American presence. Indeed, by the time a trial is over, a much-weakened T-Mobile may simply be unviable as a standalone entity.

Does AT&T have anything to give to satisfy the government? AT&T’s CEO Randall Stephenson is on record that the company is prepared to divest some assets, reducing its share of the business in some markets. That ought to open the door for a deal. The top 25 local wireless markets, served by all the major carriers along with smaller wireless companies eager to buy market share with low prices, are already so competitive that the merger would have little material effect. But divestitures in smaller markets ought to go a long way toward assuaging genuine concerns about market concentration.

We think serious settlement discussions are the way to go. Duking it out in court could lead to a winner-take-all outcome in which the only certain loser is the public.

Clever, but a tad shaky. Google operates in a “two-sided” market in which both advertisers and users of Google services are needed to make money. Without eyeballs on Google pages, the space is worthless to advertisers. But without advertising, Google couldn’t afford to give away services ranging from Google search to gmail to Google Docs.  

Google, moreover, is in no position to take its rank-and-file users for granted. While the Don’t-Be-Evil company still garners the majority of Internet searches, Microsoft’s Bing (and its ally, Yahoo!) have picked up about 30 percent of all search traffic in the United States. And there’s no reason to believe Google’s dominance would survive a serious decline in consumer goodwill, since the quality of the Bing search engine is plenty good enough – and sometimes better — than Brand G.

So, while it’s true Apple’s special place in supercool-gadget-loving hearts gives it very good reasons not to alienate the public, Google’s behaviour is also constrained by the market. We’re not claiming that either company’s incentives to balance gross commerce against high minded principle are perfectly disciplined by Adam Smith’s invisible hand. But neither are the incentives of those who would regulate them. For now, anyway, we think it makes the most sense to insist that all Internet companies make their privacy policies very clear, and let consumers decide what they think of them.

The coming wireless revolution depends on a huge expansion of transmission capacity to support 4G wireless broadband service. And while technology and oodles of cash will make it possible to cram more data through the existing wireless telecom system, avoiding hopeless traffic jams will require access to a lot more of what used to be called the “airwaves.” That’s why we’re delighted that FCC Chairman Genachowski has called for repurposing a broad swath of prime, underutilized spectrum now controlled by local TV stations. The big question is whether the broadcasters have the will and political clout to stop him.

Until the rise of cable, phone-line and satellite TV transmission, terrestrial broadcasting using FCC-assigned spectrum frequencies was the only game in town. The FCC gave away local licenses to the “most qualified” applicants. And in the heyday of advertiser-supported broadcast television (before video games, the Internet and “narrowcast” cable channels were competing for eyeballs), stations with licenses for VHF channels in major markets traded for hundreds of millions of dollars more than their investments in broadcasting facilities.

By the 1990s, the explosive growth of digital cell phones was makinge spectrum far more valuable for mobile wireless, even as the gravy generated by broadcast TV was drying up. But thanks to a potent lobby (there’s a TV station or five in every Congressional district) and the promise of delivering “free” TV to everybody with a pair of rabbit ears, nobody seriously challenged the allocation of all that spectrum until the advent of over-the-air digital TV.

As part of the deal for switching to a spectrum-efficient digital system, the broadcasters gave up about one-quarter of their spectrum – what used to be UHF channels 52-69 – which was then auctioned to the wireless telecoms for close to $20 billion. But the broadcasters still control the rest, using it to deliver content to the 10 percent of households who don’t want (or can’t afford) TV delivered from satellites or through wires.

Now, all of this remaining spectrum could be sold to the highest bidders, which would almost certainly be wireless telecoms seeking to build capacious 4G networks. Washington, which needs every penny it can scrape up, would keep the tens of billions in revenue from the auctions. But the financial bonanza from repurposing the spectrum would be so large that one could, in theory, use a modest chunk of the auction proceeds to buy out the TV broadcasters licenses at a profit and endow everybody who was still watching on-air TV with a lifetime subscription to basic cable.

Chairman Genachowksi’s approach is less sweeping and more pragmatic. He would leave the broadcasters with enough spectrum to maintain over-the-air service, thereby finessing the populist argument that he was killing free TV. And to mollify the broadcasters (who, after all, appropriated the spectrum from the taxpayers, fair-and-square) he would share some of the proceeds of the auction with them. This is plainly a compromise, designed to build a winning political coalition. But it would also serve to mollify those who worry that challenging the de facto spectrum property rights of the broadcasters could make it more difficult to get private enterprise to invest everything from pollution emissions rights to private toll roads, where investors must have faith in the government’s long term commitment of resources.

The Genachowski solution sure beats the alternative of waiting until the political cost of denying 4G service to the multitudes is higher than the cost of standing up to the broadcasting lobby. But plenty of things could happen on the way to the forum. In particular, the broadcasters could play hard ball on the premise that they hold most of the political cards. The telecoms, which know a thing or two about getting their way in DC, and in some circumstances might be expected to offset the muscle of the broadcasters, don’t really have an interest in how the proceeds from the auctions are divided. All they care about is getting access to the spectrum – and sooner rather than later.

If and when a deal is reached, there’s going to be a lot of second-guessing about how much money is diverted from the Treasury to the broadcasters’ bank accounts. But it is important to remember that the prize here isn’t just the tens of billions that the spectrum would likely fetch at auction. It’s the value-added from 4G service that consumers and telecoms will share – a figure that could approach $1 trillion!

(A shorter version was first posted on Politico.com)

But telecom technology marches (sprints?) on, and with it the notion of what constitutes must-have service. Which is why the Federal Communications Commission is planning to steer some of the cash to high-speed Internet service. Here’s a more radical thought: Open the policy debate to the broader question of whether telecom subsidies are merited in the first place.

Our educated guess is that the benefits from USF outlays for plain old phone service are far less than the cost. Indeed, we expect that the case for subsidizing broadband is also weak, in part because over 90 percent of Americans already have access to broadband, and the number is growing rapidly without cash from a government slush fund.

OK, we didn’t just fall off the turnip truck. We understand that subsidies – especially subsidies funded from a tax that is collected in nickels and dimes – are hard to reverse. But if Congress can’t bear to let rural Americans pay the full cost of living in the country and won’t alleviate poverty directly, the least it could do is deliver the pork efficiently. That means targeting the subsidies more precisely and use competitive bidding to get the job done as cheaply as possible.

Back up for a moment. All the wireless carriers are investing billions in advanced transmission systems that are fast enough to support popular Internet content offered by the likes of Hulu, YouTube, and Skype – each of which depend on high-quality streaming video. MetroPCS’s own LTE system (for Long Term Evolution) is up and running. But since the whole point of LTE is to offer data-rich service, MetroPCS is facing the same problem as all the other carriers: consumers are going to use more system capacity than they would with older technologies, and some are going to go hog-wild, even watching full length movies on their smartphones. To cover the cost, the carriers must find ways to increase revenues.

Many carriers have adjusted by abandoning unlimited flat-fee service in favor of tiered rates, charging according to usage. Seems fair to us: nobody whines when Mickey D demands three times as much for a Big Mac than for a plain old cheeseburger. And, in any case, nobody is going to be caught with an unexpectedly hefty monthly bill: the FCC insists that the carriers notify users when they exceed their allotted tier of gigabytes—a policy we support.

MetroPCS was apparently loath to muddy its image as a champion of unlimited service. So instead of tiered rates, it offers multiple plans that allow unlimited usage of varying groups of online services, much the way cable TV companies charge for varying bundles of channels. At the high end, $60 a month gets you pretty much everything MetroPCS has to sell – from unlimited international text messaging, to GPS navigation, to 30 Rock episodes on demand. At the low end of LTE service ($40 a month), you still get fast-streaming YouTube and unlimited, high-speed web access, but lose many of the data-intensive services in the high-end plan.

Free Press and a bunch of other watchdog organizations think this violates the spirit of “net neutrality,” as well as the letter of the FCC’s new “open internet” anti-discrimination rules. After all, the $40 plan blocks a variety of fabulous services including NetFlix and Skype while offering services that (in very a limited fashion) compete with them. We’re not lawyers, and thus don’t really know if Free Press has a legal leg to stand on. But we do claim some familiarity with economics and common sense. And by that criterion, we stand foursquare with MetroPCS.

Any MetroPCS subscriber with an advanced smartphone can have access to any wireless Internet service, provided they are willing to pay for it. And if MetroPCS’s rates seem excessive, subscribers can always switch to other carriers. Indeed, unlike most wireless companies, MetroPCS makes switching relatively easy because it doesn’t lock customers into fixed-term contracts.

We hope the FCC gives Free Press the brush-off it deserves.

(This post was also published on Forbes.com.)

A case in point: the charge that the chairman is abandoning sacrosanct principle in blessing the idea that it’s OK for telecoms to charge by the byte. Washington is probably the only place in America where paying for what you consume (“usage-based pricing” in econ-speak) is suspect. No, wait; there’s Disney World, too. But you get the idea.

Nobody complains when Starbucks charges more for a vente cappuccino than for a tall, and even your average 7-year-old knows it will cost more for the whole family to see the new “Harry Potter” movie than for the single teen ahead of them in line. Why shouldn’t the same concept apply to the Internet, when a minute of streaming video can use 1,000 times as much bandwidth as a two-page e-mail?

Against this common sense, Art Brodsky of Public Knowledge claims that linking what customers pay to how much they consume is just “an excuse for not building out your network.” Brodsky concludes — though without the benefit of serious bean-counting — that usage pricing could drive up the cost of Netflix streaming service about fivefold, to $60 a month.

That seems high, but we really don’t know. Reed Hastings, the CEO of Netflix, apparently isn’t worried. He recently told a reporter that usage-based pricing “doesn’t particularly scare us.” And he cited Netflix’s experience in Canada, where tiered-pricing plans have proved “pretty generous.”

What we do know is that the telecoms need a way to make a buck as they expand their networks, to accommodate the exploding demand for video. The investment will be especially daunting for the mobile carriers, which must build advanced generation wireless networks — so-called 4G and LTE systems — to be able to serve up video in high definition for millions of new smartphones and mobile tablets. While it might be possible to raise everybody’s rates equally to recoup the cost (provided the government prohibited discounts to light users), it would be wasteful and unfair.

Other critics complain that the Genachowski framework would give network operators the option to offer specialized services including “paid priority,” which would guarantee the quality of bandwidth-sensitive apps like VoIP calling and movies on demand. Right now, streaming movies occasionally break into pixel soup, and Internet phone calls way too often reverberate with echoes. Genachowski would allow operators to prioritize access when networks are overloaded — and to charge accordingly.

Seems reasonable to us. Why shouldn’t Netflix, Hulu and Skype (more precisely, their customers) be able to buy such enhancements in the same way everybody can choose between overnight delivery and ground shipping when they send stuff by FedEx?

More to the point, what’s really the alternative? One-price-fits-all Internet service is like one-size-fits-all clothing. All right in a pinch, but you wouldn’t want to live with it.

(This post was also published in San Jose Mercury News.)

Among the highlights (available here, free):

• The total number of wireless subscribers in the U.S. has risen from 4.3 million (served by 4,800 cell towers) in 1990 to 293 million (served by 252,000 cell towers) today.
• The total capital invested in the wireless networks is up from $5.2 billion in 1990 to $292 billion in 2010.
•  Industry revenues have increased from $4 billion to $156 billion in the same two-decade span.
• The number of text messages sent ballooned from 57 billion in 2005 to 1.8 trillion in 2010.

Actually, we’ve saved the most impressive statistic for last. There’s no question that the quality of service (in terms of coverage and dropped connections) has greatly improved since 1990. Ditto for the scope of services offered: Then, it was a voice-only service. Meanwhile, the hardware and software packed into a modern wireless handset now rivals the complexity and cost of a laptop PC with all the bells and whistles. Yet the average monthly bill (which typically includes most of the cost for the handset) has declined from $83.94 to $47.47.

A miracle, you say? Well, in a sense: the technology underpinning the wireless revolution is simply jaw-dropping. But we’d give some of the credit to market capitalism (which has been taking its licks in public opinion in recent years). More accurately, to competition, which has forced the wireless carriers to pass on to consumers most of the difference between what it costs to deliver the services and what they are worth.

Remember when you mostly used the Internet for shopping, email and looking up stuff like the name of Sandra Bullock’s coolest movie (Speed, co-starring Keanu Reeves)? Maybe you still do. But if you’re young, or anxious to have something to talk about with your teenager, chances are you now spend a lot of time on sites like YouTube, Facebook and Skype. What’s more, most of the content (measured in bytes) is bandwidth-hungry video “streamed” in real time — not words, music and photos downloaded for perusal at your leisure.

A sea change in Internet use? More like a tsunami that’s reshaping how, where and when we get our entertainment. But it’s going to take a lot of capital, along with some fresh thinking about how to recoup that investment, to make it happen. More ominously, it’s going to take a lot of self-restraint on the part of policymakers, who will be caught in the crossfire as content providers, telecom companies and consumers fight for bigger slices of the pie.

The long heralded, but long delayed, integration of TV and the Internet is finally upon us. In the two hours between 8:00 and 10:00 PM, Netflix streaming movies and TV shows account for one-fifth (not a misprint) of all the Internet bandwidth being used in the United States. And that’s not the half of it. True Internet TV is about to go mainstream.

One reason is that the technology is catching up with the vision: TV manufacturers are introducing sets with easy access to the Internet built in. Want to watch The Devil Wears Prada? Tonight’s network shows? Or maybe a cricket match, live from New Delhi? All that programming is available on the Internet. And with the new TVs, you’ll be able to buy it on demand just as easily as you buy clothes and books on your PC. Indeed, it will soon be practical for anyone with a broadband connection to bypass cable and satellite TV entirely, watching whatever they want, when they want it, via the Internet.

Burgeoning access to video on wireless devices promises to be equally disruptive, since most of the streaming video available on computers can also be seen on smartphones and tablets. The only constraint is access to fast wireless networks. And that probably won’t remain a constraint for long: Morgan Stanley predicts that video usage will rise 66-fold between 2008 and 2013 in the United States, by the latter year representing two-thirds of all wireless data traffic.

So, what stands between consumers and video nirvana? For starters, Internet capacity will have to keep up with demand. When 20 percent of the Internet is being hogged by Netflix, fewer than one million Netflix subscribers are online. Imagine how many terabytes of data per minute will have to pass through Internet switches when 100 million Americans are watching TV (or playing high-definition video games) online.

What’s more, those terabytes will have to flow seamlessly: Nobody knows or cares if iTunes hiccups occasionally on music downloads. But a bottleneck lasting a few seconds could mar the experience of Avatar for tens of thousands.

Wireless system operators face the biggest challenges. In part that’s because they have so much further to go in building broadband capacity, in part because the all-you-can-eat data plans now favored by most customers will not work well as use becomes more skewed. That’s why AT&T and Verizon have switched to tiered pricing plans, and why every other wireless carrier in the U.S. will be dragged in the same direction.

Now, from technological and economic perspectives, keeping the Internet ahead of the video curve is surely manageable. There will no doubt be growing pains, as consumers face additional charges for bandwidth use and premium programming and content providers duke it out with the carriers over how to split revenue from Internet-based video. But there’s no good reason to believe the market won’t sort itself out.

No good reason, but maybe some bad ones. In particular, the government could easily be drawn into interest group battles masquerading as high-minded debates over the principles of telecommunications policy.

Should content providers be allowed to charge Internet service providers, the way they now charge cable TV and satellite companies? Or look at the carrier-content relationship from the other direction: Should service providers be allowed to charge content providers for premium video quality? Then, there are the questions raised by the fact that the lines between carriers and content providers are blurred. For example, should a wireless carrier that sells a lot of voice services be allowed to block (or charge) Internet phone companies that piggyback on their systems? Finally, should there be rules on how Internet service providers and wireless providers can charge you, the consumer, to recoup their huge investments?

No doubt, consultants in search of second homes will discover a zillion reasons for believing that, without intervention, the new, video-dominated Internet will generate windfalls for somebody. But we think the proper test is different: Are regulators likely to do a better job in promoting efficiency and growth in an industry characterized by rapidly changing technology and a need for tens of billions of dollars in capital to stoke the engine of progress?

The answer may turn on how markets evolve – in particular, whether any of the players manage to find ways to build durable barriers to competition. What does seem clear, though, is that the burden of proof should be on those who want regulation now, because the Internet TV revolution has finally arrived at your doorstep and could soon be in the palm of your hand.

(This post was also published on Forbes.com.)