Economics and Technology, Inc. -- Views and News, March 2011

March 2011

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And then there were three: AT&T swallows T-Mobile

The deal was announced quietly on a Sunday evening: AT&T, the nation's second largest wireless carrier (and largest incumbent telco) hopes to buy Deutsche Telekom's T-Mobile USA, the fourth largest wireless carrier in the US. The deal will likely face regulatory scrutiny from both the FCC and the Department of Justice, and rightfully so. Despite AT&T's rhetoric that this merger will improve network quality and bring broadband to every part of America, the reality is that if this merger is allowed to proceed, the two largest wireless carriers will together have more than 80% market share in a market landscape of already diminished competition. Will AT&T receive the necessary regulatory approvals? AT&T is betting $3-billion that it will.

It seems hard to imagine that this proposed merger will be anything but a major blow to competition. We discussed the decline of wireless competition in Views and News last July. Here we revisit and update that analysis on a pro forma basis, assuming that the merger is approved, and examine some of the possible repercussions.

Market Share

Combining the second- and fourth-largest wireless carriers would further consolidate market share among the top four carriers, resulting in a "highly concentrated" market as defined by the 2010 revision of the DoJ/FTC Horizontal Merger Guidelines (Views and News, August 2010), increasing concentration levels so substantially that the merger will be "presumed to be likely to enhance market power."

Note that these are conservative estimates of the HHI's in that they are based upon national market shares rather than those applicable in specific geographic areas in which not all of the "big four" may be present.

Pricing and Contract Innovation

T-Mobile has been the only major national carrier to break rank on pricing and contract terms. For example, T-Mobile offers month-to-month service plans at a substantial discount if the consumer brings her own phone or pays full price for a new device. Losing T?Mobile as a competitor leaves MetroPCS as the next largest carrier to challenge prices and offer attractive non-contract terms and conditions. As we discussed last July, the MetroPCS pricing scheme has not elicited any response from AT&T or Verizon. This is hardly surprising since, while it is growing, MetroPCS today enjoys a national wireless market share of only about 3%.

Monopsony Power In the Handset Market

The combined AT&T/T-Mobile would become the only national carrier using GSM handsets in the US. With nearly 45% market share, AT&T would be in a position to make demands of handset manufacturers. Any GSM handset maker that cannot go along with AT&T's terms would be effectively shut out of the lucrative US market. From the consumers' perspective, if the handset is capable of supporting a feature that AT&T does not wish to offer, it won't be available to consumers in the US.

Wireline Backhaul

While most consumers may see wireless phones as not involving any wireline facilities, the wireless network is critically dependant upon traditional wireline telecom services to carry voice and data traffic from cell site transceivers to the ultimate destination of the traffic. These wired "backhaul" facilities typically consist of high capacity "Special Access" services (e.g., DS-1, DS-3) provided by wireline incumbent local exchange carriers. In most parts of the US, these ILECs are also either AT&T or Verizon affiliates. Special Access services are priced by the local telco at many multiples of cost and typically generate triple-digit rates of return. For AT&T and Verizon, overpricing these services to each other's wireless affiliate is somewhat of a wash – overpayments for out-of-region Special Access services are offset by inflated revenues for in-region services sold to other carriers. But this substantial overpricing raises a major economic barrier to any other wireless carrier that does not itself also own and operate a substantial local wireline telephone business. New entrants would have to overcome this hurdle, and existing wireless-only companies like Sprint could easily be price-squeezed out of the market.

AT&T's $3-billion Bet

Despite the obvious antitrust and regulatory issues raised by this proposed merger, AT&T appears more than confident that the combination will ultimately be allowed. AT&T has agreed to pay T-Mobile a "merger termination fee" of $3-billion plus valuable wireless spectrum should the transaction fall apart. The cash portion of the fee alone represents roughly 15% of AT&T's entire profit in 2010, and reflects the confidence with which AT&T is moving forward. Whether AT&T's confidence that it can "sell" this transaction to the FCC and the Department of Justice will be borne out remains to be seen.

Will consumers benefit from an AT&T/T-Mobile marriage?

AT&T is already hard at work touting the merits of the proposed T-Mobile deal. According to AT&T, the acquisition "provides an optimal combination of network assets to add capacity sooner than any alternative, and it provides an opportunity to improve network quality in the near term for both companies' customers. In addition, it provides a fast, efficient and certain solution to the impending exhaustion of wireless spectrum in some markets, which limits both companies' ability to meet the ongoing explosive demand for mobile broadband." But are these "benefits" worth the diminution of competition in the US wireless market?

Apparently, AT&T will seek to convince FCC and DoJ policymakers as to the merits of this efficiency vs. competition trade-off. Certainly that theory has provided the basis for treating critical economic segments as "natural monopolies" – i.e., that the massive economies of scale and huge capital outlays require a single supplier market model as the only means for achieving minimum average cost. But where competition is inefficient and cannot be relied upon to constrain the market power of a single monopoly provider, we have relied upon regulation to simulate a competitive result.

For nearly four decades, the US and most other industrialized countries have abandoned this "natural monopoly" in telecom, concluding that the dynamic gains in efficiency and innovation resulting from competition easily outweigh the static efficiencies underlying "natural monopoly" regulatory models. But the story that AT&T is now selling reverts back to that outdated static efficiency natural monopoly perspective. AT&T's theory is not compatible with the level of deregulation that the wireless industry currently enjoys. If policymakers are willing to sacrifice competition for static efficiency, then they must also be prepared to sacrifice the deregulation that has been premised upon the existence of that competition.

If you would like more information on this subject, please contact Colin B. Weir.

Read the rest of Views and News, March 2011.

About ETI. Founded in 1972, Economics and Technology, Inc. is a leading research and consulting firm specializing in telecommunications regulation and policy, litigation support, taxation, service procurement, and negotiation. ETI serves a wide range of telecom industry stakeholders in the US and abroad, including telecommunications carriers, attorneys and their clients, consumer advocates, state and local governments, regulatory agencies, and large corporate, institutional and government purchasers of telecom services.