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Attack of the 'Cuisinart' Regulators


Attack of the 'Cuisinart' Regulators

February 26, 2004

Cingular's $47-billion acquisition of AT&T Wireless (AWE) is just one more step in the expensive, essential and wearisome business of reversing two decades of bungled telecom regulation. Since an antitrust decree broke up the old Bell system in 1984, Federal Communications Commission regulators and antitrust prosecutors have aggressively promoted a policy of regulatory Cuisinart, chopping up networks to promote competition. But with wired and wireless networks alike, costs fall, service quality rises and competition develops only when things are put back together.

Customers expect their wireless phones to work flawlessly nationwide, and the cost of deploying and upgrading a ubiquitous network drops as the footprint expands. Cingular and AWE have quite complementary footprints -- both companies operate national networks, but their competitive strongholds overlap a lot less than meets the eye, so the merger will mainly unite one company's strength with the other's relative weakness. Wall Street certainly sees the deal as a net plus. AWE's stock price rose sharply, while SBC and BellSouth (Cingular's joint owners) held just about steady when the final deal was announced.

The original owners of many of the cellular licenses currently owned by AWE -- licenses today worth perhaps $5 billion to $10 billion -- were selected, back in the early 1980s, by aiming a fan at Ping-Pong balls in one of those machines used to pick winning lottery numbers. The FCC divided the country into 734 separate geographic markets and assigned each separate license by lottery in all but the 30 largest markets. Dentists and carpet vendors bought tickets, and when they got lucky and won, they immediately flipped their licenses to other, somewhat more serious operators, at great profit. Craig McCaw was an early and aggressive buyer; he then sold to AT&T. On a parallel track, SBC, the former Ameritech, and BellSouth pooled their geographically separate holdings to form Cingular. Now, finally, a single, robust national carrier is set to emerge.

Verizon's network emerged in similar fashion, through the painstaking assembly of licenses acquired separately by the former Bell Atlantic, NYNEX, PacTel, GTE and smaller operators. Sprint assembled its wireless network by buying fistfuls of PCS licenses. When the PCS bands were being allocated in the early 1990s, the FCC's chief economist,

Thomas Hazlett, urged the Commission to issue five national, 40-megahertz licenses. Instead, the FCC carved up the national map twice, once into 51 separate areas, and a second time into 493 areas, to issue a total of 2,074 separate licenses, with 1,479 of those in 10-megahertz blocks. Reassembling these regulatory fragments into usable networks then took years. Nextel constructed its national network by piecing together 41,000 of the 47,104 licenses that the FCC had assigned for dispatch services used by taxicabs and pizza delivery companies. The piecing together happened only because the company's founder, Morgan O'Brien, had learned how to work the system from the inside, working as attorney for the FCC.

* * *

Cuisinart regulation was politically attractive: It allowed the FCC to scatter about shards of valuable spectrum, thus enriching hundreds of tiny local phone companies that were effectively guaranteed a small piece of the wireless action. Even when Congress decided in 1993 to retire the wind machine and auction off licenses instead, significant blocks of spectrum were set aside for "designated entities": small businesses, women, and minority groups. The Supreme Court struck down some of these preferences, but left others in place. NextWave was the winning bidder in the designated-entity auction that the Clinton FCC then orchestrated -- and while the company was politically immaculate, it was financially hollow. NextWave couldn't pay the $4 billion it had promised in its winning bid. The company duly filed for bankruptcy, lawyers spent the next seven years trying to work out who should get the spectrum instead, and those licenses remain essentially unused to this day.

Meanwhile, the national networks that are up and running remain woefully short of spectrum -- this is the second major rationale for the Cingular-AWE deal. U.S. regulators have allocated only 189 megahertz (MHz) to the networks that link our wireless phones; Europe averages over 250 MHz, and the U.K. has allocated 340 MHz. Individual European and Asian carriers have each been allotted 80 to 90 MHz of spectrum, enough to build out voice services with room to spare for wireless data. Until the beginning of 2003, U.S. carriers were capped at 55 MHz -- too little to provide data alongside voice economically. A typical cable operator currently assigns about 8 MHz of spectrum inside its cable to provide high-speed cable-modem service to between 50 and 500 homes; a major wireless carrier in New York currently has well under 50 MHz to provide both voice and data service to everyone in the shadow of each cell tower -- as many as 10,000 people on the move. In most of the rest of the world, wireless data already accounts for a substantial share of the revenues earned by wireless carriers. By this measure, according to a recent Merrill Lynch study, U.S. wireless service ranks last in the world.

The largest U.S. wireless carriers have, however, achieved substantial economies by reassembling enough spectrum to build out national voice networks. As Mr. Hazlett recounts in a recent law review article, industry consolidation and new entry pushed down the average per-minute price of wireless calls from 51 cents to 12 cents between 1995 and 2002, and total minutes of wireless use rose 16-fold. As a result, wireless now competes directly with wireline service -- a fact recognized by every teenager, though not yet by the Cuisinart regulators.

The authorities broke up the old Bell System in 1984 because they were sure long-distance markets were quite separate from local. But wireless carriers stopped distinguishing between the two years ago, and "all-distance" service is now taking over wireline markets as well. MCI's long-distance network survives only because the company's massive fraud on its shareholders has been laundered in bankruptcy; Sprint sells its service mainly to its own local customers; and AT&T long-distance limps sadly along, awaiting its own, inevitable merger with one of its former subsidiaries.

In 1996, regulators set about "unbundling" tens of thousands of "network elements" that comprise the networks of the local wireline phone companies, on the theory that local competition just wouldn't develop otherwise. In the eight years since, cable companies have been bundling phone and high-speed data services into their wires, cable/telephone competition has emerged as the one form of local wireline competition that really counts, and forced unbundling has produced nothing but massive waste.

Every rationale for chopping up the stuff of networks has thus been repudiated by the market. The Cingular merger should be approved forthwith, and without conditions. Beyond that, we should just stick a fork into the whirling regulatory blades, retire the last few dentists and designated entities, and let real telecom companies get on with building real networks.