Ev Ehrlich's Everyday Economics

The FCC’s 15th Annual Report on Mobile Wireless Competition

The FCC just released their fifteenth annual report on mobile wireless competition.  It does everything -- describes burgeoning data traffic, talks about how 80 percent of the population has access to three or more carriers, talks about how the industry invests $20-$25 billion every year -- but answer the question “Is the wireless market competitive?”

In a way, it’s better that way.  Unless you think through what it means for the mobile broadband market to be “competitive,” you can run yourself into a lot of trouble.   For example, Douglas Holtz-Eakin, a conservative economist I know, like, and respect (even if he’s often wrong), recently was taken over the falls in a blog entry by Brad DeLong, a liberal economist I know, like, and respect (who’s more often right), in the following interchange, which Brad graciously entitled “Has Douglas Holtz-Eakin Completely Lost His Mind?”

Holtz-Eakin was advocating for the AT&T-YT-Mobile merger in the National Review (I’m untroubled by the merger, but am troubled by the National Review), and in so doing said this:

The DOJ’s “Horizontal Merger Guidelines” lay out a formula (the Hirschman-Herfindahl Index) for determining the state of competition and whether a monopoly exists. In this index, a value of 10,000 denotes a complete monopoly, while a value of zero indicates infinite competition. In the case of 1970s-era Ma Bell, the HH index was almost 8,000 (one of many reasons it was eventually split up by regulators). This merger, if successful, wouldn’t result in an  index value even half as high as Ma Bell’s, especially when taking into account the varied Internet and local options for communications.

To which DeLong replied:

I mean, you can argue that the Herfindahl index is irrelevant because competition is moving very fast as technology changes and we actually want dynamic creative-destruction oligopolies here. But you cannot argue that 4000 is not an extraordinarily high Herfindahl index, can you?

And Brad’s right.  Arguing that the post-merger mobile wireless market is “only half” as monopolistic as Ma Bell is like arguing that Muammar Gaddafi is only half as fascistic as Adolf Hitler or half as nuts as Idi Amin.  It’s not really that strong a pitch.

At the same time, today’s mobile broadband market is infinitely more competitive than the Ma Bell regime, which was the Schumpeterian equivalent
of North Korea.  So to reconcile its market structure (which is obviously dominated by a handful of firms) and its dynamic performance, we need a different theory of competition.

And I think that can be done.   I’ve argued on various posts here that competition in the broadband market takes the form of a three-dimensional cage match, in which service providers, device manufacturers, application developers, and content providers compete for the attention and loyalty of
consumers, each attempting to be the “portal” through which the consumer enters the broadband world and assembles its various components.

Signal, devices, applications, and content are at once complements and substitutes.  They complement each other in use, but they substitute for each other in terms of dividing up the total value created by their integration.   Let me try a stripped down version of this argument on you, using an example that comes from my colleague Jeff Eisenach. I hope he doesn’t mind my appropriating it.

Let’s say that people go to bars for three things – they drink beer, eat pretzels, and listen to music.  (They also go to fulfill their biological destiny, but this is a family-values analysis.)  The bar puts these components together for the consumer in an attempt to win her or his allegiance.

Let’s say that one of these three components of the “bar experience” is the subject of an innovation.  Maybe they serve a new kind of beer that makes you good-looking (although all beer does that after a while, I suppose), or come up with the most delicious pretzel ever invented, or decide to book The Strokes on Friday night instead of Tex Nebraska and the Turdblossoms.

I mean, do I even have to finish the analogy?  If something like that happens in one of the components of the “bar experience,” then the value of the other two declines.  The Piels distributor  shows up one day with his kegs and the bar owner tells him, “I’m paying too much for Piels.  I have these great new
pretzels and the Strokes are coming in, so frankly, I’m not all that interested in your beer – I can pretty much serve any old beer  I come across, what with these pretzels and my new house band.”

Well, what’s the Piels guy going to do?  He’s got a truck full of beer, it’s got to go somewhere.  He relents, and lowers his price.

Of course, we live in a more dynamic world than that of this parable.  For example, the Piels distributor might figure out that he’s going to have to deliver a better beer if he’s going to survive in a world where beer has been reduced to an incidental in the pretzel-and-band value model.  Perhaps he does, which redistributes value back to him, and forces the pretzel guys to go back to the drawing board and the barkeeper to fire the Strokes and bring in Lady Gaga.  In fact, each of the components of the “bar experience” is driven, in this model, to innovate and improve, if only to be the “hook” that brings people into bars.  Pretzels and bands, in this world, compete with the beer as surely as other beers do.

Because that’s how “cage match competition” works – whether in the bar business or the broadband business.  The pretzel innovators and the Strokes and the bar owner act – as if led by an invisible hand – in a way that competes with the beer distributor even though they’re not beer distributors themselves.  Just like the service providers, handset manufacturers, application developers, and content poducers, the brewers, bakers, musicians, and bar owner are all in the cage, forming and reforming alliances, competing and cooperating at once.  Maybe the beer distributor comes up with a pan to incorporate pretzels into his value proposition – buy my beer and you can have these innovative pretzels.  Or, as AT&T said, “Use my network and you can use the iPhone.”  Perhaps the pretzel guys will offer the Srokes as a house band for bars that make a commitment to their pretzels.  Or, perhaps handset manufacturers will
attract applications developers to their  patform.    But the struggle in the cage match continues, with alliances and strategies completely forming and reforming – an ongoing, multi-dimensional competition between brewers, bakers, bands, and bars, just as between service, devices, applications, and
content.

Here’s what got me to thinking about this.  In paragraph 154 of the report, the FCC says this:

(While Apple maintains rigid control over iPhone applications…) “Google’s Android operating system is made available free of charge to handset  manufacturers and wireless service providers, and is available on multiple devices and multiple service providers. As a result, many service providers and device manufacturers have designed customized versions of the Android platform for their products. Some commentators have noted that, because
of this, it is difficult for third-party application developers to design and test products for use on a fragmented platform can vary by device and network.

Well, boo hoo!  Don’t they get it?  The proliferation of different platforms – Android, RIM, Apple, whatever else – is the reason why we have a cage match in the first place.  It guarantees that there will always be this competitive tension among the different platforms, the systems that deliver them, and  the applications and content they carry.

This back door whining about how hard it is to develop applications for different systems is, of course, another attempt by somebody over there to keep the dead horse of net neutrality on the track.  Neutrality advocates have long argued that, technological difficulties notwithstanding, all devices should be interoperable – no exclusive deals, like AT&T’s with Apple.

But if you understand the cage match, that’s recipe for disaster.  If you had total interoperability, you would end up with one dominant competitor in devices – let’s call them….uh, give me a minute…Apple.  Imagine that government regulation required Apple to connect the iPhone to every network.  Once they had established their dominance over devices, they would have a chokehold on all of mobile broadband.  Want to offer service?  Better pay our toll.  Want to create an app?  We’ll tell you the terms.  It would be like letting Andre the Giant into a cage match with my daughter and her roommates.

And that’s the story of the FCC’s Annual Mobile Wireless Competition Report.  It’s got lots of good data, lots of charts, and not much of an idea about what “competition” means.  But it’s not alone – neither do the advocates who want it to wade into a morass of Internet regulation.