Captive Audience: The Telecom Industry and Monopoly Power in the New Gilded Age

by Susan P. Crawford J. D.

  But as a complementary service, wireless is very popular. Americans like the convenience of mobile devices and are willing to compromise on the quality of Web browsing or data access in exchange for mobility. The phone companies are happy to serve this preference because wireless is far more profitable than wireline. It is cheaper to build, for one thing; rather than string and maintain copper wires, wireless companies can locate their equipment at towers (base stations). And they can charge premiums for voice and aggregated data services because U.S. customers now expect to pay individually for each expensive service from their wireless company (even though online Internet-based voice and data services would probably be far less expensive than they currently are if the companies faced true competition).4

  The wireless world in the United States has many of the same economic characteristics as the wired world; it is extraordinarily concentrated, with just two dominant players nationwide—Verizon and AT&T—and those two players have the power to segment the market much as Comcast and Time Warner do in wired services. Monthly wireless service plans (post-paid subscriptions) for smartphones and other devices can cost more than traditional high-speed Internet access; the carriers charge overage fees for large volumes of data, and users incur many additional fees (including activation fees and early-termination fees). But while well-off Americans can afford these services, poorer Americans often depend on government-subsidized “pre-paid” wireless plans. The fastest-growing segment of the wireless marketplace in mid-2011 was Universal Service Fund federally subsidized wireless services for the poor offered by companies like Tracfone. As Bernstein Research put it, “The top is trading up, the bottom is trading down, and the middle is being hollowed out.”5

  But what is worth noting is how neatly the characters in this story have divided up their roles. The telephone companies stick to the wireless part of high-speed Internet access and have ceded the wired territory to Comcast and Time Warner. Verizon and AT&T are no longer investing in fiber beyond their current commitments. AT&T made clear in 2011 that the company would not be installing any more U-Verse “fiber to the node” service and that 40–45 percent of its customers would be left with copper wires.6 (AT&T's U-Verse was not competitive with cable's services anyway because it brings fiber only to nodes or neighborhoods and runs last-mile communications over copper wires.) Here's AT&T CEO Randall Stephenson in early 2012: “Our U-verse build is now largely complete. … We have been apprehensive on moving, doing anything on rural access lines because the issue here is, do you have a broadband product for rural America? And we've all been trying to find a broadband solution that was economically viable to get out to rural America and we're not finding one to be quite candid.” AT&T is planning instead on selling expensive “LTE” (Long Term Evolution: a wireless high-data-transfer technology designed to support data access by way of handheld devices) services in rural areas. As we have seen, Verizon stopped expanding FiOS outside of franchise agreements already in place in big cities, leaving about 40 percent of its wired customers without upgrades. While FiOS is the only kind of last-mile infrastructure that could compete successfully with cable's DOCSIS 3.0, Verizon's investors do not want the company to pay for expensive fiber installations, for which the payoff will be slow.7 For both of these companies, there is no financially compelling reason to upgrade millions of Americans to globally competitive wired data access. The result, according to Columbia University telecommunications scholar Eli Noam: areas of the country relegated to AT&T's 4G wireless access will be limited to “little 4G mobile screens or tablets while their metropolitan brethren enjoy 2-way, 3D, 4K, 5.1 sound, and 6-foot screen televisions.”8 Relying on wireless access for rural and other “unserved” areas means forcing millions of Americans to use compressed, highly curated information over a second-best network characterized by lower speeds and higher prices. And thus, a racial and economic digital divide is emerging in America: Hispanics, rural Americans, African Americans, and low-income Internet users disproportionately rely on wireless connections for access to the Internet. The online world of the rich—who can afford truly high-speed wired Internet access—is growing increasingly divorced from the online world of the poor, who generally have only mobile access. This new digital divide has significant consequences for the country's future, as health services, educational opportunities, and economic life migrate online. As the Media Action Grassroots Network put it in April 2011, “Many everyday Internet needs such as applying for a job, conducting research, registering for classes, or accessing government or social services are difficult or impossible on a mobile device.”9

  Wireless is the near-term growth area for both Verizon and AT&T, and to please Wall Street, both companies have to focus their energies there, where they are wringing out profits. But even in the wireless realm, both AT&T and Verizon face enormous challenges. Their margins for voice services are ten times higher than their margins for data services, but Americans prefer data services, and data usage is skyrocketing. AT&T and Verizon need to keep wireless data usage as low as possible for as long as possible by managing scarcity: imposing usage-based billing and not installing fiber to their towers (or building additional towers) unless they have to. To keep their average revenues per user as high as possible, they need to spread their costs across as many users as they can. Faced with the unassailable advantages of scale and scope, the wireless companies have chosen to combine rather than compete.

  And so AT&T in 2011 made a big play for T-Mobile, its scrappy, low-price national competitor. T-Mobile was pushing an open platform for development of new applications (the Android operating system), had great customer service, and was backing policy positions in Washington aimed at increasing competition. It had not been able to get access to the spectrum it needed in order to compete effectively with AT&T and Verizon, but discussions were under way with the third-place wireless carrier, Sprint, about joining forces. Then AT&T swooped in and proposed its own deal, and T-Mobile's investors could not turn it down; who wanted to partner with the number 3 company when they could do a deal with number 1?

  How did AT&T and Verizon Wireless become the dominant providers of mobile wireless services in the United States? Accidents of history, combined with multiple mergers, led to this state of affairs.

  When the cellular phone emerged as a consumer product in the 1980s, it operated in 800 megahertz (MHz) frequencies, for which the FCC initially gave away two licenses for 40 MHz of spectrum in each of the 306 market areas in the United States—one to a wireless provider and one to a wired provider. Small-market licenses frustrated the buildup of viable nationwide wireless infrastructure; companies in urban areas had only a few voice channels, which did not provide enough capacity to serve demand, and companies in rural areas could not earn enough revenue to survive. No one could operate at the scale needed to make the business worthwhile.10

  The 1980s licensing process led, predictably, to quick consolidation and market-division agreements among the applicants.11 This desirable “beachfront” low-frequency spectrum—so-called because of their desirable properties: these frequencies travel well over long distances and inside buildings, which means operators can build 20 to 25 percent fewer towers as they do in areas which require higher frequencies—went to the corporate ancestors of today's AT&T and Verizon.

  Two big breakthroughs came in the 1990s. First, the government had grown increasingly concerned that a decade of a wireless duopoly had led to too little competition and innovation in the mobile marketplace. Lack of competition and high interconnection charges made wireless calls about ten times more expensive per minute than wireline, turning them into tools for the rich. After the General Accounting Office (GAO) and others criticized the lack of competition, Congress and the Clinton White House allowed the FCC to auction additional spectrum to break up the wireless duopoly.12

  The second big breakthrough was the development of digital standards, vaguely referred to as second-generation or 2G standards, that could compress audio
signals and use spectrum more efficiently than the old analog standards, and across cheaper and smaller components. Though all were developed to use frequencies more efficiently, these 2G standards were often incompatible. They were based on different basic ideas, like separating users’ transmissions by frequency and time (users communicate using the same channel but have different time slots) and particular encryption codes (users use the same channel, but their communications travel within varied envelopes of encryption). This latter, CDMA (Code Division Multiple Access), standard was widely adopted in America, and was based on many redundant communications across a wide range of frequencies and careful power control over all mobile units within a particular cell.13 At around the same time the European Groupe Spéciale Mobile developed its own standard based on dividing up the channel by both frequency and time. This standard was called GSM—later Global Systems for Mobile Communications—and had been adopted by consensus across 103 countries by 1996.14 In sum, this second digital generation of wireless service was more efficient, but users could not roam between standards or easily among countries.

  The United States quickly stepped into the lead as it implemented the GAO's suggested legislation to allocate more spectrum at higher frequencies to more competitors for use in digital communications.15 The government auctioned these bands for billions of dollars beginning in late 1994—the so-called PCS, or Personal Communications Services, auction. The government was hoping to avoid the paperwork, delay, and deal-making associated with the spectrum licensing and lottery systems it had tried earlier. It also sought to break up the Bell wireless duopoly (the two licenses in each market that had been issued at no cost to the Bell Operating Companies and other providers) that had limited competition and innovation and left consumers with the worst wireless network of any developed nation. The goal was to increase the number of competitors in every market. The incumbent wireless operators tried to block the effort and forestall new competition, but Congress and the White House prevailed. The ensuing auctions sparked new competition, innovation, and investment, and wireless moved from being a tool for the rich to an affordable way for families to connect. The corporate ancestors of Verizon, Cingular, and AT&T Wireless paid billions for spectrum, as did Voice-stream, the corporate ancestor of T-Mobile.16

  After the auction, consolidation proceeded apace. Bell Atlantic absorbed NYNEX in 1996 and then merged with GTE; then in 1999 the company merged with Vodafone to become Verizon. South Western Bell became SBC, bought Pacific Telesis in 1997 and Ameritech in 1999, and finally merged with Bell South in 2000 to become Cingular.17

  Prices did go down for cell service during the late 1990s because of the new competition, the breakup of AT&T in 1984, and increased efficiencies from better technology. Spurred on by the breakup and by its technological advantages, AT&T introduced the Digital One flat rate in 1998 for wireless service, which was wildly popular with both consumers and businesses.18

  Still, by 2003, enough companies had consolidated that Americans were left with just three large wireless providers. Verizon had a nationwide CDMA network and 30 percent of the market; Cingular had a GSM network that covered urban areas and a 15 percent share; and AT&T Wireless (the former McCaw Communications) had a 13 percent market share from an old-fashioned standard (D-AMPS) that was unable to produce sufficient bit rates for Internet access. Sprint PCS, T-Mobile, Nextel Communications, Alltel, and others divided up the rest of the market.19

  Then something big happened: Cingular bought AT&T Wireless (and adopted its name) in 2004 for $41 billion. The new AT&T Wireless got the GSM standard and a new lease on wireless life.20

  Meanwhile, technical innovation continued. Again the government found additional spectrum, this time for the third generation of wireless phones, and held another round of auctions in 2008. The goods were again beachfront property—low-frequency spectrum that had been reclaimed from TV broadcasters and was perfect for building out wireless phone systems. The problem was that the established licensees had no incentive to allow new entrants into the market, and could afford to bid high enough to keep them out. Verizon paid $9.6 billion to win a national allocation of 22 MHz in a single contiguous nationwide block. AT&T spent $6.6 billion for more than two hundred 12-MHz licenses in mostly small geographic areas around the country, amounting to 35 percent of these available licenses. It also bought two smaller blocks in private purchases. Between them, the two companies accounted for about 85 percent of the $19.6 billion raised by the auction.21

  Even before this auction, the low-frequency spectrum that the corporate ancestors of today's AT&T and Verizon had bought in 1993 represented a significant windfall advantage that Sprint or T-Mobile could not replicate. As a result, an enormous gap had existed between AT&T/Verizon and everyone else in terms of subscribers, revenues, profit margins, and cash flow.

  This gap increased following the 2008 sale. Because it was clear that the value to the two giants of keeping a new competitor out of the arena would exceed any reasonable market value for the spectrum, and because the giants were allowed to bid even though they already had enormous holdings in beachfront low-frequency spectrum, T-Mobile did not even enter the auction.

  And so in some ways by 2011 the wireless marketplace was even less competitive than the wired market: it had been a concentrated field since 1995, and it was growing more concentrated every year. If AT&T were allowed to merge with T-Mobile, the combined company, along with Verizon, would control 80 percent of the national market.22 But even without the merger, Verizon (31 percent) and AT&T (32 percent) divided most of the market between them in terms of both spectrum holdings and revenues, with Sprint (17 percent market share) and T-Mobile (11 percent) barely hanging on as distant third and fourth players, with uncertain ability to constrain the prices charged by Verizon and AT&T.23 And by 2011, AT&T and Verizon had done an impressive job of shaping the federal government's policies for the future of high-speed data access along lines that favored their own business plans.

  The federal government's problem was that almost a third of Americans were not subscribing to high-speed Internet access (often because of price), and many of those nonsubscribers were rural, minority, or low-income residents.24 In 2011 an estimated 18 million Americans had no wired access at all; it was unavailable where they lived.25

  To solve this problem, AT&T and Verizon offered a compelling proposal to policy makers and journalists. Arguing that wireless access would help close the broadband gap in rural areas, they pointed out that data usage was exploding across wireless networks. Wireless had become so popular that their networks were buckling under the strain. The carriers helpfully pinpointed the source of the problem: given this popularity and the greatly increased use of data services by way of smartphones like the iPhone, limitations on the frequencies available to them for data access were constraining their ability to serve U.S. consumers—particularly in rural areas, where Internet access adoption was low.26

  The Obama administration, seeking to spark innovation, investment, and competition in the wireless market, took seriously the talking point about a “looming spectrum crisis.” The administration proclaimed that spectrum reallocation and auctions of the resulting freed-up spectrum for high-speed Internet access use were the keys to the future of mobile Internet access in America. If spectrum were reassigned from old-fashioned, inefficient uses like broadcast television, the argument went, more companies and more people would have access to broadband. And if some of that spectrum were auctioned off, it would bring billions into the U.S. Treasury. Other reallocated spectrum could be made available to public safety officials, and based on the explosive benefits of technologies like WiFi (which uses unlicensed radio waves at low power to connect to access points), some could be reserved for unlicensed uses. At the same time, a lot of money could be made by Americans manufacturing devices and selling wireless applications to be used across the newly available broadband spectrum.27

  Spectrum reform became the focus of the administration
's approach to mobile high-speed Internet access: the FCC's March 2010 National Broadband Plan relied on revenue obtained by reallocating and auctioning off spectrum to fund its recommendations and asserted that improving wireless access was the best way of solving the country's high-speed Internet access deficit.28 The Justice Department went along, saying, “Given the potential of wireless services to reach underserved areas and to provide an alternative to wireline broadband providers in other areas, the Commission's primary tool for promoting broadband competition should be freeing up spectrum.”29

  It sounded like a win-win-win: wireless would fix the nation's high-speed access problems, auctions could raise billions of dollars for the Treasury, and the administration could solve a public safety problem by using the auction proceeds to fund the development of interoperable networks and devices. The administration could help make more wireless high-speed Internet access possible by releasing more spectrum. And all this could be done without a dime of federal spending.

  There were just two problems. First, AT&T and Verizon had plenty of spectrum—the spectrum crisis did not exist. But their investors did not want them to spend money improving the wires and adding the additional towers that facilitated better wireless communications. Without a high-capacity wire and a tower in close proximity to the wireless communicator, a wireless transmission cannot go very far. Capital expenditures would obviously reduce the companies’ return on capital—bad for investors.