Congressional debates about STELA reauthorization have resurrected the notion that TV stations “must provide a free service” because they “are using public spectrum.” This notion, which is rooted in 1930s government policy, has long been used to justify the imposition of unique “public interest” regulations on TV stations. But outdated policy decisions don’t dictate future rights in perpetuity, and policymakers abandoned the “public spectrum” rationale long ago.

All wireless services use the public spectrum, yet none of them are required to provide a free commercial service except broadcasters. Satellite television operators, mobile service providers, wireless Internet service providers, and countless other commercial spectrum users are free to charge subscription fees for their services.

There is nothing intrinsic in the particular frequencies used by broadcasters that justifies their discriminatory treatment. Mobile services use spectrum once allocated to broadcast television, but aren’t treated like broadcasters.

The fact that broadcast licenses were once issued without holding an auction is similarly irrelevant.  All spectrum licenses were granted for free before the mid-1990s. For example, cable and satellite television operators received spectrum licenses for free, but are not required to offer their video services for free.

If the idea is to prevent companies who were granted free licenses from receiving a “windfall”, it’s too late. As Jeffrey A. Eisenach has demonstrated, “the vast majority of current television broadcast licensees [92%] have paid for their licenses through station transactions.”

The irrelevance of the free spectrum argument is particularly obvious when considering the differential treatment of broadcast and satellite spectrum. Spectrum licenses for broadcast TV stations are now subject to competitive bidding at auction while satellite television licenses are not. If either service should be required to provide a free service on the basis of spectrum policy, it should be  satellite television.

Although TV stations were loaned an extra channel during the DTV transition, the DTV transition is over. Those channels have been returned and were auctioned for approximately $19 billion in 2008. There is no reason to hold TV stations accountable in perpetuity for a temporary loan.

Even if there were, the loan was  not free. Though TV stations did not pay lease fees for the use of those channels, they nevertheless paid a heavy price. TV stations were required to invest substantial sums in HDTV technology and to broadcast signals in that format long before it was profitable. The FCC required “rapid construction of digital facilities by network-affiliated stations in the top markets, in order to expose a significant number of households, as early as possible, to the benefits of DTV.” TV stations were thus forced to “bear the risks of introducing digital television” for the benefit of consumers, television manufacturers, MVPDs, and other digital media.

The FCC did not impose comparable “loss leader” requirements on MVPDs. They are free to wait until consumer demand for digital and HDTV content justifies upgrading their systems — and they are still lagging TV stations by a significant margin. According to the FCC, only about half of the collective footprints of the top eight cable MVPDs had been transitioned to all-digital channels at the end of 2012. By comparison, the DTV transition was completed in 2009.

There simply is no satisfactory rationale for requiring broadcasters to provide a free service based on their use of spectrum or the details of past spectrum licensing decisions. If the applicability of a free service requirement turned on such issues, cable and satellite television subscribers wouldn’t be paying subscription fees.

Shortly after Tom Wheeler assumed the Chairmanship at the Federal Communications Commission (FCC), he summed up his regulatory philosophy as “competition, competition, competition.” Promoting competition has been the norm in communications policy since Congress adopted the Telecommunications Act of 1996 in order to “promote competition and reduce regulation.” The 1996 Act has largely succeeded in achieving competition in communications markets with one glaring exception: broadcast television. In stark contrast to the pro-competitive approach that is applied in other market segments, Congress and the FCC have consistently supported policies that artificially limit the ability of TV stations to compete or innovate in the communications marketplace.

Radio broadcasting was not subject to regulatory oversight initially. In the unregulated era, the business model for over-the-air broadcasting was “still very much an open question.” Various methods for financing radio stations were proposed or attempted, including taxes on the sale of devices, private endowments, municipal or state financing, public donations, and subscriptions. “We are today so accustomed to the dominant role of the advertiser in broadcasting that we tend to forget that, initially, the idea of advertising on the air was not even contemplated and met with widespread indignation when it was first tried.”

Section 303 of the Communications Act of 1934 thus provided the FCC with broad authority to authorize over-the-air subscription television service (STV). When the D.C. Circuit Court of Appeals addressed this provision, it held that “subscription television is entirely consistent with [the] goals” of the Act. Analog STV services did not become widespread in the marketplace, however, due in part to regulatory limitations imposed on such services by the FCC. As a result, advertising dominated television revenue in the analog era.

The digital television (DTV) transition offered a new opportunity for TV stations to provide STV services in competition with MVPDs. The FCC had initially hoped that “multicasting” and other new capabilities provided by digital technologies would “help ensure robust competition in the video market that will bring more choices at less cost to American consumers.”

Despite the agency’s initial optimism, regulatory restrictions once again crushed the potential for TV stations to compete in other segments of the communications marketplace. When broadcasters proposed offering digital STV services with multiple broadcast and cable channels in order to compete with MVPDs, Congress held a hearing to condemn the innovation. Chairmen from both House and Senate committees threatened retribution against broadcasters if they pursued subscription television services — “There will be a quid pro quo.” Broadcasters responded to these Congressional threats by abandoning their plans to compete with MVPDs.

It’s hard to miss the irony in the 1996 Act’s approach to the DTV transition. Though the Act’s stated purposes are to “promote competition and reduce regulation, it imposed additional regulatory requirements on television stations that have stymied their ability to innovate and compete. The 1996 Act broadcasting provision requires that the FCC impose limits on subscription television services “so as to avoid derogation of any advanced television services, including high definition television broadcasts, that the Commission may require using such frequencies,” and prohibits TV stations from being deemed an MVPD. The FCC’s rules require TV stations to “transmit at least one over-the-air video programming signal at no direct charge to viewers” because “free, over-the-air television is a public good, like a public park, and might not exist otherwise.

These and other draconian legislative and regulatory limitations have forced TV stations to follow the analog television business model into the 21st Century while the rest of the communications industry innovated at a furious pace. As a result of this government-mandated broadcast business model, TV stations must rely on advertising and retransmission consent revenue for their survival.

Though the “public interest” status of TV stations may once have been considered a government benefit, it is rapidly becoming a curse. Congress and the FCC have both relied on the broadcast public interest shibboleth to impose unique and highly burdensome regulatory obligations on TV stations that are inapplicable to their competitors in the advertising and other potential markets. This disparity in regulatory treatment has increased dramatically under the current administration — to the point that is threatening the viability of broadcast television.

Here are just three examples of the ways in which the current administration has widened the regulatory chasm between TV stations and their rivals:

• In 2012, the FCC required only TV stations to post “political file” documents online, including the rates charged by TV stations for political advertising; MVPDs are not required to post this information online. This regulatory disparity gives political ad buyers and incentive to advertise on cable rather than broadcast channels and forces TV stations to disclose sensitive pricing information more widely than their competitors.
• This year the FCC prohibited joint sales agreements for television stations only; MVPDs and online content distributors are not subject to any such limitations on their advertising sales. This prohibition gives MVPDs and online advertising platforms a substantial competitive advantage in the market for advertising sales.
• This year the FCC also prohibited bundled programming sales by broadcasters only; cable networks are not subject to any limitations on the sale of programming in bundles. This disparity gives broadcast networks an incentive to avoid limitations on their programming sales by selling exclusively to MVPDs (i.e., becoming cable networks).

The FCC has not made any attempt to justify the differential treatment — because there is no rational justification for arbitrary and capricious decision-making.

Sadly, the STELA process in the Senate is threatening to make things worse. Some legislative proposals would eliminate retransmission consent and other provisions that provide the regulatory ballast for broadcast television’s government mandated business model  without eliminating the mandate. This approach would put a quick end to the administration’s “death by a thousand cuts” strategy with one killing blow. The administration must be laughing itself silly. When TV channels in smaller and rural markets go dark, this administration will be gone — and it will be up to Congress to explain the final TV transition.

The Federal Communications Commission (FCC) recently sought additional comment on whether it should eliminate its network non-duplication and syndicated exclusivity rules (known as the “broadcasting exclusivity” rules). It should just as well have asked whether it should eliminate its rules governing broadcast television. Local TV stations could not survive without broadcast exclusivity rights that are enforceable both legally and practicably.

The FCC’s broadcast exclusivity rules “do not create rights but rather provide a means for the parties to exclusive contracts to enforce them through the Commission rather than the courts.” (Broadcast Exclusivity Order, FCC 88-180 at ¶ 120 (1988)) The rights themselves are created through private contracts between TV stations and video programming vendors in the same manner that MVPDs create exclusive rights to distribute cable network programming.

Local TV stations typically negotiate contracts for the exclusive distribution of national broadcast network or syndicated programming in their respective local markets in order to preserve their ability to obtain local advertising revenue. The FCC has long recognized that, “When the same program a [local] broadcaster is showing is available via cable transmission of a duplicative [distant] signal, the [local] broadcaster will attract a smaller audience, reducing the amount of advertising revenue it can garner.” (Program Access Order, FCC 12-123 at ¶ 62 (2012)) Enforceable broadcast exclusivity agreements are thus necessary for local TV stations to generate the advertising revenue that is necessary for them to survive the government’s mandatory broadcast television business model.

The FCC determined nearly fifty years ago that it is an anticompetitive practice for multichannel video programming distributors (MVPDs) to import distant broadcast signals into local markets that duplicate network and syndicated programming to which local stations have purchased exclusive rights. ( See First Exclusivity Order, 38 FCC 683, 703-704 (1965)) Though the video marketplace has changed since 1965, the government’s mandatory broadcast business model is still required by law, and MVPD violations of broadcast exclusivity rights are still anticompetitive.

The FCC adopted broadcast exclusivity procedures to ensure that broadcasters, who are legally prohibited from obtaining direct contractual relationships with viewers or economies of scale, could enjoy the same ability to enforce exclusive programming rights as larger MVPDs. The FCC’s rules are thus designed to “allow all participants in the marketplace to determine, based on their own best business judgment, what degree of programming exclusivity will best allow them to compete in the marketplace and most effectively serve their viewers.” (Broadcast Exclusivity Order at ¶ 125.)

When it adopted the current broadcast exclusivity rules, the FCC concluded that enforcement of broadcast exclusivity agreements was necessary to counteract regulatory restrictions that prevent TV stations from competing directly with MVPDs. Broadcasters suffer the diversion of viewers to duplicative programming on MVPD systems when local TV stations choose to exhibit the most popular programming, because that programming is the most likely to be duplicated. ( See Broadcast Exclusivity Order at ¶ 62.) Normally firms suffer their most severe losses when they fail to meet consumer demand, but, in the absence of enforceable broadcast exclusivity agreements, this relationship is reversed for local TV stations: they suffer their most severe losses precisely when they offer the programming that consumers desire most.

The fact that only broadcasters suffer this kind of [viewership] diversion is stark evidence, not of inferior ability to be responsive to viewers’ preferences, but rather of the fact that broadcasters operate under a different set of competitive rules. All programmers face competition from alternative sources of programming. Only broadcasters face, and are powerless to prevent, competition from the programming they themselves offer to viewers. (Id. at ¶ 42.)

The FCC has thus concluded that, if TV stations were unable to enforce exclusive contracts through FCC rules, TV stations would be competitively handicapped compared to MVPDs. ( See id. at ¶ 162.)

Regulatory restrictions effectively prevent local TV stations from enforcing broadcast exclusivity agreements through preventative measures and in the courts: (1) prohibitions on subscription television and the use of digital rights management (DRM) prevent broadcasters from protecting their programming from unauthorized retransmission, and (2) stringent ownership limits prevent them from obtaining economies of scale.

Preventative measures may be the most cost effective way to protect digital content rights. Most digital content is distributed with some form of DRM because, as Benjamin Franklin famously said, “an ounce of prevention is worth a pound of cure.” MVPDs, online video distributors, and innumerable Internet companies all use DRM to protect their digital content and services — e.g., cable operators use the CableCard standard to limit distribution of cable programming to their subscribers only.

TV stations are the only video distributors that are legally prohibited from using DRM to control retransmission of their primary programming. The FCC adopted a form of DRM for digital television in 2003 known as the “broadcast flag”, but the DC Circuit Court of Appeals struck it down.

The requirement that TV stations offer their programming “at no direct charge to viewers” effectively prevents them from having direct relationships with end users. TV stations cannot require those who receive their programming over-the-air to agree to any particular terms of service or retransmission limitations through private contract. As a result, TV stations have no way to avail themselves of the types of contractual protections enjoyed by MVPDs who offer services on a subscription basis.

The subscription television and DRM prohibitions have a significant adverse impact on the ability of TV stations to control the retransmission and use of their programming. The Aereo litigation provides a timely example. If TV stations offered their programming on a subscription basis using the CableCard standard, the Aereo “business” model would not exist and the courts would not be tying themselves into knots over potentially conflicting interpretations of the Copyright Act. Because they are legally prohibited from using DRM to prevent companies like Aereo from receiving and retransmitting their programming in the first instance, however, TV stations are forced to rely solely on after-the-fact enforcement to protect their programming rights — i.e., protected and uncertain litigation in multiple jurisdictions.

Localism policies make after-the-fact enforcement particularly cost for local TV stations. The stringent ownership limits that prevent TV stations from obtaining economies of scale have the effect of subjecting TV stations to higher enforcement costs relative to other digital rights holders. In the absence of FCC rules enforcing broadcast exclusivity agreements, family owned TV stations could be forced to defend their rights in court against significantly larger companies who have the incentive and ability to use litigation strategically.

In sum, the FCC’s non-duplication and syndication rules balance broadcast regulatory limitations by providing clear mechanisms for TV stations to communicate their contractual rights to MVPDs, with whom they have no direct relationship, and enforce those rights at the FCC (which is a strong deterrent to the potential for strategic litigation). There is nothing unfair or over-regulatory about FCC enforcement in these circumstances. So why is the FCC asking whether it should eliminate the rules?

Today is a big day in Congress for the cable and satellite (MVPDs) war on broadcast television stations. The House Judiciary Committee is holding a hearing on the compulsory licenses for broadcast television programming in the Copyright Act, and the House Energy and Commerce Committee is voting on a bill to reauthorize “STELA” (the compulsory copyright license for the retransmission of distant broadcast signals by satellite operators). The STELA license is set to expire at the end of the year unless Congress reauthorizes it, and MVPDs see the potential for Congressional action as an opportunity for broadcast television to meet its Waterloo. They desire a decisive end to the compulsory copyright licenses, the retransmission consent provision in the Communications Act, and the FCC’s broadcast exclusivity rules — which would also be the end of local television stations.

The MVPD industry’s ostensible motivations for going to war are retransmission consent fees and television “blackouts”, but the  real motive is advertising revenue.

The compulsory copyright licenses prevent MVPDs from inserting their own ads into broadcast programming streams, and the retransmission consent provision and broadcast exclusivity agreements prevent them from negotiating directly with the broadcast networks for a portion of their available advertising time. If these provisions were eliminated, MVPDs could negotiate directly with broadcast networks for access to their television programming and appropriate TV station advertising revenue for themselves.

The real motivation is in the numbers. According to the FCC’s most recent media competition report, MVPDs paid a total of approximately $2.4 billion in retransmission consent fees in 2012. (See 15th Report, Table 19) In comparison, TV stations generated approximately $21.3 billion in advertising that year. Which is more believable: (1) That paying $2.4 billion in retransmission consent fees is “just not sustainable” for an MVPD industry that generated nearly $149 billion from video services in 2011 (See 15th Report, Table 9), or (2) That MVPDs want to appropriate $21.3 billion in additional advertising revenue by cutting out the “TV station middleman” and negotiating directly for television programming and advertising time with national broadcast networks? (Hint: The answer is behind door number 2.)

What do compulsory copyright licenses, retransmission consent, and broadcast exclusivity agreements have to do with video advertising revenue?

• The compulsory copyright licenses prohibit MVPDs substituting their own advertisements for TV station ads: Retransmission of a broadcast television signal by an MVPD is “actionable as an act of infringement” if the content of the signal, including “any commercial advertising,” is “in any way willfully altered by the cable system through changes, deletions, or additions” (see 17 U.S.C. § 111(c)(3), 119(a)(5), and 122(e));
• The retransmission consent provision prohibits MVPDs from negotiating directly with television broadcast networks for access to their programming or a share of their available advertising time: An MVPD cannot retransmit a local commercial broadcast television signal without the “express authority of the originating station” (see 47 U.S.C. § 325(b)(1)(A)); and
• Broadcast exclusivity agreements (also known as non-duplication and syndicated exclusivity agreements) prevent MVPDs from circumventing the retransmission consent provision by negotiating for nationwide retransmission consent with one network-affiliated own-and-operated TV station. (If an MVPD were able to retransmit the TV signals from only one television market nationwide, MVPDs could, in effect, negotiate with broadcast networks directly, because broadcast programming networks own and operate their own TV stations in some markets.)

The effect of the compulsory copyright licenses, retransmission consent provision, and broadcast exclusivity agreements is to prevent MVPDs from realizing any of the approximately $20 billion in advertising revenue generating by broadcast television programming every year.

Why did Congress want to prevent MVPDs from realizing any advertising revenue from broadcast television programming?

Congress protected the advertising revenue of local TV stations because TV stations are legally prohibited from realizing any subscription revenue for their primary programming signal. (See 47 U.S.C. § 336(b)) Congress chose to balance the burden of the broadcast business model mandate with the benefits of protecting their advertising revenue. The law forces TV stations to rely primarily on advertising revenue to generate profits, but the law also protects their ability to generate advertising revenue. Conversely, the law allows MVPDs to generate both subscription revenue and advertising revenue for their own programming, but prohibits them from poaching advertising revenue from broadcast programming.

MVPDs want to upset the balance by repealing the regulations that make free over-the-air television possible  without repealing the regulations that require TV stations to provide free over-the-air programming. Eliminating only the regulations that benefit broadcasters while retaining their regulatory burdens is not a free market approach — it is a video marketplace firing squad aimed squarely at the heart of TV stations.

Adopting the MVPD version of video regulation reform would not kill broadcast programming networks. They always have the options of becoming cable networks and selling their programming and advertising time directly to MVPDs or distributing their content themselves directly over the Internet.

The casualty of this so-called “reform” effort would be local TV stations, who are required by law to rely on advertising and retransmission consent fees for their survival. Policymakers should recognize that killing local TV stations for their advertising revenue is the ultimate goal of current video reform efforts before adopting piecemeal changes to the law. If policymakers intend to kill TV stations, they should not attribute the resulting execution to the “friendly fire” of unintended consequences. They should recognize the legitimate consumer and investment-backed expectations created by the current statutory framework and consider appropriate transition mechanisms after a comprehensive review.

The FCC is set to vote later this month on rules for the incentive auction of spectrum licenses in the broadcast television band. These licenses would ordinarily be won by the highest bidders, but not in this auction. The FCC plans to ensure that Sprint and T-Mobile win licenses in the incentive auction even if they aren’t willing to pay the highest price, because it believes that Sprint and T-Mobile will expand their networks to cover rural areas if it sells them licenses at a substantial discount.

This theory is fundamentally flawed. Sprint and T-Mobile won’t substantially expand their footprints into rural areas even if the FCC were to give them spectrum licenses for free. There simply isn’t enough additional revenue potential in rural areas to justify covering them with four or more networks no matter what spectrum is used or how much it costs. It is far more likely that Sprint and T-Mobile will focus their efforts on more profitable urban areas while continuing to rely on FCC roaming rights to use networks built by other carriers in rural areas.

The television band spectrum the FCC plans to auction is at relatively low frequencies that are capable of covering larger areas at lower costs than higher frequency mobile spectrum, which makes the spectrum particularly useful in rural areas. The FCC theorizes that, if Sprint and T-Mobile could obtain additional low frequency spectrum with a substantial government discount, they will pass that discount on to consumers by expanding their wireless coverage in rural areas.

The flaw in this theory is that it considers costs without considering revenue. Sprint and T-Mobile won’t expand coverage in rural areas unless the potential for additional revenue exceeds the costs of providing rural coverage.

A study authored by Anna-Maria Kovacs, a scholar at Georgetown University, demonstrates that the potential revenue in rural areas is insufficient to justify substantial rural deployment by Sprint and T-Mobile even at lower frequencies. The study concludes that the revenue potential per square mile in areas that are currently covered by 4 wireless carriers is $41,832. The potential revenue drops to $13,632 per square mile in areas covered by 3 carriers and to $6,219 in areas covered by 2 carriers. The potential revenue in areas covered by 4 carriers is thus approximately 3.5 times greater than in areas covered by 3 carriers and nearly 8 times greater than in areas covered by 2 carriers. It is unlikely that propagation differences between even the lowest and the highest frequency mobile spectrum could reduce costs by a factor greater than three due to path loss and barriers to optimal antenna placement.

Even assuming the low frequency spectrum could lower costs by a factor greater than three, the revenue data in the Kovacs report indicates that additional low frequency spectrum would, at best, support only 1 additional carrier in areas currently covered by 3 carriers. Low frequency spectrum wouldn’t support even one additional carrier in areas that are already covered by 1 or 2 carriers: It would be uneconomic for additional carriers to deploy in those areas at any frequency.

The challenging economics of rural wireless coverage are the primary reason the FCC gave Sprint and T-Mobile a roaming right to use the wireless networks built by Verizon and AT&T even in areas where Sprint and T-Mobile already hold low frequency spectrum.

When the FCC created the automatic roaming right, it exempted carriers from the duty to provide roaming in markets where the requesting carrier already has spectrum rights. (2007 Roaming Order at ¶ 48) The FCC found that, “if a carrier is allowed to ‘piggy-back’ on the network coverage of a competing carrier in the same market, then both carriers lose the incentive to buildout into high cost areas in order to achieve superior network coverage.” (Id. at ¶ 49). The FCC subsequently repealed this spectrum exemption at the urging of Sprint and T-Mobile, because “building another network may be economically infeasible or unrealistic in some geographic portions of [their] licensed service areas.” (2010 Roaming Order at ¶ 23)

As a result, Sprint and T-Mobile have chosen to rely primarily on roaming agreements to provide service in rural areas, because it is cheaper than building their own networks. The most notorious example is Sprint, who actually reduced its rural coverage to cut costs after the FCC eliminated the spectrum exemption to the automatic roaming right. This decision was not driven by Sprint’s lack of access to low frequency spectrum — Sprint has held low frequency spectrum on a nationwide basis for years.

The limited revenue potential offered by rural areas and the superior economic alternative to rural deployment provided by FCC’s automatic roaming right indicate that Sprint and T-Mobile won’t expand their rural footprints at any frequency. Ensuring that Sprint and T-Mobile win low frequency spectrum at a substantial government discount would benefit their bottom lines, but it won’t benefit rural Americans.

The Supreme Court hears oral arguments today in a case that will decide whether Aereo, an over-the-top video distributor, can retransmit broadcast television signals online without obtaining a copyright license. If the court rules in Aereo’s favor, national programming networks might stop distributing their programming for free over the air, and without prime time programming, local TV stations might go out of business across the country. It’s a make or break case for Aereo, but for broadcasters, it represents only one piece of a broader regulatory puzzle regarding the future of over-the-air television.

If the court rules in favor of the broadcasters, they could still lose at the Federal Communications Commission (FCC). At a National Association of Broadcasters (NAB) event earlier this month, FCC Chairman Tom Wheeler focused on “the opportunity for broadcast licensees in the 21st century . . . to provide over-the-top services.” According to Chairman Wheeler, TV stations shouldn’t limit themselves to being in the “television” business, because their “business horizons are greater than [their] current product.” Wheeler wants TV stations to become over-the-top “information providers”, and he sees the FCC’s role as helping them redefine themselves as a “growing source of competition” in that market segment.

If TV stations share Chairman Wheeler’s vision for their future, the FCC’s “help” in redefining the role of broadcast licensees in the digital era could represent a potential win rather than a loss. If Wheeler truly seeks to enable TV stations to deliver a competitive, fixed and mobile cable-like service, it could signal a positive shift in the FCC’s traditionally stagnant approach to broadcast regulation.

Like all regulatory pronouncements, the devil is always in the details — notwithstanding the existing and legitimate skepticism that TV stations have as to whether the FCC can and will treat them fairly in the future. For better or worse, many will judge the “success” of the broadcast incentive auction by the amount of revenue it raises. This reality provides the FCC with unique incentives to “encourage” TV stations to give up their spectrum licenses. In Washington, “encouragement” can range from polite entreaty to regulatory pain.

After the FCC imposed new ownership limits on TV stations last month, some fear the FCC will choose pain as its persuader. Last month’s FCC action prompts them to ask, if Wheeler is sincere in his desire to help broadcasters pivot to a broader business model, why impose new ownership limits on TV stations that could hinder their ability to compete with cable and over-the-top companies?

Chairman Wheeler attempted to address this question in his NAB speech, but his answer was oddly inconsistent with his broader vision. He said the FCC’s new ownership limits are rooted in the traditional goals of competition, diversity, and localism among TV stations. That only makes sense, however, if you believe TV stations should compete only with other TV stations. Imposing new ownership limits on TV stations won’t help them pivot to a future in which they compete in a broader “information provider” market — it would hinder them.

I expect TV station owners are wondering: If we accept Chairman Wheeler’s invitation to look beyond our current product, will he meet us on the horizon? Or will we find ourselves standing there alone? It’s hard to predict the future, because the future is always just over the horizon.

After yesterday’s FCC meeting, it appears that Chairman Wheeler has a finely tuned microscope trained on broadcasters and a proportionately large blind spot for the cable television industry.

Yesterday’s FCC meeting was unabashedly pro-cable and anti-broadcaster. The agency decided to prohibit television broadcasters from engaging in the same industry behavior as cable, satellite, and telco television distributors and programmers. The resulting disparity in regulatory treatment highlights the inherent dangers in addressing regulatory reform piecemeal rather than comprehensively as contemplated by the #CommActUpdate. Congress should lead the FCC by example and adopt a “clean” approach to STELA reauthorization that avoids the agency’s regulatory mistakes.

The FCC meeting offered a study in the way policymakers pick winners and losers in the marketplace without acknowledging unfair regulatory treatment. It’s a three-step process.

• First, the policymaker obfuscates similarities among issues by referring to substantively similar economic activity across multiple industry segments using different terminology.
• Second, it artificially narrows the issues by limiting any regulatory inquiry to the disfavored industry segment only.
• Third, it adopts disparate regulations applicable to the disfavored industry segment only while claiming the unfair regulatory treatment benefits consumers.

The broadcast items adopted by the FCC yesterday hit all three points.

“Broadcast JSAs”

The FCC adopted an order prohibiting two broadcast television stations from agreeing to jointly sell more than 15% of their advertising time using the three-step process described above.

• First, the FCC referred to these agreements as “JSA’s” or “joint sales agreements”.
• Second, the FCC prohibited these agreements only among broadcast television stations even though the largest cable, satellite, and telco video distributors sell their advertising time through a single entity.
• Third, FCC Chairman Tom Wheeler said all the agency was “doing [yesterday was] leveling the negotiating table” for negotiations involving the largely unrelated issue of “retransmission consent”, even though the largest cable, satellite, and telco video distributors all sell their advertising through a single entity.

If the FCC had  acknowledged that cable, satellite, and telcos jointly sell their advertising, and had the FCC included them in its inquiry as well, Chairman Wheeler could not have kept a straight face while asserting that all the agency was doing was leveling the playing field. Hence the power of obfuscatory terminology and artificially narrowed issues.

“Broadcast Exclusivity Agreements”

The FCC also issued a further notice yesterday seeking comment on broadcast “non-duplication exclusivity agreements” and “syndicated exclusivity agreements.” These agreements, which are collectively referred to as “broadcast exclusivity agreements”, are a form of territorial exclusivity: They provide a local television station with the exclusive right to transmit broadcast network or syndicated programming in the station’s local market only.

Unlike cable, satellite, and telco television distributors, broadcast television stations are  prohibited by law from entering into exclusive programming agreements with other television distributors in the same market: The Satellite Television Extension and Localism Act (STELA) prohibits television stations from entering into exclusive retransmission consent agreements — i.e., a television station must make its programming available to all other television distributors in the same market. Cable, satellite, and telco distributors are legally permitted to enter into exclusive programming agreements on a nationwide basis — e.g., DIRECTV’s NFL Sunday Ticket.

If the FCC is concerned by the limited form of territorial exclusivity permitted for broadcasters, it should be even more concerned about the broader exclusivity agreements that have always been permitted for cable, satellite, and telco television distributors. But the FCC nevertheless used the three-step process for picking winners and losers to limit its consideration of exclusive programming agreements to broadcasters  only.

• First, the FCC uses unique terminology to refer to “broadcast” exclusivity agreements (i.e., “non-duplication” and “syndicated exclusivity”), which obfuscates the fact that these agreements are a limited form of exclusive programming agreements.
• Second, the FCC is seeking comment on exclusive programming agreements between broadcast television stations and programmers only even though satellite and other video programming distributors have entered into exclusive programming agreements.
• Third, it appears the pretext for limiting the scope of the FCC’s inquiry to broadcasters will again be “leveling the playing field” between broadcasters and other television distributors — to benefit consumers, of course.

“Joint Retransmission Consent Negotiations”

Finally, the FCC prohibited a television broadcast station ranked among the top four stations (as measured by audience share) from negotiating “retransmission consent” jointly with another top four station in the same market if the stations are not commonly owned. The FCC reasoned that “the threat of losing programming of two more top four stations at the same time gives the stations undue bargaining leverage in negotiations with [cable, satellite, and telco television distributors].”

As an economic matter, “retransmission consent” is essentially a substitute for the free market copyright negotiations that could occur absent the “compulsory copyright license” in the 1976 Copyright Act and an earlier Supreme Court decision interpreting the term “public performance”. In the absence of retransmission consent, compensation for the use of programming provided by broadcast television stations and programming networks would be limited to the artificially low amounts provided by the compulsory copyright license.

To the extent retransmission consent is merely another form of program licensing, it is indistinguishable from negotiations between cable, satellite and telco distributors and cable programming networks — which typically involve the sale of  bundled channels. If bundling two television channels together “gives the stations undue bargaining leverage” in retransmission consent negotiations, why doesn’t a cable network’s bundling of multiple channels together for sale to a cable, satellite, or telco provider give the cable network “undue bargaining leverage” in its licensing negotiations? The FCC avoided this difficultly using the old one, two, three approach.

• First, the FCC used the unique term “retransmission consent” to refer to the sale of programming rights by broadcasters.
• Second, the FCC instituted a proceeding seeking comment only on “retransmission consent” rather than all programming negotiations.
• Third, the FCC found that lowering retransmission consent costs could lower the prices consumers pay to cable, satellite, and telco television distributors — to remind us that it’s all about consumers, not competitors.

If it were really about lowering prices for consumers, the FCC would also have considered whether prohibiting channel bundling by cable programming networks would lower consumer prices too. For reasons left unexplained, cable programmers are permitted to bundle as many channels as possible in their licensing negotiations.

“Clean STELA”

After yesterday’s FCC meeting, it appears that Chairman Wheeler has a finely tuned microscope trained on broadcasters and a proportionately large blind spot for the cable television industry. To be sure, the disparate results of yesterday’s FCC meeting could be unintentional. But, even so, they highlight the inherent dangers in any piecemeal approach to industry regulation. That’s why Congress should adopt a “clean” approach to STELA reauthorization and reject the demands of special interests for additional piecemeal legislative changes. Consumers would be better served by a more comprehensive effort to update video regulations.

Most conservatives and many prominent thinkers on the left agree that the Communications Act should be updated based on the insight provided by the wireless and Internet protocol revolutions. The fundamental problem with the current legislation is its disparate treatment of competitive communications services. A comprehensive legislative update offers an opportunity to adopt a technologically neutral, consumer focused approach to communications regulation that would maximize competition, investment and innovation.

Though the Federal Communications Commission (FCC) must continue implementing the existing Act while Congress deliberates legislative changes, the agency should avoid creating  new regulatory disparities on its own. Yet that is where the agency appears to be heading at its meeting next Monday.

A recent ex parte filing indicates that the FCC is proposing to deem joint retransmission consent negotiations by two of the top four Free-TV stations in a market a per se violation of the FCC’s good-faith negotiation standard and adopt a rebuttable presumption that joint negotiations by non-top four station combinations constitute a failure to negotiate in good faith.” The intent of this proposal is to prohibit broadcasters from using a single negotiator during retransmission consent negotiations with Pay-TV distributors.

This prohibition would apply in  all TV markets, no matter how small, including markets that lack effective competition in the Pay-TV segment. In small markets without effective competition, this rule would result in the absurd requirement that marginal TV stations with no economies of scale negotiate alone with a cable operator who possesses market power.

In contrast, cable operators in these markets would remain free to engage in joint negotiations to purchase their programming. The Department of Justice has issued a press release “clear[ing] the way for cable television joint purchasing” of national cable network programming through a single entity. The Department of Justice (DOJ) concluded that allowing nearly 1,000 cable operators to jointly negotiate programming prices would not facilitate retail price collusion because cable operators typically do not compete with each other in the sale of programming to consumers.

Joint retransmission consent negotiations don’t facilitate retail price collusion either. Free-TV distributors don’t compete with each other for the sale of their programming to consumers — they provide their broadcast signals to consumers for  free over the air. Pay-TV operators complain that joint agreements among TV stations are nevertheless responsible for retail price increases in the Pay-TV segment, but have not presented evidence supporting that assertion. Pay-TV’s retail prices have increased at a steady clip for years irrespective of retransmission consent prices.

To the extent Pay-TV distributors complain that joint agreements increase TV station leverage in retransmission consent negotiations, there is no evidence of harm to competition. The retransmission consent rules  prohibit TV stations from entering into exclusive retransmission consent agreements with any Pay-TV distributor — even though Pay-TV distributors are allowed to enter into such agreements for cable programming — and the FCC has determined that Pay- and Free-TV distributors do not compete directly for viewers. The absence of any potential for competitive harm is especially compelling in markets that lack effective competition in the Pay-TV segment, because the monopoly cable operator in such markets is the de facto single negotiator for Pay-TV distributors.

It is even more surprising that the FCC is proposing to prohibit joint sales agreements among Free-TV distributors. This recent development apparently stems from a DOJ Filing in the FCC’s incomplete media ownership proceeding.

A fundamental flaw exists in the DOJ Filing’s analysis: It failed to consider whether the relevant product market for video advertising includes other forms of video distribution, e.g., cable and online video programming distribution. Instead, the DOJ relied on precedent that considers the sale of advertising in  non-video media only.

Similarly, the Department has repeatedly concluded that the purchase of broadcast television spot advertising constitutes a relevant antitrust product market because advertisers view spot advertising on broadcast television stations as sufficiently distinct from advertising on other media (such as radio and newspaper). (DOJ Filing at p.8)

The DOJ’s conclusions regarding joint sales agreements are clearly based on its incomplete analysis of the relevant product market.

Therefore, vigorous rivalry between multiple independently controlled broadcast stations in each local radio and television market ensures that businesses, charities, and advocacy groups can reach their desired audiences at competitive rates. (Id. at pp. 8-9, emphasis added)

The DOJ’s failure to consider the availability of advertising opportunities provided by cable and online video programming renders its analysis unreliable.

Moreover, the FCC’s proposed rules would result in another video market double standard. Cable, satellite, and telco video programming distributors, including DIRECTV, AT&T U-verse, and Verizon FIOS, have entered into a joint agreement to sell advertising through a  single entity, NCC Media (owned by Comcast, Time Warner Cable, and Cox Media). NCC Media’s Essential Guide to planning and buying video advertising says that cable programming has surpassed 70% of all viewing to ad-supported television homes in Prime and Total Day, and 80% of Weekend daytime viewing. According to NCC, “This viewer migration to cable [programming] is one of the best reasons to shift your brand’s media allocation from local broadcast to Spot Cable,” especially with the advent of NCC’s new consolidated advertising platform. (Essential Guide at p. 8) The Essential Guide also states:

• “It’s harder than ever to buy the GRP’s [gross rating points] you need in local broadcast in prime and local news.” (Id. at p. 16)
• “[There is] declining viewership on broadcast with limited inventory creating a shortage of rating points in prime, local news and other dayparts.” (Id. at p. 17)
• “The erosion of local broadcast news is accelerating.” (Id. at p. 18)
• “Thus, actual local broadcast TV reach is at or below the cume figures for wired cable in most markets.” (Id. at p. 19)

This Essential Guide clearly indicates that cable programming is part of the relevant video advertising product market and that there is intense competition between Pay- and Free-TV distributors for advertising dollars.  So why is the FCC proposing to restrict joint marketing agreements among Free-TV distributors in local markets when virtually the entire Pay-TV industry is jointly marketing all of their advertising spots nationwide?

The FCC should refrain from adopting new restrictions on local broadcasters until it can answer questions like this one. Though it is appropriate for the FCC to prevent anticompetitive practices, adopting disparate regulatory obligations that distort competition in the same product market is not good for competition  or consumers. Consumer interests would be better served if the FCC decided to address video competition issues more broadly — or there might not be any Free-TV competition to worry about.

Sprint’s Chairman, Masayoshi Son, is coming to Washington to explain how wireless competition in the US would be improved if only there were less of it.

After buying Sprint last year for $21.6 billion, he has floated plans to buy T-Mobile. When antitrust officials voiced their concerns about the proposed plan’s potential impact on wireless competition, Son decided to respond with an unusual strategy that goes something like this: The US wireless market isn’t competitive enough, so policymakers need to approve the merger of the third and fourth largest wireless companies in order to improve competition, because going from four nationwide wireless companies to three will make things even more competitive. Got it? Me neither.

An argument like that takes nerve, especially now. When AT&T attempted to buy T-Mobile a few years ago, Sprint led the charge against it, arguing vociferously that permitting the market to consolidate from four to only three nationwide wireless companies would harm innovation and wireless competition. After the Administration blocked the merger, T-Mobile rebounded in the marketplace, which immediately made it the poster child for the Administration’s antitrust policies.

It also makes Son’s plan a non-starter. Allowing Sprint to buy T-Mobile three years after telling AT&T it could not would take incredible regulatory nerve. It would be hard to convince anyone that such an immediate about face in favor of the company that fought the previous merger the hardest isn’t motivated by a desire to pick winners in losers in the marketplace or even outright cronyism. That would be true in almost any circumstance, but is doubly true now that T-Mobile is flourishing. It’s hard to swallow the idea that it would harm competition if a nationwide wireless company were to buy T-Mobile —  unless the purchaser is Sprint.

The special irony here is that Son has built his reputation on a knack for relentless innovation. When he bought Sprint, he expressed confidence that Sprint would become the number 1 company in the world. But, a year later, it is T-Mobile that is rebounding in the marketplace, even though T-Mobile has fewer customers than Sprint and less spectrum than Sprint. Buying into T-Mobile’s success now wouldn’t improve Son’s reputation for innovation, but it would double down on his confidence. I expect US regulators will want to see how he does with Sprint before betting the wireless competition farm on a prodigal Son.

Verizon v. FCC, the court decision overturning the Federal Communications Commission’s (FCC) net neutrality rules, didn’t rule directly on the First Amendment issues. It did, however, reject the reasoning of net neutrality advocates who claim Internet service providers (ISPs) are not entitled to freedom of speech.

The court recognized that, in terms of the functionality that it offers consumers and the economic relationships among industry participants, the Internet is as similar to analog cable networks as it is to analog telephone networks. As a result, the court considered most of the issues in the net neutrality case to be “indistinguishable” from those addressed in  Midwest Video II, a seminal case addressing the FCC’s authority over cable systems. The court’s emphasis on the substantive similarities between analog cable services, which are clearly entitled to First Amendment protection, indicates that ISPs are likewise entitled to protection.

Net neutrality advocates argued that ISPs are not First Amendment “speakers” because ISPs do not exercise editorial discretion over Internet content. In essence, these advocates argued that ISPs forfeited their First Amendment rights as a result of their “actual conduct” in the marketplace.

Though the court didn’t address the First Amendment issues directly, the court’s reasoning regarding common carrier issues indicates that the “actual conduct” of ISPs is legally irrelevant to their status as First Amendment speakers.

In  Verizon v. FCC , the FCC argued that its net neutrality rules couldn’t be considered common carrier obligations with respect to edge providers because ISPs did not have direct commercial relationships with edge providers. But the court concluded that the nature of preexisting commercial relationships between ISPs and edge providers was irrelevant to the legal status of ISPs:

[T]he Commission appears to misunderstand the nature of the inquiry in which we must engage. The question is not whether, absent the [net neutrality rules], broadband providers would or did act as common carriers with respect to edge providers; rather, the question is whether, given the rules imposed by the [FCC], broadband providers are now obligated to act as common carriers.

FCC v. Verizon, No. 11-1355 at 52 (2014) (emphasis in original).

A court must engage in a similar inquiry when determining whether ISPs are “speakers” entitled to First Amendment protection. The question is not whether ISPs would or actually have exercised editorial discretion in the past. There is no Constitutional requirement that ISPs (or anyone else)  must speak at the earliest opportunity in order to preserve their right to speak in the future. The question is whether ISPs have the legal option of speaking — i.e., exercising editorial discretion.[2]

Of course, everyone knows ISPs have the ability to exercise such discretion. The court noted there was little dispute regarding the FCC’s finding that that ISPs have the technological ability to distinguish among different types of Internet traffic. Indeed, ISPs’ ability to exercise editorial discretion is the very reason the FCC adopted its net neutrality rules. It is also for this reason that, for First Amendment purposes, ISPs are substantially similar to television broadcasters and analog cable operators for whom First Amendment protections have already been applied.

Some net neutrality advocates attempt to skirt this fact by arguing that ISPs don’t “need” to exercise editorial discretion because today’s ISPs are less capacity constrained than broadcasters and analog cable operators. The essence of this argument is that the First Amendment permits the government to abridge a potential speaker’s freedom of speech if, in the government’s subjective view, the speaker would be able to get along just fine without speaking.

In their zeal to defend net neutrality, these advocates appear to have forgotten that, no matter how comfortable or familiar it may be, a muzzle is still a muzzle. The courts have not.

In  Verizon v. FCC, the court recognized that the relationships among ISPs, their subscribers, and edge providers are “indistinguishable” from those present in the analog cable market addressed by the Supreme Court in Midwest Video II:

The Midwest Video II cable operators’ primary “customers” were their subscribers, who paid to have programming delivered to them in their homes. There, as here, the Commission’s regulations required the regulated entities to carry the content of third parties to these customers—content the entities otherwise could have blocked at their discretion. Moreover, much like the rules at issue here, the Midwest Video II regulations compelled the operators to hold open certain channels for use at no cost—thus permitting specified programmers to “hire” the cable operators’ services for free.

FCC v. Verizon, No. 11-1355 at 54 (2014).

The court rejected the FCC’s arguments attempting to distinguish the Internet from cable — arguments that are substantially the same as those advanced by net neutrality advocates in the First Amendment context.

First, the court was unmoved by the argument that Internet content is delivered to end users only when an end user “requests” it, i.e., by clicking on a link. The court noted that cable customers could not actually receive content on a particular cable channel either unless they affirmatively chose to watch those channels, i.e., by changing the channel. ( See id.) The court recognized that, “The access requested by [cable video] programmers in Midwest Video II, like the access requested by edge providers here, is the ability to have their communications transmitted to end-user subscribers if those subscribers so desire.” (Id.)

Second, the court considered the capacity differences between the analog cable systems at issue in  Midwest Video II and the broadband Internet to be irrelevant to common carriage analysis:

Whether an entity qualifies as a carrier does not turn on how much content it is able to carry or the extent to which other content might be crowded out. A short train is no more a carrier than a long train, or even a train long enough to serve every possible customer.

FCC v. Verizon, No. 11-1355 at 55 (2014). The capacity issue is irrelevant to the applicability of the First Amendment for the same reason. A speaker has the right to refrain from speaking even if speaking would be undemanding.

Finally, the court concluded that the FCC could not distinguish its net neutrality rules from the rules at issue in  Midwest Video II using another variation on the “actual conduct” argument. In Midwest Video II, the Supreme Court emphasized that the FCC cable regulations in question “transferred control of the content of access cable channels from cable operators to members of the public.” Midwest Video II, 440 U.S. at 700. In Verizon v. FCC, the FCC argued that its net neutrality rules had not “transferred control” over the Internet content transmitted by ISPs because, “unlike cable systems, Internet access providers traditionally have not decided what sites their end users visit.” (FCC Brief at 65) The court did not consider the “actual conduct” of ISPs a relevant distinction:

The [net neutrality] regulations here accomplish the very same sort of transfer of control: whereas previously broadband providers could have blocked or discriminated against the content of certain edge providers, they must now carry the content those edge providers desire to transmit.

FCC v. Verizon, No. 11-1355 at 56 (2014).

Based on the court’s repeated emphasis on the substantive similarities between analog cable services, which the Supreme Court has held are “speakers”, and Internet services, it should now be obvious that ISPs are also “speakers” entitled to First Amendment protection. The use of Internet protocol rather than analog cable technology to deliver video services changes neither the economic nor the First Amendment considerations applicable to network operators, edge providers, and end users.

To be clear, application of the First Amendment to ISPs does not automatically mean that net neutrality rules would be unconstitutional. Whether a particular regulation is violative of the First Amendment depends on the applicable level of judicial scrutiny, the importance of the government interest at stake, and the degree of relatedness between the law and its purpose. Whether net neutrality rules would survive First Amendment scrutiny would thus depend in part on their own terms and the government’s rationale for adopting them.

That is why the applicability of the First Amendment to ISPs is so important. When Constitutional rights are at stake, the government has stronger incentives to adopt regulations that are well-reasoned and likely to achieve their intended goals than it does when it makes rules in the ordinary administrative context.

[1] The doctrine of constitutional avoidance counsels against deciding a constitutional question when a case can be resolved on some other basis. Once the court concluded that the FCC exceeded its authority in adopting the anti-blocking and anti-discrimination rules, the court had no need to address their constitutionality.

[2] Even if the “actual conduct” argument were valid, it would not control application of the First Amendment to ISPs. The fact that ISPs don’t exercise editorial discretion was motivated in part by FCC policies that chilled or prohibited the exercise of such discretion.

• In the dial-up era, telephone companies were subject to common carrier regulations prohibiting their exercise of editorial discretion over Internet content transmitted by third-party companies (e.g., America Online, who exercised editorial discretion over Internet content) while reducing economic incentives for telephone companies to provide their own Internet services;
• Though the FCC exempted cable broadband services from common carrier regulation relatively early in the broadband era, the FCC simultaneously asked whether and to what extent it should impose editorial restrictions on such services;
• In conjunction with its subsequent order extending the cable broadband exemption to telephone companies, the FCC issued a Broadband Policy Statement announcing that it would take action if it observed ISPs exercising editorial discretion; and
• After the DC Circuit ruled that the Broadband Policy Statement was unenforceable, the FCC adopted the net neutrality rules that the court struck down in Verizon v. FCC.

This history indicates that the “actual conduct” of ISPs evidences nothing more than their intent to comply with FCC rules and policies. It would be absurd to conclude that ISPs forfeited their right to First Amendment protection by virtue of their regulatory compliance.

It appears that Federal Communications Commission (FCC) Chairman Tom Wheeler is returning to a competition-based approach to communications regulation. Chairman Wheeler’s emphasis on “competition, competition, competition” indicates his intent to intervene in communications markets only when it is necessary to correct a market failure.

I expect most on both sides of the political spectrum would welcome a return to rigorous market analysis at the FCC, but you can’t please all of the people all of the time. The American Television Alliance (ATVA), whose FCC petition wouldn’t withstand even a cursory market power analysis, is sure to be among the displeased.

The ATVA petition asks the FCC to regulate prices for retransmission consent (the prices video service providers (VSPs) pay for the rights to provide broadcast television programming to pay-TV subscribers) because retransmission fees and competition among VSPs are increasing. Though true, this data doesn’t indicate that TV stations or broadcast television networks have market power — it indicates that legislative and policy efforts to increase competition among VSPs are working.

The increase in retransmission consent fees is the natural consequence of the increase in competition among VSPs. When incumbent cable companies were the dominant VSPs, they could use the threat of a blackout to force broadcasters to grant retransmission consent at extremely low prices (or even for free). If a TV station balked, it risked losing substantial advertising revenue because there was no other VSP to retransmit the station’s signal.

As a result of increasing competition among VSPs, broadcasters are finally in a position to negotiate fairer prices for their content. When a VSP threatens a blackout today, a broadcaster has the option of calling the VSP’s bluff, as Wall Street observed when Time Warner yanked CBS off the air during a dispute about wireless distribution rights last fall. Now that there are competitive VSPs in most markets, cable operators have something to lose from a blackout too — their subscribers.

VSPs have responded to increasing market competition by asking the government for special treatment. ATVA has cloaked their rent-seeking request in the language of market power, but haven’t provided any analysis supporting their contention that retransmission consent fees are “too high.” They appear to be hoping that, if they cry wolf loud enough, they can avoid paying a fairer price for television programming.

If retransmission fees were really “too high,” one would expect that they would be significantly higher than the fees VSPs charge for their own content. According to the data, however, VSPs charge significantly more for their affiliated content than broadcasters charge for retransmission consent. In 2012, VSPs paid an average of $1.50 for the top ten channels affiliated with cable networks. In comparison, VSPs paid an average of $0.58 in 2012 for the right to retransmit the channels of the top ten TV station companies (e.g., Sinclair) — sixty one percent (61%) less than VSPs were willing to pay for their affiliated content. (Sources: Kagan and SNL)

Are the significantly higher prices cable networks charged for their programming in 2012 driven by consumer ratings? No. Kagan data indicates that, in 2012, VSPs paid approximately the same amount — $0.57 per subscriber — for CNN (CNN en Español sold for $0.58) as the average for the top ten TV stations. Despite its similar price, however, CNN averaged only about 600,000 daily viewers during primetime whereas each of the national broadcast network news programs averaged over 8 million evening viewers daily. This viewership data, albeit limited, indicates that broadcasters are charging ten times less for their programming than VSPs charge for similar programming.

The premium VSPs pay for their own content reflects the economics of the video programming market. Though competition among VSPs has increased, there is still significantly greater concentration and market power in the video distribution market than in the video programming market. According to the FCC’s most recent video competition report, only about one-third (35%) of homes had access to at least four VSPs in 2011. (See Fifteenth Report at Table 2) The FCC found that, even in areas with four VSPs, the Herfindahl-Hirschman Index (HHI), a common measure of horizontal market concentration, was over 2,500 (a highly concentrated marketplace). (See id. at ¶ 37) In comparison, there were more than twenty national video programming networks. (See id. at App. B)

Even a cursory review of the data indicates that recent increases in retransmission consent fees are a sign of market success, not a failure. It should be no surprise that, as competition among VSPs has increased, the price of retransmission consent has increased with it. It is the predictable result of cable’s decreasing monopsony power.

The Internet is abuzz with news that Federal Communications Commission Chairman Tom Wheeler favors a case-by-case approach to addressing Internet competition issues. It is the wisest course, and perhaps the most courageous. Some on the right will say he is going too far, and some on the left will say he isn’t going far enough. That is one reason Wheeler’s approach should be commended. Staunch disagreements about net neutrality and other Internet governance issues reflect the uncertainty inherent in a dynamic market.

Chairman Wheeler’s comments this week echoed Socrates (“I’m not smart enough to know what comes next [in innovation]”) and, to my surprise, Virginia Postrel (the Chairman favors addressing Internet issues “in a dynamic rather than a static way”). He recognizes that, in a two-sided market, there is no reason to assume that ISPs will necessarily have the ability to charge content providers rather than the other way around. The potential for strategic behavior on the Internet today is radically different than in the dial-up Internet era, and the Chairman appears prepared to consider those differences in his approach to communications regulation.

The Chairman also noted that section 706 gives the FCC authority over the entire Internet. Though my friends at TechFreedom have expressed alarm that the Chairman thinks this is positive, an approach that recognizes the potential for strategic behavior by so-called edge providers is preferable to the one-sided approach embodied in net neutrality. The FCC’s decision to impose strict limitations on only one side of the two-sided Internet marketplace was bound to create market distortions and always smacked of cronyism. A broader approach, fairly applied, is more likely to discourage strategic behavior and protect consumers than the FCC’s previous net neutrality rules, which were designed to protect the commercial interests of edge providers.

To be clear, I remain unconvinced that intervention is necessary. But that is the virtue of the common law approach. If anticompetitive behavior occurs, the FCC would have the ability to take action. If not, the market would have the freedom to experiment with new business models and service arrangements. In comparison, a  per se rule “will almost always favor one group over another.”

There is another reason the Chairman should be commended for not rushing to reinstate the invalidated net neutrality rules – respect for the role of Congress. As Commissioner Pai noted in his statement on the DC Circuit’s decision striking down the rules, it was “the second time in four years” that the court had ruled that the agency exceeded its authority in attempting to regulate the Internet. In the meantime, Congress has begun a #CommActUpdate process to modernize the statute for the Internet era. In these circumstances, comity counsels that the FCC defer to Congress on Internet rules. A case-by-case approach would give the FCC flexibility to address any serious anti-competitive or consumer issues that might arise while avoiding the issuance of comprehensive rules in the face of a Congressional rewrite. That is indeed wise.

My response to Free State Foundation’s blog post, “Understanding the Un-Free Market for Retrans Consent Is the First Step for Reforming It”

The Free State Foundation (FSF) questioned my most recent blog post at RedState, which noted that the American Television Alliance’s (ATVA) arguments supporting FCC price regulation of broadcast television content are inconsistent with the arguments its largest members make against government intervention proposed by net neutrality supporters. FSF claimed that my post created a “false equivalency” between efforts to modify an existing regulatory regime and efforts to impose new regulations in a previously free market.

FSF’s “false equivalence” theory is a red herring that is apparently intended to distract from the substantive issues I raised. The validity of the economic arguments related to two-sided markets discussed in my blog doesn’t depend on the regulatory status of the two-sided markets those arguments address. The notion that the existence of regulation in the video marketplace gives ATVA a free pass to say anything it wants without heed for intellectual consistency is absurd.

I suspect FSF knows this. Its blog post does not dispute that ATVA’s arguments at the FCC are inconsistent with the arguments its largest members make against net neutrality; in fact, FSF failed to address the ATVA petition at all. Though the FSF blog was ostensibly prompted by my post at RedState, FSF decided to “leave the merits of ATVA’s various proposals to others” (except me, apparently).

FSF’s decision to avoid the merits of ATVA’s arguments at the FCC (the subject of my blog post), begs the question: What was the FSF blog actually about? It appears FSF wrote the blog to (1) reiterate its previous (and misleading) analyses of the video programing market, and (2) argue that the Next Generation Television Marketplace Act “represents the proper direction” for reforming it.

To be clear, I haven’t previously addressed either issue. But, in the spirit of collegial dialogue initiated by FSF, I discuss them briefly in this blog.

Retransmission Consent

FSF is right that, “In a truly free marketplace, private parties have the liberty to pursue [or not pursue] commercial deals with whomever they choose.” I also agree that the market for video programming is not a “truly free marketplace,” and that the rules governing retransmission consent “restrict private bargaining.” But, FSF’s one-sided characterization of retransmission consent as granting “special rights” to broadcasters only is flatly misleading.

FSF highlights how local broadcasters benefit from (1) “must carry” rules and (2) non-duplication and syndication agreements.

The must carry rules require for-pay video distributors (e.g., cable operators) to carry the programming of broadcasters who elect mandatory program carriage while prohibiting distributors from charging such broadcasters for that carriage. Although I agree with FSF that the must carry rules are particularly intrusive, they are also irrelevant to retransmission consent negotiations. Once a broadcaster elects to engage in retransmission consent negotiations for carriage, it cannot take advantage of must carry for three years. Even if it could, the existence of must carry wouldn’t provide the broadcaster any pricing advantage in negotiations with for-pay video distributors, whose goal is to carry the programming at the lowest possible cost (which must carry sets at zero).

FSF correctly notes that non-duplication and syndication agreements limit the ability of for-pay video distributors (e.g., cable operators) to bargain with non-local broadcasters for new and syndicated broadcast programming, respectively. But FSF sidesteps the fact that these limitations are created in the free market by private contractual arrangements between broadcast stations and the providers of network or syndicated programming, not the government. The FCC’s non-duplication and syndication “rules do not create these rights but rather provide a means for the parties to exclusive contracts to enforce them through the Commission rather than the courts.”

Finally, FSF fails to mention, either in its blog post or its scholarly papers, that the retransmission consent rules limit the ability of broadcasters to choose with whom they bargain by prohibiting broadcasters from entering into exclusive program carriage agreements with for-pay video distributors – a limitation on bargaining that does not apply to programming owned by for-pay video distributors. Unlike non-duplication and syndication, this exclusivity prohibition is not grounded in private contractual arrangements.

FSF does not address whether the potential negotiating advantages conferred on broadcasters by FCC enforcement of network non-duplication and syndication agreements is more valuable in retransmission consent negotiations than the potential disadvantages imposed by the prohibition on exclusive program carriage agreements. To the extent the value of exclusive carriage agreements (the opportunity cost of the retransmission consent regime for broadcasters) outweighs the value of network non-duplication and syndication enforcement (the benefit to broadcasters), for-pay video distributors benefit more from the retransmission consent regime than broadcasters.

Next Generation TV Act

To be sure, even if for-pay video distributors benefit more from retransmission consent than broadcasters, retransmission consent negotiations do not occur in a “truly free market.” I agree with FSF that, “The ultimate goal should be to eliminate regulatory intrusion in this space – and to thereby eliminate occasions for debate over whether this or that particular modification to the old regulations will tip the scales in favor of one class of competitors over another.” Unfortunately, the modifications proposed by the Next Generation TV Act (the Bill) would not eliminate such debates.

FSF describes the Bill as a “comprehensive free market reform.” It would indeed eliminate FCC enforcement of network non-duplication and syndication agreements (and compulsory copyright licenses—an issue that merits additional discussion), but it is far from comprehensive.

First, the Bill doesn’t eliminate must carry for non-profit (e.g., religious and educational) broadcasters – the broadcasters most likely to elect mandatory carriage. Retaining such protections for religious and educational broadcasters is certainly reasonable when viewed from a political perspective; however, it falls short of being a free market approach to video regulation generally.

More importantly, the Bill wouldn’t eliminate any of the underlying reasons for which broadcasters enter into non-duplication and syndication agreements. Broadcasters negotiate exclusive distribution rights in local markets because government regulations require broadcasters to provide their programming for free. As a result of this government mandate, broadcasters rely on local advertising revenue to generate profit. If for-pay video distributors could retransmit duplicative programming (syndicated or otherwise) from non-local broadcasters (e.g., because the local broadcaster had not negotiated exclusive distribution rights), the local broadcaster would lose a substantial portion (if not all) of its advertising revenue. In a “truly free market,” the local broadcaster could respond to the potential loss of advertising revenue by charging subscription fees for its over-the-air video programming delivery or repurposing its spectrum for an alternative use. But broadcasters today don’t operate in a truly free market, and the government generally won’t allow them to pursue other business models.

Although the Bill aims toward a more vibrant free market, my primary concern is that it would leave in place the intrusive business model restrictions on broadcasters while eliminating rules that help make the government-mandated business model work. Perhaps FSF would agree that, if the goal is to “eliminate regulatory intrusions in this space,” the Bill should also eliminate government restrictions on broadcast business models and spectrum use. Anything less is better described as “picking winners and losers,” not “comprehensive free market reform.”

The decision to forgo distribution is referred to as a “blackout” in the cable context and “blocking” in the Internet context, but the economic considerations affecting such negotiations are substantially the same.

The American Television Alliance (ATVA), a coalition comprised primarily of cable and satellite TV operators, is using the playbook of net neutrality proponents in abid to convince the Federal Communications Commission (FCC) to regulate prices for broadcast television content. The goal of ATVA’s cable and satellite members is to increase their profit margins by convincing the government to artificially lower the cost of programming they resell to consumers. I suspect the goal of ATVA’s non-profit members, e.g., Public Knowledge and New America Foundation, is to solidify the FCC’s flawed rationale for adopting net neutrality rules in 2010, which imposed restrictions on market arrangements between Internet Service Providers (ISPs) and Internet content providers without finding a market failure.

Many of ATVA’s cable members are also ISPs that have routinely argued against the imposition of net neutrality regulations in the market for Internet services. By supporting ATVA, these same companies appear to have abandoned the intellectual foundation for opposition to net neutrality. Are they now signaling their intent to embrace net neutrality regulation of the Internet?

An analysis of the similarities between the cable and Internet services markets illuminates this apparent inconsistency. Both cable and Internet services exhibit the characteristics of two-sided markets, and the economic relationships among the participants in both of these markets are substantially similar. All else being equal, consumers prefer distribution platforms (i.e., cable or ISP networks) that provide access to more rather than less content, and content providers prefer distribution on platforms with more rather than less users. As a result, either side of the market has the potential to behave anticompetitively, but only if it has substantial market power relative to the other. Recent economic literature demonstrates that, in the absence of market failure, permitting full pricing flexibility on both sides of two-sided communications markets maximizes consumer welfare by increasing investment in both network infrastructure and content.

Prominent ATVA members who are also ISPs recognized as much in their fight against net neutrality at the FCC. In its comments opposing net neutrality, Time Warner Cable argued that the “critical gap in the [FCC]‘s selective proposal to regulate broadband Internet access service providers is the absence of any assertion that they possess  market power—without which, it is unclear that even manifestly harmful discrimination would warrant regulatory intervention.” (Time Warner Cable Comments at 27 (emphasis in original)) Yet, the ATVA petition, filed by Time Warner Cable at the FCC, fails to provide any economic analysis or cite any precedent finding that broadcasters exercise market power warranting government intervention in retransmission consent negotiations.

The core of ATVA’s argument is a straightforward attack on the ordinary functioning of any two-sided market –  the same attack on the previously unregulated Internet made by net neutrality proponents. ATVA argues that, when a cable operator asks a broadcaster for consent to retransmit broadcast content (which is known as “retransmission consent”), the cable operator must either agree to pay the broadcasters or forgo distribution of that broadcaster’s content. Net neutrality advocates similarly argue that, if an Internet content provider were required to pay an ISP for Internet content distribution, the Internet content provider would either have to agree to pay the ISP or forgo distribution of its content. The decision to forgo distribution is referred to as a “blackout” in the cable context and “blocking” in the Internet context, but the economic considerations affecting such negotiations are substantially the same.

ATVA’s attack on retransmission consent agreements suffers from the same infirmity as the net neutrality attack on ISPs: It is a “solution in search of a problem.” As Time Warner Cable noted in its comments on net neutrality:

“Consumers have to come to expect that they can access the content and services they want, when they want. Service providers almost invariably meet those expectations, and in those isolated instances when they have not, the marketplace has exerted the discipline necessary to rectify matters.” (Time Warner Cable Comments at 18)

Those who believe in free markets should exhibit the same trust in the marketplace when addressing the issue of “black outs” for video content as they do when addressing the issue of “blocking” Internet content. Broadcasters have no greater incentive to “black out” cable viewers (and potentially lose advertising revenue) than ISPs have to “block” Internet content (and potentially lose subscription revenue).

Of course, ATVA doesn’t complain about blackouts,  per se. Every blackout to date has been resolved by the marketplace without restrictive FCC rules, and even if they weren’t, consumers could still access broadcast programming over the air free of charge. ATVA’s real complaint is that broadcasters are demanding “excessive” retransmission consent fees due to the popularity of their programming – an allegation that is uncomfortably similar to the “gatekeeper” theory the FCC relied on in its net neutrality order. There, the FCC concluded that an ISP could “force” edge providers to pay “inefficiently high fees” because that ISP is “typically” an Internet content provider’s “only option” for reaching a particular end user. Both theories reflect a desire to intervene in the ordinary pricing mechanisms of two-sided markets without engaging in a thorough market power analysis. They also ignore the fact that, in a two-sided market, charging for content distribution “may well have important pro-competitive effects.” (Time Warner Cable Comments at 31)

The apparent inconsistency of ATVA members who support regulation of retransmission consent agreements while opposing net neutrality is not a new or surprising phenomenon in Washington. It is essential, however, for those who believe in liberty to recognize the danger that ATVA’s theory represents to free market principles: An ATVA win on retransmission consent would continue the expansion of FCC authority unbounded by rigorous analysis that began with the net neutrality order. With a rewrite of the Communications Act on the horizon, free market advocates cannot afford to lose this battle. If we do, we risk losing the war before it even begins.

Yesterday’s decision requiring AT&T to continue offering seven-year term discounts on POTS lines while the FCC conducts a meritless investigation is more than a drag – it is a government shackle on the deployment of modern IP-based infrastructure to rural and low-income consumers.

In early 2010, the Federal Communications Commission (FCC) issued the National Broadband Plan (Plan) to ensure that all people of the United States have access to broadband Internet communications. The Plan concluded that “broadband is a foundation for economic growth, job creation, global competitiveness and a better way of life” and urged that everyone “must now act and rise to our era’s infrastructure challenge.” (Plan at XI, XV) Yesterday the FCC threatened to turn its back on this call to action when it suspended revisions to AT&T tariffs that sought to stop offering term discount plans of five to seven years for 1960s era “Plain Old Telephone Service” (POTS) technology using circuit switched “special access” lines. The FCC suspended the tariff revisions for five months to investigate their “lawfulness” (even though the remaining tariff rates have already been conclusively presumed to be just and reasonable).

Ironically, at the open Commission meeting on Thursday, the Technology Transitions Policy Task Force will provide a status update on the National Broadband Plan’s recommendation that the FCC eliminate—within the next five to seven years—the requirement that AT&T and other carriers offer POTS technologies using circuit-switched networks (known as the “IP transition”).

Why would the FCC open a five-month investigation on  Monday to determine whether it is “lawful” for AT&T to stop providing long-term discounts for services using outdated technologies the FCC will discuss eliminating altogether at its meeting on Thursday?

The most plausible answer is that the FCC intends to use its regulatory leverage to pressure AT&T into renegotiating its tariffed rates for outdated special access services while the agency decides how to proceed with the IP transition. That might provide some short-term benefits to AT&T competitors who would prefer to avoid investing in their own infrastructure, but in the long-term, the uncertainty created by this regulatory overreach might also forestall investment in the IP infrastructure necessary to fulfill the goals of the National Broadband Plan.

Neither possibility would benefit residential consumers in rural and low-income areas that don’t have access to broadband. The transition from POTS circuit-switched networks to all Internet Protocol networks was a key recommendation of the National Broadband Plan for achieving universal broadband access. The Plan noted that legacy regulation requiring certain carriers to maintain POTS—a requirement the Plan concluded is not sustainable—leads to investments in stranded assets that siphon funding away from IP networks and services. (Plan at 59) Consistent with previous technology transitions, the Plan recommended that the FCC ensure that legacy regulations and services do not become a drag on the transition to a more modern and efficient communications infrastructure while ensuring that consumers don’t lose services they need and businesses can plan for and adjust to the new standards. ( Id.) “The challenge for the country is to ensure that as IP-based services replace circuit-switched services, there is a smooth transition.” (Id.)

It’s been nearly four years since the FCC recognized the need to ensure that legacy regulations and services do not become a drag on the IP transition. Yesterday’s decision requiring AT&T to continue offering seven-year term discounts on POTS lines while the FCC conducts a meritless investigation is more than a drag – it is a government shackle on the deployment of modern IP-based infrastructure to rural and low-income consumers. Most special access lines are not capable of providing broadband Internet services, and they are almost never used to provide services to residential consumers. Other carriers typically lease special access lines from AT&T at government-regulated rates in order to provide phone lines and narrowband data services to businesses – a regressive policy framework that subsidizes corporate telephony at the expense of investment in high-speed broadband services for residential consumers.

In addition to being bad policy, suspending tariff revisions in order to protect competitors and shift costs from corporations to consumers is bad law. The current AT&T tariffs have already been “deemed lawful,” which means that AT&T’s tariffed rates for special access services offered for terms of three years or less have been conclusively presumed to be “just and reasonable” within the meaning of section 201(b) of the Communications Act. ( See Virgin Islands Tele. Corp. v. FCC, 444 F.3d 666 (DC Circ. 2006)) Those rates cannot be deemed unjust and unreasonable merely because AT&T is no longer offering discounts for longer-term arrangements. The Communications Act does not require a carrier to offer any term discounts at all. (See BellSouth v. FCC, 469 F.3d 1052 (D.C. Cir. 2006))

Of course, as noted above, I suspect the FCC’s decision to suspend this tariff was not driven by concerns about the reasonableness of AT&T’s rates (which have already been deemed lawful). It was likely driven by the desire to obtain additional regulatory leverage over services that benefit particular competitors and to buy time for an express decision on the timeline for the IP transition. Even if those were appropriate regulatory goals (and the former certainly is not), bending tariff laws and procedures is not an appropriate means of achieving them.

One year ago I wrote that conservatives were the leading voices in technology policy. Conservative leadership on tech policy issues became even more apparent last week, when House Energy and Commerce Committee Chairman Fred Upton (R-MI) and Communications and Technology Subcommittee Chairman Greg Walden (R-OR) announced plans to update the Communications Act for the Internet era (#CommActUpdate). Virtually everyone recognizes that the Act, which Rep. Walden noted was “written during the Great Depression and last updated when 56 kilobits per second via dial-up modem was state of the art,” is now hopelessly out of date. But it was conservative leadership that was willing to begin the legislative process necessary to update it.

Although the term “progressive” literally means “advocating progress, change, improvement, or reform, as opposed to wishing to maintain things as they are,” some political progressives have focused their communications advocacy on maintaining the status quo. In response to the #CommActUpdate, Free Press said, “We’re not going to get a better act than we have now.” (Communications Daily, Dec. 5, 2013 (subscription required)) Free Press, which describes itself as a “movement to change media and technology policies,” also told Comm Daily, “The IP transition should be governed by the laws on the books today.”

The “do-nothing” approach advocated by Free Press is symptomatic of the regressive policies pursued by some communications advocates today. The laws Free Press seeks to preserve unreasonably discriminate among similar networks providing substantially the same services based solely on their historical identity. Among other things, this discriminatory statutory framework artificially shifts the costs of communications services provided to corporations to residential consumers, inhibits investment in the modern communications infrastructure to serve rural and low-income areas, and distorts competition.

When did self-described “progressives” start believing that Congress cannot improve such painfully outdated laws?

I have more faith in the legislative process than Free Press. I am confident that Congress can work in a bipartisan way to improve laws that are unfairly subsidizing business services at the expense of residential consumers, inhibiting investment in modern communications infrastructure, and distorting competition. Previous revisions to the Communications Act have not provoked partisan rancor, and this one shouldn’t either. Policymakers and advocates from both right and left of center understand the importance of ensuring that consumer-focused communications laws provide a level playing field for all market participants and foster the investment necessary to bring high-speed Internet services to every American.

Of course, improving the act will require that Congress conduct a thorough examination of the current communications market and retain only those policies that have proven successful – which is why the #CommActUpdate announcement is so important. Reviewing the Communications Act will take time, and in a global economy, we have no more time to waste.

From the time Tom Wheeler was nominated to become the next FCC Chairman, many have wondered, “What would Wheeler do?” Though it is still early in his chairmanship, the only ruling issued in Chairman Wheeler’s first meeting signals a pro-investment approach to communications regulation.

The declaratory ruling clarified that the FCC would evaluate foreign investment in broadcast licensees that exceeds the 25 percent statutory benchmark using its existing analytical framework. It had previously been unclear whether broadcasters were subject to the same standard as other segments of the communications industry. The ruling recognized that providing broadcasters with regulatory certainty in this respect would promote investment and that greater investment yields greater innovation.

The FCC’s decision to apply the same standards for reviewing foreign ownership of broadcasters as it applies to other segments of the communications industry is very encouraging. It affirms the watershed policy decisions in the USF/ICC Transformation Order, in which the FCC concluded that “leveling the playing field” promotes competition whereas implied subsidies deter investment and are “unfair for consumers.”

Chairman Wheeler’s separate statement is also very encouraging. Its first sentence declares that, “Promoting a regulatory framework that does not inhibit the flow of capital to the US communications sector is an important goal of Commission policy.” This Chairman understands that, in a global economy, U.S. companies must compete with innovators around the world to obtain the necessary investment to develop new information technologies and deploy new communications infrastructure. His separate statement indicates the Chairman’s intent to renew the FCC’s commitment to encouraging private investment.

Regrettably, the Chairman’s separate statement is potentially troubling as well. After noting that the broadcast incentive auction is intended to allow the market to assure that the spectrum is put to its highest and best use, Chairman Wheeler says he will “assess foreign ownership petitions and applications by looking at, among other factors, whether they will help to fulfill these goals, including efficient spectrum usage.”

It is not entirely clear what the Chairman meant by this non sequitur (would the FCC impose channel sharing conditions on stations seeking approval for foreign investment exceeding the benchmark?). But it indicates a willingness to use the FCC’s authority over mergers and acquisitions to promote unrelated policy goals through the imposition of unrelated conditions. As I’ve noted previously, using the FCC’s transaction authority in this way silences public debate over critical policy issues and shields the resulting decision from judicial review – due process protections that are essential to ensure that the FCC acts in the public interest. Ironically, the prospect of unpredictable, case-by-case conditions on foreign investment would appear to be at odds with the Chairman’s goal of promoting a regulatory framework that doesn’t inhibit the flow of private capital to the U.S. communications industry.

It is also possible that the Chairman was merely attempting to deter speculative investments in broadcast spectrum that could sabotage the incentive auction. The success of the incentive auction is critical to the future of our mobile broadband ecosystem, and it is appropriate that the FCC be mindful of sudden, significant foreign investments in broadcast spectrum in these circumstances.

It is still early in Wheeler’s chairmanship, and the future is bright in the spring. If the Chairman maintains his focus on pro-investment policies during his term, the future could be brighter in every season.

I recently prepared a paper for the Expanding Opportunities for Broadcasters Coalition and Consumer Electronics Association that provides empirical data regarding the costs of restricting the eligibility of large firms to participate in FCC spectrum auctions (available in PDF here). The paper demonstrates that there is no significant likelihood that an open incentive auction would substantially harm the competitive positions of Sprint and T-Mobile. It also demonstrates that Sprint and T-Mobile have incentives to constrain the ability of Verizon and AT&T to expand their network capacity, and that Sprint and T-Mobile could consider FCC restraints on their primary rivals a “win” even if Sprint and T-Mobile don’t place a single bid in the incentive auction. (Winning regulatory battles is a lot cheaper than winning spectrum in a competitive auction.)

Some might think it is implausible that Sprint or T-Mobile would decide to forgo participation in the incentive auction. However, the recent announcement by Sprint that it won’t compete in the H block auction highlights the difficulty in predicting accurately whether any particular company will participate in a particular auction. Sprint’s announcement stunned market analysts, who had considered Sprint a key contender for the H block spectrum. Until recently, Sprint had given every indication it was keen to acquire this spectrum, which is located directly adjacent to the nationwide G block that Sprint already owns. It participated heavily in the FCC’s service rules proceeding for the H block (WT Docket No. 12-357) and even conducted its own testing to assist the FCC in assessing the technical issues. But, by the time the H Block auction was actually announced, Sprint decided its business would be better served by focusing its efforts on the deployment of its trove of spectrum in the 2.5 GHz band.

Such reversals are not unusual during the FCC auction process. Frontline Wireless, a company that no longer exists, successfully persuaded the FCC that it would build a nationwide, interoperable public safety network in the 700 MHz band, if the FCC imposed a public/private partnership condition on the D Block. But, shortly before the auction was scheduled to start, Frontline announced that it had been unable to obtain sufficient financing, and as a result, the D block was never sold.

To be clear, I’m not suggesting that Sprint or Frontline acted deceitfully in seeking spectrum rules they considered favorable to their interests without actually participating in the resulting auction. My point is that there is a critical distinction between regulatory efforts and business decisions. Companies often participate in regulatory proceedings to optimize their potential business options, but the results they seek are just that –  options – until a business decision must be made.

This distinction leads to another important point: It is impossible for the FCC to predict accurately the ultimate business decisions of multiple independent companies whose particular business plans and the circumstances determining them are unknown to the FCC or anybody else. A particular company often cannot accurately predict its  own decisions in rapidly changing circumstances (e.g., when Frontline was lobbying the FCC, it could not know with certainty that it would obtain the financing it required to buy the D Block). This inherent uncertainty is why the discredited licensing methodology of comparative hearings failed. It required the FCC to make reliable predictive judgments about the needs and efficiency of potential spectrum users, which proved to be an impossible task.

Ironically, the bidding restrictions proposed for the incentive auction are a form of “comparative hearing lite”. The DOJ’s recommendation – that the FCC “ensure” that Sprint and T-Mobile win spectrum in the incentive auction – is based on its own predictive judgments regarding the relative spectrum needs of all four nationwide mobile providers and their willingness to use future spectrum resources efficiently. Of course, there is no reason to believe that the DOJ is capable of judging such matters more reliably than the FCC did during the era of comparative hearings. As the H and D Block auctions demonstrate, it is impossible for the DOJ to know whether Sprint and T-Mobile will even show up to participate in the incentive auction.

It could be argued that the exact match between the DISH bid commitment and the H block reserve price is purely coincidental. To actually believe this was a coincidence would require the same willing suspension of disbelief indulged by summer moviegoers who enjoy the physics-defying stunts enabled by computer-generated special effects. When moviegoers leave the theater after watching the latest Superman flick, they don’t actually believe they can fly home.

The FCC’s Wireless Bureau recently adopted an unusually high $1.564 billion reserve price for the auction of the H block spectrum. Though the FCC has authorized the Bureau to adopt reserve prices based on its consideration of “relevant factors that could reasonably have an impact on valuation of the spectrum being auctioned,” it appears the Bureau exceeded its delegated authority in this proceeding by considering factors unrelated to the value of the H block spectrum that have the effect of giving a particular firm an advantage in the auction. Specifically, the Bureau considered the value to DISH Network Corporation of amendments to FCC rules governing other spectrum bands already licensed to DISH (e.g., the 700 MHz E block) in exchange for DISH’s commitment to meet the $1.564 billion reserve price in the H block auction – a commitment that is contingent on the FCC Commissioners amending rules governing multiple spectrum bands no later than Friday, December 13, 2013.

No matter what the FCC Commissioners decide, if the reserve price stands, the only sure winner would be DISH. If the FCC Commissioners  don’t endorse the DISH deal, DISH need not honor its commitment to meet the artificially inflated reserve price, which could result in the spectrum auction’s total failure. If the Commissioners do endorse the DISH deal, the artificially inflated reserve price could deter the participation of other bidders and lower auction revenues that are expected to fund the national public safety network. Neither option would result in an open and transparent auction designed to provide all potential bidders with a fair opportunity to participate.

The FCC would be the only sure loser. The appearance of impropriety in the H block proceeding could compromise public trust in the integrity of FCC spectrum auctions. To ensure the public trust is maintained, the FCC Commissioners should thoroughly review the processes and procedures implemented by the Wireless Bureau in this proceeding before auctioning the H block spectrum.

The following discussion provides background information on the purposes of spectrum auctions and reserve prices. This background information is followed by a more detailed analysis of the terms of the DISH deal and the advantages it would bestow on DISH, the lack of analysis in the Wireless Bureau’s order, the role of the Commissioners, and the potential damage to the integrity of FCC auctions.

The Purpose of Spectrum Auctions

FCC spectrum auctions are intended to assign licenses to the firms that value the spectrum most highly, who are presumed to be most likely to provide the highest quality and most timely service to the public. Though this presumption was controversial when Congress first authorized spectrum auctions in 1993, twenty years and eighty-two auctions later, there is widespread agreement that open and transparent auctions have generally succeeded in licensing spectrum to the most efficient firms while minimizing delays in service to the public, preventing unjust enrichment, and providing revenue to the public treasury. Like any other market-based mechanism, however, competitive bidding mechanisms are vulnerable to market distortions. When the rules governing a spectrum auction are likely to produce market distortions, it weakens the presumption that the resulting auction is likely to award spectrum licenses to the most efficient firms.

The Purpose of Reserve Prices

The FCC has previously concluded that artificially inflated reserve prices are likely to result in market distortions.

The Balanced Budget Act of 1997 established a presumption requiring the FCC to impose minimum opening bids or reserve prices in FCC auctions unless it is not in the public interest. ( See FCC 97-413 at ¶ 139) Traditionally, reserve prices are used to maximize auction revenue and cannot be lowered once an auction begins. In its order implementing the Balanced Budget Act, the FCC determined that the minimum opening bid/reserve price requirement was not intended to require traditional reserve prices designed to maximize auction revenue – the provision was intended only as protection against assigning spectrum licenses at unacceptably low prices. (See id. at ¶ 140) The FCC thus directed the Wireless Bureau to consider only “relevant factors that could reasonably have an impact on valuation of the spectrum being auctioned” when establishing reserve prices. (See id. at ¶ 141 (emphasis added))

It is implicit in this delegation of authority that the Wireless Bureau cannot consider factors that are  irrelevant to the valuation of the spectrum being auction. As the Bureau has previously recognized, establishing reserve prices based on factors that are unrelated to the valuation of the spectrum being auctioned could artificially inflate reserve prices, which could deter bidders from participating in the auction and preclude the assignment of the spectrum to the most efficient firms. (See DA 97-2147 at ¶¶ 13-14)

Despite its lack of delegated authority to do so, it appears that the Wireless Bureau considered irrelevant factors that may have artificially inflated the reserve price in the H block auction, including the value to DISH Network Corporation of amendments to FCC rules governing other spectrum bands already licensed to DISH. There is no rational (let alone reasonable) relationship between amendments to rules governing other spectrum bands that are  uniquely valuable to a particular firm and the value of the H block spectrum generally. The Bureau nevertheless considered the unique interests of DISH while playing a larger game of Let’s Make a Deal involving otherwise unrelated FCC proceedings.

The Deal with Dish

The terms of the deal with DISH were memorialized in an  ex parte letter (DISH Letter) filed by DISH in WT Docket No. 12-69 (“Promoting Interoperability in the 700 MHz Commercial Spectrum”) on September 10 (three days before the Wireless Bureau issued its order establishing the H block reserve price), and a petition for waiver (DISH Petition) filed by DISH on September 9 (which has not yet been assigned a docket number). According to these deal documents, DISH agreed to:

• Consent to a reduction in the power limits currently applicable to its E block spectrum in the lower 700 MHz band (see DISH Letter at 2-3); and

• Bid “at least a net clearing price equal to any aggregate nationwide reserve price established by the Commission in the upcoming H Block auction (not to exceed the equivalent of $0.50 per MHz/POP [i.e., $1.564 billion])” in order “to provide critical funds for FirstNet.” (DISH Petition at 2)

DISH stated that its consent and bid commitment are “contingent” on FCC actions to:

• Extend DISH’s buildout deadlines in both the lower 700 MHz E block and the AWS-4 band; and

• Authorize DISH to operate its AWS-4 spectrum in the 2000-2020 MHz band, which currently must be used only as uplink, as either uplink or downlink. (See DISH Letter at 2-3)

In the DISH Letter, DISH stated its “anticipat[ion] that the Commission will adopt a final order effectuating these changes no later than December 31, 2013,” including the “ grant in its entirety” of the DISH Petition. (See Dish Letter at 2-3 (emphasis added)) In the DISH Petition, DISH stated that the FCC must adopt an order effectuating these changes “at least 30 days prior to the commencement of the H Block auction,” or its $1.564 billion bid commitment “shall no longer apply.” (See DISH Petition at 15) After the DISH Petition was filed, the Wireless Bureau ordered the H block auction to commence on January 14, 2014, which means DISH’s bid commitment applies only if the FCC Commissioners grant the DISH Petition in its entirety and modify the rules governing the 700 MHz E block no later than Friday, December 13, 2013.

Despite the fact that the deal gives the FCC Commissioners less than three months to grant DISH’s desires, DISH would have  two and one-half years from the date the DISH Petition is granted to file an election stating whether it would deploy the 2000-2020 MHz band for downlink or uplink. (See DISH Petition at 1-2)

The Advantages Bestowed on Dish

If DISH were given the ability to elect whether to deploy the 2000-2020 MHz band for downlink or uplink for nearly two and one-half years  after the H block auction concludes, DISH would have a substantial advantage in the auction relative to other potential bidders.

A discussion of the relationship between the H block and the AWS-4 spectrum and previous industry positions regarding this relationship is informative when analyzing the advantages bestowed on DISH and how it could affect the strategies of other potential bidders.

The current uplink requirement in the AWS-4 spectrum at 2000-2020 MHz and the downlink requirement in the adjacent H block spectrum at 1995-2000 MHz creates “particularly difficult technical issues” that “affect the use and value” of these bands. ( See FCC 12-151 at ¶¶ 53, 65 (AWS-4 Order)) The deployment of downlink and uplink in adjacent bands increases the potential for harmful interference from out-of-band emissions (OOBE) and receiver blocking (or “overload”). (See AWS-4 Order at ¶ 72) In the AWS-4 proceeding, DISH argued that these interference issues meant the H block could not be auctioned at all and must be treated as a guard band (which would have eliminated most of its value). (See id. at ¶¶ 66, 69) The FCC chose to reduce the utility (and thus the value) of the AWS-4 spectrum instead by (1) increasing the OOBE limits applicable to the 2000-2020 MHz band, (2) limiting the power of mobile terrestrial devices in the 2000-2005 MHz portion of the AWS-4 band, and (3) requiring that DISH accept any OOBE and overload interference into that portion of the AWS-4 band caused by future, lawful operations in the H block. (See id. at ¶ 72) According to DISH, these restrictions render the 2000-2005 MHz portion of its AWS-4 spectrum unsuitable for mobile services.

In its order establishing service rules for the H block (H Block Order), the FCC noted that DISH had accepted the limitations on its AWS-4 spectrum and that “nothing [in the H Block Order was] intended to revisit these determinations.” (H Block Order, FCC 13-88 at ¶ 49) The FCC did, however, “specifically adopt . . . rules to adequately protect operations in adjacent bands, including the . . . 2000-2020 MHz AWS-4 uplink band.” (Id. at ¶ 48) These rules include a “more stringent OOBE limit of 70 + 10 log10 (P) dB, where (P) is the transmitter power in watts, for transmissions from the Upper H Block into the 2005-2020 MHz AWS-4 band.” (See id. at ¶ 59-60 (the FCC typically applies an OOBE limit of 43 + 10 log10 (P) dB at the edges of mobile bands only)) Sprint (who holds all of the licenses for the PCS G Block, which is contiguous with and complementary to the H block) had advocated for a less stringent limit of 60 + 10 log10 (P) dB across the 2005-2020 MHz band, and DISH (who holds all of the AWS-4 licenses) had advocated for an even more stringent 79 + 10 log10 (P) dB limit. (Id. at ¶ 65) The FCC split the difference, finding that an OOBE limit of 70 + 10 log10 (P) dB was “more consistent with the balancing of interference concerns between the AWS-4 and H Block bands discussed in the [AWS-4 Order]” than the less stringent limits proposed by Sprint and the more stringent limits proposed by DISH. (See id. at ¶ 68-73) The FCC also noted that licensees in the H block and the AWS-4 band could agree to modify the technical restrictions governing interference between these bands through private negotiation. (See AWS-4 Order at ¶ 73; H Block Order at ¶¶ 65, 208)

Relationship Between H Block & AWS-4 Spectrum

If the FCC Commissioners were to endorse the DISH deal, it would give DISH the  unilateral ability to rebalance the interferences issues the FCC previously considered and resolved in its 2012 AWS-4 Order and its 2013 H Block Order – a unilateral ability that DISH could choose to exercise after the H block auction concludes. This would create a significant information asymmetry between DISH and all other potential bidders in the H block auction, which would improve DISH’s bidding position relative to other firms and potentially deter their participation in the auction. For example, if DISH were to elect to use the AWS-4 spectrum for downlink, it would mitigate the interference concerns that currently exist between the H block and ASW-4 bands, which would tend to increase the value of the H block to all potential bidders. Because DISH would have the unilateral ability to stall its election for nearly two and one-half years after the H block auction ends, however, DISH would be uniquely positioned to accurately assess the probability that it would choose to mitigate interference concerns by electing the downlink option. In these circumstances, other firms are likely to discount or ignore entirely whatever increase in value they would otherwise accord to the H block spectrum based on the mere possibility that DISH could elect to limit the 2000-2020 MHz band to downlink transmissions.

The proposed downlink election would also give DISH leverage in subsequent interference negotiations between itself and future H block licensees, which would tend to lower the bids of other firms while simultaneously limiting DISH’s incentive to bid any higher on the H block spectrum than its commitment would otherwise require. Assume, for example, that DISH meets its commitment by bidding the $1.564 billion reserve price but is subsequently outbid by Sprint. In the absence of the proposed election right, DISH would have an incentive to raise its previous bid because, if DISH owned both the H block and the AWS-4 spectrum, it could unilaterally eliminate the technical restrictions on both bands through private agreement with itself (a common practice when a single licensee owns spectrum across multiple blocks or bands). With the downlink election right, however, DISH’s incentive to bid on the H block in order to mitigate interference would be substantially diminished, because DISH could use its election right as leverage in post-auction interference mitigation negotiations with Sprint.

For example, assuming Sprint wins the H block, it would have an incentive to seek DISH’s agreement to the less stringent OOBE limits Sprint sought, but did not obtain, in the H block rulemaking proceeding. DISH likewise would have an incentive to seek Sprint’s agreement to technical parameters that would allow DISH to use the 2000-2005 MHz portion of the AWS-4 band for mobile services, which is something DISH sought, but did not obtain, in the AWS-4 and H block rulemaking proceedings. Because the downlink election would mitigate the interference concerns the FCC was required to balance in these rulemaking proceedings, it is possible DISH could use the election right to rebalance the technical rules in its favor (and thus increase the value of its AWS-4 spectrum)  without paying for the H block spectrum at auction or paying to obtain the agreement of the H block licensees (in this hypothetical, Sprint). This possibility would tend to lower the price DISH would be willing to pay for the H block spectrum at auction while giving Sprint and other potential bidders incentives to discount their bids to account for the potential costs of their subsequent interference negotiations with DISH.

In effect, endorsing the DISH deal would provide DISH with an implicit government subsidy for its anticipated interference negotiations, the cost of which would be borne by the government (and, ultimately, public safety) in the form of lower auction revenues for the H block, which would tend to explain the Bureau’s decision to adopt the unusually high H block reserve price proposed by DISH.

The Lack of Analysis

Despite the obvious connection, the Wireless Bureau did not cite the DISH Letter or DISH Petition in its order adopting DISH’s minimum bid commitment as the reserve price for the H block auction. The Bureau didn’t discuss the DISH deal at all. It instead cited a brief ex parte letter (DISH Ex Parte) filed by DISH in the H block auction proceeding (AU Docket No. 13-178) on the same day DISH separately filed the DISH Petition (which has not yet been assigned a docket number).

The DISH Ex Parte also neglects to mention the DISH Petition filed that same day or the deal memorialized in the DISH Letter filed in WT Docket No. 12-69 the following day. The DISH Ex Parte addresses the reserve price issue in a single paragraph, which states only that “DISH estimates that the value of the H Block is at least $0.50 per” MHz-Pop on a nationwide aggregate basis (i.e., $1.564 billion) based on recent auctions and secondary market sales. ( See DISH Ex Parte at 1 (citing the 2006 AWS-1 auction, the Verizon SpectrumCo transaction, and a Morgan Analyst Report)). Though it states the value of the H block is “at least” $1.564 billion, the DISH Ex Parte does not offer any analysis indicating that this estimate is an appropriate reserve price based on factors considered relevant by the FCC when establishing reserve prices – and neither does the Wireless Bureau’s order.

As noted above, the FCC has determined that reserve prices should be used only as protection against assigning licenses at unacceptably low prices and not as a tool to maximize auction revenue. In its order delegating authority to the Wireless Bureau to establish minimum opening bids or reserve prices, the FCC directed the Bureau to consider “the amount of spectrum being auctioned, levels of incumbency, the availability of technology to provide service, the size of the geographic service areas, issues of interference with other spectrum bands, and any other relevant factors that could reasonably have an impact on valuation of the spectrum being auctioned.” ( See FCC 97-413 at ¶ 141) The Wireless Bureau didn’t discuss any of these factors in its order adopting the H block reserve price or find that a lesser amount would be “unacceptably low” (which seems unlikely given the more stringent technical limitations imposed on the H block in order to mitigate its “particularly difficult technical issues”). The Bureau simply concluded without analysis that the amount of DISH’s bid commitment is “appropriate” given the Spectrum Act’s requirement to use the auction proceeds for public safety purposes. (See DA 13-1885 at ¶ 172) The reasons why the Bureau believes this particular amount is appropriate were left unstated.

Though the FCC has occasionally adopted relatively high reserve prices in the past, they were expressly based on the potential value of the spectrum being auctioned or statutory incumbency issues. For example, in Auction 66, the FCC adopted a relatively high reserve price to ensure the auction raised enough revenue to relocate incumbent federal spectrum users as required by statute. The FCC also adopted relatively high reserve prices in Auction 73 because it was concerned that the unique public interest obligations and stringent buildout requirements it had imposed on that spectrum could result in unacceptably low auction prices. Safeguarding against the assignment of spectrum at unacceptably low prices due to factors relevant to the valuation of the spectrum being auctioned is the purpose the reserve price requirement is intended to serve.

As noted above, however, the FCC has concluded that it is inappropriate to adopt a high reserve price merely to maximize revenue (no matter how noble the cause) or to serve purposes unrelated to the spectrum being auctioned, because reserve prices adopted for such reasons are more likely to result in a failed auction. The irony in this instance is that, if the unusually high reserve price makes it more likely that the H block auction could fail, public safety could be worse off than if there were no reserve price at all. It is also ironic that DISH’s bid commitment is  itself evidence that the reserve price adopted by the Bureau is artificially inflated. If the H block spectrum were actually worth “at least” as much as DISH estimates (and DISH were actually interested in winning it), DISH would not have had a legitimate reason to make its H block bidding commitment contingent on the FCC granting “in its entirety” the relief sought by DISH.

The unusually high reserve price placed on the H block spectrum is especially troubling given the obvious implication that the Bureau’s decision was driven primarily by factors unrelated to  either the value of the H block or the interests of public safety – i.e., it appears the Bureau was motivated by the DISH deal’s role in resolving interoperability issues in the 700 MHz band. Though that is undoubtedly a noble goal, it is ignoble to achieve it by compromising the integrity of an unrelated spectrum auction.

It could be argued that the exact match between the DISH bid commitment and the H block reserve price is purely coincidental. The Bureau’s failure to mention that DISH had concurrently filed a petition committing to bid an amount identical to its suggested reserve price is not, however, enough to satisfy a claim of coincidence that meets the straight face test. To believe this was a coincidence would require the same willing suspension of disbelief indulged by summer moviegoers who enjoy the physics-defying stunts enabled by computer-generated special effects. When moviegoers leave the theater after watching the latest Superman flick, they don’t actually believe they can fly home.

The Role of the Commissioners

The particular process followed by the Wireless Bureau in this instance creates additional risk that the auction could fail and leave public safety with no revenue from the H block.

The Bureau’s adoption of an unusually high reserve price was presumably premised on the notion that, even if the reserve price is artificially inflated, there is little risk that the H block auction would fail because DISH committed to meet the reserve price. The problem with this premise is that DISH’s commitment is contingent on the FCC Commissioners agreeing to grant DISH specific relief before the auction, a decision that is outside the Bureau’s control. If the full FCC chooses to deny the DISH Petition and other rules changes sought by DISH, or simply fails to act within the requisite time, the H block auction may have to proceed  with an artificially inflated reserve price and without any commitment by DISH to meet it.

In these circumstances, the Bureau’s decision to adopt an unusually high reserve price also has the effect of placing inappropriate pressure on the FCC Commissioners to act in accordance with the will of the Bureau. If the H block auction procedures stand, the options of the Commissioners would appear to be limited to (1) endorsing the DISH deal or (2) risking the failure of the H block auction due to the unusually high reserve price, which could in turn delay the payment of auction revenue slated for use by public safety. The Wireless Bureau’s decision thus has the effect of forcing the Commissioners into making a Hobson’s choice.

Given that the H block reserve price is based on considerations that lie outside the scope of the Bureau’s delegated authority, the reserve price should only have been approved (if at all) by a full FCC vote after a thorough analysis of its potential impact. In no event should the Bureau have adopted DISH’s proposed reserve price without a reasonable opportunity for comment by the public and thorough consideration by the Commissioners, especially given its potential impact on other spectrum bands.

The Integrity of FCC Auctions

The process for adopting the reserve price in the H block proceeding begs the question: Was this intended to be an open and transparent auction designed to assign H block licenses to the firms that value them most highly  or a privately negotiated retail sale designed to ensure a minimum level of auction revenue while accomplishing unrelated policy goals that also benefit a particular firm? No matter the answer, the fact that this question must be asked is enough to compromise the public’s trust in the ability and willingness of the FCC to conduct open and transparent spectrum auctions that provide all potential bidders with a fair opportunity to participate. To restore public trust in the integrity of FCC auctions, the Commissioners should thoroughly review the Wireless Bureau’s competitive bidding processes and procedures before auctioning the H block spectrum.

Last week on The Diane Rehm Show, Susan Crawford, former special assistant to President Obama for science, technology, and innovation policy, claimed that China “makes us look like a backwater when it comes to [broadband] connectivity.” When she was asked how this could be, Ms. Crawford responded:

It happened because of [Chinese industrial] policy. You can call that overregulation. It’s the way we make innovation happen in America.

Ms. Crawford is wrong on the facts and the philosophy.

The Actual Facts

Two months ago, Ms. Crawford’s former employer, the Office of Science and Technology Policy, released a report with these conclusions:

• “Broadband networks at a baseline speed of >10 megabits per second now reach more than 94% of U.S. homes.”

• “In 2012, North America’s average mobile data connection speed was 2.6 Mbps, the fastest in the world, nearly twice that available in Western Europe, and over five times the global average.”

• “Just two of the largest U.S. telecommunications companies account for greater combined stateside investment than the top five oil/gas companies, and nearly four times more than the big three auto companies combined.”

• “The average connection speed in the United States in the fourth quarter of 2012 was 7.4 Mbps, the eighth fastest among all nations, and the fastest when compared to other countries with either a similar population or land mass.”

In comparison, the same source used in the President’s report indicates that China’s average connection speed in the fourth quarter of 2012 was only 1.8 Mbps – seventy-five percent slower than in the United States.

Although our average connection speeds lag those in South Korea and Japan, the differences in speed are less significant from a consumer perspective (7.4 Mbps is enough to delivery high definition video, 1.8 Mbps is not) and reflect differences in population densities and landmass.

The Winning Philosophy

Ms. Crawford believes government intervention “makes free markets and free speech possible.” The facts recited above and the First Amendment to our Constitution – written when government intervention in mass communications was commonplace – both refute that philosophy. Whatever you call it, this type of government intervention “has a record of failure so blatant that only an intellectual could ignore or evade it.”

In the communications context, that record of failure includes government-sanctioned telephone and cable monopolies that policymakers have spent the last two decades unwinding through market-based policies.

The results of that effort demonstrate that it is liberty – the absence of overregulation – that drives innovation in America. The market-based approach to communications regulation pioneered by the Clinton Administration in the 1990s yielded massive investment in new technologies, competition among communications networks, an explosion in new media, and unprecedented consumer choice. We don’t need government intervention for private sector innovation and investment to continue flourishing – we need continued government restraint.

“In today’s globally competitive era, the United States cannot continue to delay its transition to Internet-enabled infrastructure.”

Last week the Department of Defense (DoD) filed comments with the FCC in its proceeding examining the transition from outdated telephone technologies to Internet Protocol (the “IP-transition”). The comments, which were filed “on behalf of the consumer interests” of the DoD by a civilian attorney in the Army’s Regulatory Law Office (emphasis added), ask the FCC to “consider potential adverse consequences on public safety and national security” of requiring federal agencies to “prematurely transition to different technologies.”

What are these potential adverse consequences? The italicized “interests” of the DoD provide the answer: It wants to avoid incurring any costs to upgrade its outdated telephone technologies to modern, Internet Protocol technologies when its current communications contracts expire in 2017.

While that may be a legitimate concern for DoD procurement plans, federal budgetary pressures are not a legitimate regulatory concern. The FCC cannot require private companies to maintain outdated technologies in order to reduce DoD budgetary pressure or give it additional leverage in its future contract negotiations. The appropriate forum for addressing federal budgetary concerns is Congress, not the FCC.

The DoD filing nevertheless asks the FCC to consider the impact of the IP-transition on federal contracts with private companies for communications services that use legacy telephone technologies. Most of these contracts are administered by the Government Services Administration through its “Networx” contracting program, which is “set to expire” in 2017. The replacement program, which is considering the use of “standardized IP” infrastructure, is entitled “Network Services 2020”. The obvious implication of this date is that the federal government is considering extending the “Networx” program beyond its set expiration and is concerned that the IP-transition could hinder its negotiations.

Though the federal government is free to seek an extension of its Networx contract until 2020, it cannot use federal regulation to increase its negotiating leverage. The FCC has a “longstanding policy” of declining to adjudicate private contractual issues – a policy that is particularly appropriate when the federal government is a party to the contract. It would not serve the public interest to deny consumers additional access to modern technologies merely to give the federal government additional leverage in its contract negotiations.

That does not mean the FCC should ignore public safety and national security. It should honor the DoD request to participate in the trial selection process and coordinate with it and other government agencies throughout the IP-transition to avoid disruption to critical communications.

It should also recognize, however, that the other concerns raised by the DoD are primarily commercial in nature. The DoD filing carefully avoids saying that the legacy telephone network is technologically necessary to meet its operational demands. It instead “embraces advances in telecommunications technologies and services” and “applauds” efforts to pursue “more efficient, reliable and functionally robust” networks – so long as the DoD isn’t required to “prematurely” (i.e., prior to 2020) expend any funding on such networks.

These budgetary concerns are misplaced. The capabilities offered by the all-IP networks of the future will ultimately enhance public safety and national security, while improving education and healthcare, and significantly contributing to our Nation’s economy. In today’s globally competitive era, the United States cannot continue to delay its transition to Internet-enabled infrastructure. The longer we wait to begin our transition, the more likely it is that another nation’s flag will greet us when we finally reach its end.

Senator Marco Rubio is right on immigration. In his remarks regarding the immigration bill passed by the Senate last week, Rubio noted that immigration is an American story.

For over two hundred years now, they have come. . . . From Ireland and Poland, from Germany and France. From Mexico and Cuba, they have come. They have come because in the land of their birth, their dreams were bigger than their opportunities.

As Jack Kemp so famously said, “We are a nation of immigrants.” From the Native Americans who crossed the land bridge over what is now the Bering Strait to the apex of European immigration in the early 20^th Century (when 13.5 million immigrants were living in the United States), America has always been the land of opportunity.

“We are still the hope of the world” today, and we still need immigrants. We are not producing enough skilled workers to support our high-tech economy and our population is aging. If immigrants had the opportunity, they could fill our high-tech vacancies, expand our workforce, and grow our economy. Without them, we will export more jobs overseas and watch our economy continue to struggle.

We should of course take prudent measures to improve border security and curb illegal entry into the United States. But we should also recognize that fences will not stop those who earnestly seek the American dream any more than the Great Wall of China stopped the Qing (the people who conquered those who built the Great Wall). The best antidote to illegal immigration is a sensible system that provides immigrants with an opportunity to enter and remain in the country legally.

Ideas, not walls, have always been America’s greatest strength. The American dream is our greatest idea and immigration is its legacy. Throughout our history immigrants have energized economic growth and innovation in this country by pursuing freely their dreams for a more prosperous future. We share the same dream, and when we dream it together, America is at its very best.

“Permitting voluntary spectrum transactions between federal and commercial users would harness the power of market forces to put both commercial and federal spectrum to its highest and best uses.”

The House Energy and Commerce Committee’s Subcommittee on Communications and Technology is holding a hearing today to ask, “How can Congress meet the needs of Federal agencies while addressing carriers’ spiraling demand for spectrum in the age of the data-intensive smartphone?” In my view, the answer requires a flexible approach that permits experimentation among multiple approaches.

There are challenges and opportunities for  both (1) clearing and reallocating federal spectrum for commercial use and (2) sharing spectrum among federal and commercial users. Economic and technical issues may require different strategies for different spectrum bands and different uses. Experience indicates that voluntary negotiations among interested parties – not bureaucratic fiat – are likely to produce the most efficient strategy in any particular instance. Unfortunately, current law does not provide market incentives or mechanisms for the relevant parties (federal and commercial spectrum users and spectrum regulators) to achieve efficient outcomes.

Congressional action creating markets for spectrum transactions between federal and commercial users would provide the relevant parties with an opportunity to maximize their spectrum use through voluntary negotiation. A market-oriented approach would permit experimentation, encourage innovation, and promote investment while increasing the efficiency of spectrum use. The result would benefit consumers, federal agencies, and the economy.

Federal users lack incentives to relinquish or share spectrum with commercial users

The law requires the NTIA and FCC to jointly plan spectrum allocations to accommodate all users and promote the efficient use of the spectrum. Although the agencies have agreed to share spectrum when the potential for harmful interference is low, the NTIA typically does not voluntarily agree to repurpose federal spectrum for exclusive commercial use. That typically requires a Presidential memorandum, Congressional legislation, or both.

The reason: NTIA and its constituent federal spectrum users have no  incentive to voluntarily relinquish federal spectrum rights.

First, government agencies generally cannot profit from relinquishing their spectrum (i.e., they are not subject to the opportunity costs applicable in commercial markets). They are entitled to reimbursement for the costs of relocating their wireless systems after a commercial spectrum auction, but the majority of auction proceeds are remitted to the general Treasury.

Second, government agencies face an uncertain funding environment (i.e., they cannot raise capital in commercial markets). Agencies often reserve federal spectrum allocations for planned wireless systems that are unfunded, which can result in federal spectrum lying fallow for years. An agency that reserves spectrum for a planned system can remain optimistic that it will receive funding in the next budget cycle. But, if the agency relinquishes its spectrum, it cannot build the planned system even if it does receive funding.

The lack of potential benefits and the funding uncertainty inherent in the government budgeting process combine to create an environment in which federal agencies have low opportunity costs for reserving spectrum and high opportunity costs for relinquishing it. Creating market mechanisms that  reverse these opportunity costs would provide government agencies with incentives to voluntarily relinquish or share their spectrum in ways that promote overall spectrum efficiency.

Federal users lack incentives to share spectrum with other federal users

The lack of incentives for efficient use of federal spectrum extends to intra-agency sharing as well.

There are approximately eighty different federal entities that are authorized to use federal spectrum. It would be more efficient for multiple agencies to share spectrum and systems in certain bands, but the lack of market incentives combined with jurisdictional issues make it difficult for them to work together. For example, DOJ, DHS, and DOT tried to build a shared wireless network for voice communications, but, “despite costing over $356 million over 10 years,” the project failed to achieve the results intended.

Market mechanisms that permit federal agencies to profit from their spectrum could eliminate the funding issues and alleviate the “turf wars” that plague intra-agency projects.

Potential mechanisms for repurposing federal spectrum

The current proposals for repurposing federal spectrum fall into three general categories.

One option is to create a GSA-like agency for federal spectrum users. This would provide an incentive for efficient use of federal spectrum by imposing an opportunity cost for inefficiency (in the form of rents paid by federal spectrum users to the new agency), but it would not improve funding mechanisms for federal wireless systems.

Another option is the sharing-only approach proposed by the President’s Council of Advisors on Science and Technology (PCAST). This approach could provide commercial users with additional access to federal spectrum, but it would not alter federal incentives or funding and lacks the degree of certainty that is typically necessary for substantial commercial investment.

The third option would permit federal spectrum users to sell or lease their spectrum rights and use the funds to build new systems or secure usage rights on commercial systems. This could be accomplished through the use of incentive auctions in some circumstances, though individually negotiated transactions between federal and commercial users would provide significantly more flexibility. This alternative would tend to reverse (by merging) the incentives discussed above: Federal users would face higher opportunity costs for reserving spectrum and lower opportunity costs for relinquishing it.

The third option also has the advantage of permitting multiple approaches to the issue of apportioning spectrum for federal and commercial uses. I expect that, even if government agencies were permitted to engage in secondary market transactions with commercial spectrum users, they would still prefer sharing on a non-interference basis in bands with unique requirements, which would accommodate additional spectrum for unlicensed uses. If it appeared that federal users still lacked sufficient incentives to improve the efficiency of their spectrum use, Congress would retain the option of creating a GSA-like agency to charge rents to federal spectrum users.

Permitting voluntary spectrum transactions between federal and commercial users would harness the power of market forces to put both commercial and federal spectrum to its highest and best uses. As FCC Commissioner Rosenworcel noted recently, “our federal spectrum policy needs to be built on carrots, not sticks.” Giving federal spectrum users an opportunity to negotiate a share in the benefits of repurposing federal spectrum would be a carrot worth pursuing.

The Department of Justice has suddenly reversed course from its previous findings that mobile providers who lack spectrum below 1 GHz can become “strong competitors” in rural markets and are “well-positioned” to drive competition locally and nationally. Those supporting government intervention as a means of avoiding competition in the upcoming incentive auction attempt to avoid these findings by highlighting misleading FCC statistics, including the assertion that Verizon owns “approximately 45 percent of the licensed MHz-POPs of the combined [800 MHz] Cellular and 700 MHz band spectrum, while AT&T holds approximately 39 percent.”

Sprint Nextel Corporation (Sprint Nextel) recently sent a letter to the Federal Communications Commission (FCC) signed by Dick Thornburgh, a former US Attorney General who is currently of counsel at K&L Gates, expressing his support for the ex parte submission of the Department of Justice (DOJ) that was recently filed in the FCC’s spectrum aggregation proceeding. The DOJ ex parte recommends that the FCC “ensure” Sprint Nextel and T-Mobile obtain a nationwide block of mobile spectrum in the upcoming broadcast incentive auction. In his letter of support on behalf of Sprint Nextel, Mr. Thornburgh states he believes the DOJ ex parte “is fully consistent with its longstanding approach to competition policy under Republican and Democratic administrations alike.”

Mr. Thornburgh is mistaken. The principle finding on which the DOJ’s new recommendation is based – that the FCC should adopt an inflexible, nationwide restriction on spectrum holdings below 1 GHz – is clearly  inconsistent with the DOJ’s previous approach to competition policy in the mobile marketplace. Both the FCC and the DOJ have traditionally found that there is no factual basis for making competitive distinctions among mobile spectrum bands in urban markets, and the DOJ has distinguished among mobile spectrum bands only in rural markets.

In its 2006 complaint against the merger of Alltel and Western Wireless, the DOJ found that, in rural markets with relatively low population densities, it cost more to achieve broad mobile coverage using 1.9 GHz PCS spectrum, which made it less likely that providers with PCS spectrum would deploy in those markets. Based on that finding, the DOJ concluded that additional mobile entry would be difficult in certain rural markets in which the combined firm would own all available 800 MHz Cellular spectrum – the only mobile spectrum below 1 GHz that was available on a nationwide basis at that time.

In that same merger proceeding (I was the FCC Chairman’s wireless advisor at the time), the FCC refused to adopt the DOJ’s rural market distinction and instead maintained its traditional view that spectrum bands above 1 GHz are suitable for the provision of competitive services in both urban and rural markets.

Although the DOJ continued to apply its rural market distinction in subsequent merger reviews ( i.e., Alltel/Midwest Wireless and AT&T/Dobson), it recognized that the distinction wasn’t reliably predictive in every rural market and was competitively irrelevant to nationwide competition. For example, in the 2008 Verizon/Alltel merger, the DOJ found that Verizon was a “strong competitor” in rural markets in which Verizon didn’t own any Cellular spectrum below 1 GHz, “because, unlike many other providers with PCS spectrum in rural areas, it has constructed a PCS network that covers a significant portion of the population.” Similarly, in its 2011 complaint against the proposed merger of AT&T and T-Mobile, the DOJ concluded that “T-Mobile in particular” was “especially well-positioned to drive competition, at both a national and local level,” in the mobile market even though T-Mobile owned very little spectrum below 1 GHz at that time.

The DOJ’s new recommendation is a sudden reverse in course from its previous findings that mobile providers who lack spectrum below 1 GHz can become “strong competitors” in rural markets and are “well-positioned” to drive competition locally and nationally.

The DOJ’s sudden reversal is particularly surprising given that the amount of spectrum below 1 GHz has increased substantially since the DOJ adopted its rural distinction in 2006. At that time, the 800 MHz Cellular band was the  only spectrum band below 1 GHz that was broadband-capable and fully available on a nationwide basis. Since then, two additional sub-1 GHz spectrum bands capable of supporting mobile broadband services have become available on a nationwide basis – the 800 MHz SMR and 700 MHz bands. Sprint Nextel owns nearly all of the 800 MHz SMR band nationwide, T-Mobile acquired 700 MHz spectrum through its acquisition of MetroPCS this year, and many rural and regional mobile providers own 800 MHz Cellular and 700 MHz spectrum in rural areas across the country.

Those supporting government intervention as a means of avoiding competition in the upcoming incentive auction attempt to avoid these facts by highlighting misleading FCC statistics, including the assertion that Verizon owns “approximately 45 percent of the licensed MHz-POPs of the combined [800 MHz] Cellular and 700 MHz band spectrum, while AT&T holds approximately 39 percent.” This statistic is misleading in two respects.

First, this statistic  excludes the 800 MHz SMR band, which is owned almost exclusively by Sprint Nextel. Excluding an entire spectrum band below one gigahertz from the statistical calculation creates the misleading impression that Verizon and AT&T hold a higher percentage of mobile spectrum below 1 GHz than they actually do.

Second, the FCC’s “MHz-POPs” methodology is weighted by population, which skews the resulting percentage of spectrum ownership significantly higher for companies that own spectrum in densely populated urban areas. A hypothetical using this methodology to calculate the percentage of “MHz-POPs” in the Cellular Market Areas (CMAs) covering the State of New York demonstrates just how skewed this methodology can be in the spectrum aggregation context.

Assume that “Company A” and “Company B” both own spectrum “Block X” (i.e., both companies own the same amount of spectrum in absolute terms) in different geographic areas in New York State. Specifically, assume that “Company A” owns “Block X” in geographic license area CMA001 (covering New York City and Newark, New Jersey), and “Company B” owns the same spectrum block in the other sixteen CMAs, including all six rural license areas in the state. If their spectrum holdings are calculated using the FCC’s population-weighted “MHz-POPs” methodology, “Company A” holds 70 percent of the “Block X” spectrum and “Company B” holds only 30 percent. (For an explanation of this methodology, see the “Technical Appendix” at the bottom of this post.)

As this example demonstrates, analyzing the percentage of spectrum mobile providers hold on a nationwide basis using the FCC’s “MHz-POPs” methodology is particularly misleading given the DOJ’s determination that spectrum below 1 GHz is competitively relevant only in sparsely populated rural areas. For example, if the FCC were to adopt a rule prohibiting any one mobile provider from holding 50% or more of the spectrum below 1 GHz in New York State on a “MHz-POPs” basis, “Company A” would be in violation of the rule even though it holds spectrum in  only 1 market and doesn’t hold any spectrum in rural markets.

When the 800 MHz SMR band is included and spectrum holdings are evaluated on a market-by-market basis, at least four different mobile providers hold spectrum below 1 GHz in most markets – a result that wasn’t even possible in 2006 (absent nationwide spectrum disaggregation on the secondary market) when the DOJ adopted its rural distinction.

Mr. Thornburgh’s broad statements about the DOJ’s past approach to competition policy generally and the FCC’s skewed statistics are not legitimate, data-based substitutes for a detailed analysis of DOJ precedent and current spectrum holdings below 1 GHz in both urban and rural markets. A detailed analysis indicates that the DOJ’s new recommendation is  not “fully consistent” with its previous approach to competition in the mobile marketplace, though it is consistent with a desire to rig the spectrum auction to favor certain competitors.

Technical Appendix

The FCC calculates “MHz-POPs” by multiplying the megahertz of spectrum held by a mobile provider in a given area by the population of that area.

The FCC also weights spectrum holdings by population using a “population-weighted average megahertz” calculation. The FCC calculates the nationwide “population-weighted average megahertz” of a mobile provider by dividing that provider’s “MHz-POPs” (as calculated above) by the US population.

The calculations for the New York State example in this blog post use “Cellular Market Areas,” which consist of Metropolitan Statistical Area (MSA) and Rural Service Area (RSA) licenses as defined by the FCC in Public Notice Report No. CL-92-40, “Common Carrier Public Mobile Services Information, Cellular MSA/RSA Markets and Counties,” DA 92-109, 7 FCC Rcd. 742 (1992). The population figures are from the 2000 U.S. Census, U.S. Department of Commerce, Bureau of the Census.

This post is a parody of “ Dialogue Concerning the Two Chief World Systems ” written by Galileo Galilei in 1632, which attempted to prove that the earth revolves around the sun (the Copernican system). Although the Copernican system was ultimately proven to be scientifically correct, Galileo was convicted of heresy and his book was placed on the Index of Forbidden Books for more than two hundred years.

Galileo’s book was written as a dialogue between three characters, Salviati, who supported Galileo’s view, Simplicio, who believed the universe revolves around the earth (the Ptolemaic system), and Sagredo, an open-minded person with no established position. In this parody, Salviati supports the use of actual or de facto guard bands between broadcast and mobile services, Simplicio supports the FCC’s competing guard band proposals in the 600 MHz and 700 MHz bands, and Sagredo remains open-minded.

INTERLOCUTORS

Salviati, Sagredo, Simplicio

SALVIATI. We resolved to meet today and discuss the differences in the FCC’s approach to the potential for harmful interference between broadcast and mobile services in the 600 MHz band on the one hand and the lower 700 MHz band on the other.

To prevent harmful interference between broadcast and mobile services in the 600 MHz band, the FCC has proposed separating these services with guard bands in which neither service would be allowed to operate. To make this easier to understand, let us use this tablet to illustrate the FCC’s proposed 600 MHz band plan and other such matters as they arise during our discussion.

The FCC adopted a very different approach to this issue in the 700 MHz band. Rather than require a spectral guard band between broadcast and mobile services, the FCC created geographic exclusion zones to protect broadcast services from the potential for harmful interference from mobile services in the lower 700 MHz A Block.

The FCC considered imposing additional limitations to protect mobile services in the A Block from broadcast services in Channel 51, but ultimately decided to provide A Block licensees with the flexibility to account for harmful interference through their own business plans, services, and facilities.

As a result, the 3GPP defined two LTE band classes for paired spectrum in the lower 700 MHz band:

• Band Class 17, which uses the A Block as a de facto guard band separating mobile services in the lower 700 MHz B and C Blocks from broadcast services in Channel 51; and

• Band Class 12, which has no guard band.

A group of A Block licensees subsequently filed a petition asking the FCC to initiate a rulemaking proceeding to require that all devices operating on paired commercial spectrum in the 700 MHz band be capable of operating on all paired frequencies in the band and also to suspend authorization of 700 MHz devices that are incapable of operating on all such frequencies. Last year the FCC initiated a rulemaking proceeding to evaluate whether the lower 700 MHz B and C Blocks would experience harmful interference, and to what degree, if the FCC were to impose an interoperability mandate.

It would appear that the FCC has since answered the first question, whether eliminating the  de facto guard band in 3GPP Band Class 17 would cause harmful interference, by proposing 6 MHz guard bands between broadcast and mobile services in the 600 MHz band.

SIMPLICIO. The 600 MHz band uses different frequencies than the 700 MHz band, and different frequencies have different characteristics. The FCC has often adopted different rules for different frequency bands. If the potential for harmful interference between broadband mobile services were similar in both bands, the FCC would not have omitted that fact.

SAGREDO. You might at least add, “if it had occurred to the FCC to consider the question.” If the FCC were to consider it, could the FCC plausibly conclude that the potential for harmful interference between broadcast and mobile services is substantially different in the 600 MHz band?

SALVIATI. Your question seems to me most excellent. Though I grant that the FCC adopts spectrum rules on an ad hoc basis, I feel no compulsion to grant that the arbitrary distinctions of FCC process confer legitimacy on question of physics. Whether the potential for harmful interference is substantially the same in the 600 MHz and 700 MHz bands is a question amenable to answer only by demonstrative science, not speculation regarding past FCC actions and current omissions.

Neither the FCC nor the industry has adduced any evidence that the potential for harmful interference varies substantially between the 600 MHz and 700 MHz bands. To the contrary, the available evidence indicates that the potential for harmful interference in these bands is substantially similar due their relatively close proximity within the electromagnetic spectrum and the fact that the phenomena responsible for interference between broadcast and mobile services are not frequency dependent.

SIMPLICIO. I do not mean to join the number of those who are too curious about the mysteries of physics. But as to the point at hand, I reply that licensees in the A Block are asking the FCC to impose an interoperability mandate for competitive reasons. AT&T, who owns spectrum in the lower 700 MHz B and C Blocks, has deployed only Band Class 17, which excludes the A Block. Licensees in the A Block must use Band Class 12, which is not supported by AT&T. That is preventing A Block licensees from taking advantage of AT&T’s economies of scale for purchasing devices and roaming on its network. This seems to be conclusive evidence that AT&T excluded Band Class 12 from its B and C Block devices to raise the costs of its rivals, a form of anticompetitive behavior.

SAGREDO: I do not claim to comprehend the mysteries of physics, but I have some knowledge of the laws governing competition. The law does not penalize a company merely for being successful in the marketplace – it prohibits only anticompetitive behavior that is “unreasonable” or “wrongful.” The fact that AT&T’s decision to deploy Band Class 17 may incidentally raise its rivals’ costs is irrelevant if AT&T had legitimate business reasons to make that decision.

SALVIATI. Exactly so, which brings us full circle. Whether AT&T had legitimate reasons to deploy Band Class 17 depends on the laws of physics. If deploying Band Class 12 has the potential to cause harmful interference to the B and C Blocks, AT&T’s decisions to deploy Band Class 17 cannot be considered anticompetitive.

SIMPLICIO. What about the expectations of the A Block licensees? Band Class 17 was not proposed to the 3GPP until after the 700 MHz auction was completed. It seems legitimate to me that the FCC honor their expectation that all licensees would deploy Band Class 12.

SALVIATI. Another question answers yours. Did the FCC require or even encourage the deployment of interoperable devices in the 700 MHz band?

SIMPLICIO . You already know the answer. The FCC clearly said licensees could make their own determinations respecting the services and technologies they deploy in the band so long as they comply with the FCC’s technical rules. What does that have to do with the expectations of the A Block licensees?

SALVIATI. It demonstrates that the ostensible expectations of the A Block licensees were unreasonable. The FCC’s rules clearly gave B and C block licensees the absolute right to eschew deploying Band Class 12, and it was reasonably foreseeable that B and C Block licensees would exercise that right given the potential for harmful interference inherent in Band Class 12. Based on the FCC’s rules, the ostensible expectation of the A Block licensees is more reasonably categorized as a blind hope or a calculated risk. On average, the A Block licensees paid less than half the price the B Block licensees paid for the same amount of spectrum. If the B Block licensees had decided to deploy Band Class 12, the A Block licensees would have enjoyed access to maximal economies of scale while the B Block licensees suffered from the same interference potential at twice the price. If not, the A Block licensees knew that they could still deploy Band Class 12 on their own at half the price.

SIMPLICIO. You say the A Block licensees could still deploy Band Class 12 systems in their spectrum, but they say they cannot deploy without AT&T’s help. Why should I favor your position over theirs?

SALVIATI. Experience proves my position is correct. US Cellular, one of the A Block licensees who petitioned the FCC in this matter, has already deployed Band Class 12 in its A Block spectrum.

SAGREDO. I cannot without great astonishment – I might say without great insult to my intelligence – hear it said that something cannot be done that has already been done. I submit that I am better satisfied with your discourse than that of the A Block licensees in respect to the competitive and economic issues. But my knowledge is insufficient to reach my own conclusion regarding the physics. Perhaps AT&T was acting unreasonably when it chose to use the A Block as a de facto guard band to protect its operations in the C and B Blocks from harmful interference.

SALVIATI. That is the question Simplicio dreads. He knows that, if the FCC answers that question in the affirmative, it cannot establish guard bands in the 600 MHz band. The law governing the 600 MHz band provides that “guard bands shall be no larger than is technically reasonable to prevent harmful interference between licensed services outside the guard bands.” It can hardly be technically reasonable to require a 6 MHz guard band in the 600 MHz band while finding it was technically unreasonable for AT&T to treat the 6 MHz A Block as a de facto guard band given the evidence that the interference potential is substantially the same.

SAGREDO. Let us close our discussions for the day. The honest hours being past, I think Simplicio might like to contemplate this question during our cool ones. Tomorrow I shall expect you both so that we may continue the discussions now begun.

” . . . the cooperative process envisioned by the National Broadband Plan is at risk of shifting to the traditionally contentious band plan process that has delayed spectrum auctions in the past.”

The National Broadband Plan proposed a new way to reassign reallocated spectrum. The Plan noted that, “Contentious spectrum proceedings can be time-consuming, sometimes taking many years to resolve, and incurring significant opportunity costs.” It proposed “shifting [this] contentious process to a cooperative one” to “accelerate productive use of encumbered spectrum” by “motivating existing licensees to voluntarily clear spectrum through incentive auctions.” Congress implemented this recommendation through legislation requiring the FCC to transition additional broadcast spectrum to mobile use through a voluntary incentive auction process rather than traditional FCC mandates.

Among other things, the FCC’s Notice of Proposed Rulemaking initiating the broadcast incentive auction proceeding proposed a “lead” band plan approach and several alternative options, including the “down from 51” approach. An overwhelming majority of broadcasters, wireless providers, equipment manufacturers, and consumer groups rejected the “lead” approach and endorsed the alternative “down from 51” approach. This remarkably broad consensus on the basic approach to the band plan promised to meet the goals of the National Broadband Plan by accelerating the proceeding and motivating voluntary participation in the auction.

That promise was broken when the FCC’s Wireless Bureau unilaterally decided to issue a Public Notice seeking additional comment on a variation of the FCC’s “lead” proposal as well as a TDD approach to the band plan. The Bureau issued this notice over the objection of FCC Commissioner Ajit Pai, who issued a separate statement expressing his concern that seeking comment on additional approaches to the band plan when there is a “growing consensus” in favor of the “down from 51” approach could unnecessarily delay the incentive auction. This statement “peeved” Harold Feld, Senior Vice President at Public Knowledge, who declared that there is no consensus and that the “down from 51” plan would be a “disaster.” As a result, the cooperative process envisioned by the National Broadband Plan is at risk of shifting to the traditionally contentious band plan process that has delayed spectrum auctions in the past.

Consumer groups, including Public Knowledge, acknowledged the consensus

Mr. Feld’s “pique” with Commissioner Pai’s view that the “down from 51” approach had become the “consensus framework” for the 600 MHz band plan is surprising. According to Mr. Feld, Sprint, Microsoft, and the Public Interest Spectrum Coalition (PISC) objected to the “down from 51” approach. As support for this position, Mr. Feld cited reply comments filed by the PISC, a coalition that includes, among others, Public Knowledge.

Contrary to Mr. Feld’s assertion, however, the PISC reply comments  support Commissioner Pai’s view. The PISC reply comments expressly state that there is a “consensus in favor of a 51-down band plan with a duplex gap,” which is “supported as technically superior by virtually all major industry commenters.”

To be sure,  after Commissioner Pai issued his statement, Mr. Feld met with the Wireless Bureau to state for the record that there is no consensus support for the “down from 51” approach. Prior to that meeting, however, Public Knowledge had not expressed that view.

Why has Mr. Feld suddenly become so vehemently opposed to the “down from 51” approach?

“Down from 51” would not reduce revenue

Mr. Feld claims that the “down from 51” approach embraced by the broadcasters and “so many carriers and equipment manufacturers” would be an “absolute disaster” for that very reason – i.e., most of the industry supports it. In Mr. Feld’s view, the fact that the overwhelming majority of industry participants support the “down from 51” approach is evidence that they are “colluding” to reduce auction revenue.

Although the service rules and auction revenue are to some extent interdependent, insofar as band plans are concerned, wireless providers have far greater incentives to promote spectral and operational efficiency than to reduce auction prices. The costs of building and operating wireless networks are significantly higher than the one-time costs of acquiring spectrum at auction, and consumer demand for wireless broadband capacity is rapidly increasing. Given these facts, no rational wireless provider has an incentive to promote a band plan designed to reduce auction revenue.

In any event, Mr. Feld’s theory that the “down from 51” approach could reduce revenue by making too much spectrum available is irrelevant to the band plan issue. Even assuming his theory is correct, the FCC’s other proposed approaches to the band plan, none of which “cap” the amount of spectrum that would be accepted in the reverse auction, would run the same risk. Similarly, Mr. Feld’s proposed solution of limiting the amount of spectrum accepted in the reverse auction could be applied to any approach to the band plan, including “down from 51.”

“Down from 51”  is not anticompetitive

Mr. Feld claims that the “down from 51” approach is anticompetitive because, in his view, wireless providers that lack spectrum below 1 GHz “are the only ones capable of using the downlink spectrum, and even then only if they bid exclusively on the supplementary downlinks.” According to Mr. Feld, this means such providers will bid only on the downlink spectrum and leave the paired spectrum to Verizon and AT&T even though, in his view, providers that lack spectrum below 1 GHz are the ones that “most need” uplink spectrum.

Of course, if this were true, it would be irrational for any wireless provider to join Verizon and AT&T in supporting the “down from 51” approach. Yet, T-Mobile, the only nationwide provider that lacks nationwide spectrum below 1 GHz, is a signatory to the “Joint Accord” supporting the “down from 51” approach, an approach that is also supported by rural and regional providers.

Given the current state of the record, a finding based on Mr. Feld’s hypothesis would require the FCC to assume that wireless providers generally behave irrationally when developing band plans – an assumption so absurd it would fail even the most deferential application of the  Chevron standard for judicial review.

“Down from 51” is not inefficient

Mr. Feld claims the “down from 51” approach is spectrally inefficient because it “maximizes the total number of guard bands” while retaining a duplex gap.

To the contrary, the “down from 51” approach proposed by the FCC would require the  minimum total number of guard bands while retaining a duplex gap: one.

If enough spectrum is cleared to place the guard band adjacent to Channel 37 as proposed by T-Mobile, the “down from 51” approach would also minimize the amount of spectrum that must be allocated to guard bands. This specific version of the “down from 51” approach would require a total of only 4 MHz of guard band spectrum while providing 10 MHz of protection against interference (6 MHz in Channel 37 plus an additional 4 MHz yielded by broadcasters in the reverse auction).

In comparison, the “down from 51 reversed” approach proposed by the Wireless Bureau in the Public Notice would require at least  two guard bands.

If the FCC intends to maximize spectral efficiency by minimizing the total number of guard bands, it will not adopt the “down from 51 reversed” approach proposed by the Wireless Bureau. That is why the FCC proposed to place the 600 MHz uplink band adjacent to the lower 700 MHz uplink band in the “lead” proposal in its Notice of Proposed Rulemaking.

A TDD approach is inefficient

Mr. Feld claims that a “down from 51 TDD” approach would make “maximum use” of spectrum above Channel 37 because it would eliminate the duplex gap required for FDD deployments. He neglects to mention, however, that a TDD approach would require an additional guard band that would be the same or substantially similar in size to the FDD duplex gap in the “down from 51″ approach. Compare the FCC’s “down from 51” approach with the Wireless Bureau’s “down from 51 TDD” approach:

As I’ve noted previously, the switching times inherent in LTE TDD systems also produce latency and reduce coverage – issues that would be exacerbated in rural deployments in the 600 MHz band. LTE TDD operates in two modes: a 10-millisecond mode (more latency, but more coverage) and a 5-millisecond mode (less latency, but less coverage). In the 10-millisecond mode, LTE TDD is generally not suitable for the streaming applications that stress mobile networks the most (e.g., video chat applications). In the 5-millisecond mode, LTE TDD is generally suitable for streaming applications, but suffers from significantly reduced coverage. According to Qualcomm, in a coverage-limited system using the same frequency, TDD requires 31 to 65 percent more base stations than FDD to maintain the same throughput.

This doesn’t mean that TDD technologies have no role to play in the wireless marketplace. In the absence of channel aggregation opportunities, TDD is the only choice when paired spectrum is unavailable. It can also be used to enhance capacity when coverage is not the delimiting factor.

The primary driver behind LTE TDD deployment generally, however, appears to be Chinese industrial policy, not spectral efficiency. After China’s TDD-based SCDMA technology failed to gain traction internationally, it focused its efforts on developing a TDD version of LTE that would be backward compatible with its SCDMA standard and expand China’s technological influence globally. As a result, China became the primary promoter of the LTE TDD standard and a major owner of the standard’s essential patents (i.e., Huawei states that it leads the world in essential LTE patents). Based on likely deployment scenarios in the 600 MHz band, an FCC-mandated TDD approach would benefit Chinese patent holders, not American consumers.

The Public Notice Should Not Have Been Issued by the Bureau

Finally, Mr. Feld accused Commissioner Pai of “poisoning” the rulemaking process by calling attention to the Wireless Bureau’s disregard for his role as a Commissioner. Mr. Feld portrayed the Public Notice as a routine matter, but as a former Chief of the Wireless Bureau, I know that Bureaus do not circulate routine items to the Commissioners. A Bureau typically circulates an item to the Commissioners with a waiting period only when its authority to issue the item at the Bureau-level is unclear. If a Commissioner objects to the issuance of the item at the Bureau level, established practice requires that it be submitted to the Commission for a vote.

In my experience, the Bureau’s decision to ignore Commissioner Pai’s objection was, at a minimum, a serious breach of comity and established protocol. If anything “poisoned” the process in this instance, it was the Bureau’s insistence on issuing a Public Notice on authority delegated to it by the Commission over the objection of a Commissioner.

Conclusion

The surest path to “disaster” in this proceeding is for the FCC to take the incentives out of the incentive auction. The Bureau’s insistence on pushing an approach that most broadcasters, wireless providers, and equipment manufacturers don’t support is more likely to deter participation in the auction than incent it. It is the industry – not the Wireless Bureau – that ultimately must agree to risk its capital in the auction and deploy new wireless infrastructure. If the Wireless Bureau’s preferred approach wins and, as a result, the industry declines to participate in the auction, everyone loses.

This week at CTIA 2013, FCC Commissioner Jessica Rosenworcel presented ten ideas for spectrum policy. Though I don’t agree with all of them, she articulated a reasonable vision for spectrum policy that prioritizes consumer demand, incorporates market-oriented solutions, and establishes transparent goals and timelines. Commissioner Rosenworcel’s principled approach stands in stark contrast to the intellectually bankrupt incentive auction recommendation offered by the Department of Justice last month.

Commissioner Rosenworcel clearly defines three simple goals for a successful incentive auction:

• Raising enough revenue to support the nation’s first interoperable, wireless broadband public safety network;
• Making more broadband spectrum available through policies that are attractive to broadcasters; and
• Providing fair treatment to those broadcasters who do not wish to participate in the auction.

All three goals are consistent with consumer demand for wireless broadband services, the market-oriented reassignment of broadcast spectrum envisioned by the National Broadband Plan, and the will of Congress.

In comparison, the DOJ’s recommendation focuses on only one goal: Subsidizing two particular companies – Sprint Nextel and T-Mobile – to ensure they obtain spectrum in the auction. The DOJ claims these subsidies are necessary to promote competition. But, there is a substantial difference between fair government policies that promote competition generally and a policy of favoring foreign-owned companies over their domestic competitors.

Unfortunately, the DOJ is not alone in its belief that bestowing government benefits on favored companies is a legitimate goal in a free society. Some members of the House Commerce Committee believe the DOJ’s past merger reviews provide “a solid factual and analytical basis” for its current recommendation to the FCC.

The fatal flaw in this theory is that the DOJ’s recommendation to the FCC is inconsistent with the factual findings and analysis of the DOJ in its past merger reviews. As I’ve noted previously, in its complaint against the AT&T/T-Mobile merger, the DOJ found that, “due to the advantages arising from their scope and scale of coverage,” Sprint Nextel and T-Mobile are “especially well-positioned to drive competition” in the wireless industry. That finding doesn’t provide any factual or analytical basis whatsoever to conclude that Sprint Nextel and T-Mobile require special government treatment in the incentive auction in order to compete with Verizon and AT&T.

That’s why the DOJ recommendation relies on an irrational and discriminatory presumption that Verizon and AT&T are using spectrum less efficiently than Sprint Nextel and T-Mobile. A speculative presumption doesn’t require the DOJ to admit its own deceit. It merely requires audacity.

In an era when government officials routinely revise the facts to suit their preferred outcomes and disclaim responsibility for the actions of the agencies they’re charged with leading, Commissioner Rosenworcel’s speech required intellectual bravery and political courage. Her ideas deserve a fair hearing.

Frontline relied on the DOJ foreclosure theory to predict that the lack of eligibility restrictions in the 700 MHz auction would “inevitably” increase prices, stifle innovation, and reduce the diversity of service offerings as Verizon and AT&T warehoused the spectrum. In reality, the exact opposite occurred.

The DOJ recently recommended that the FCC rig the upcoming incentive auction to ensure Sprint Nextel and T-Mobile are winners and Verizon and AT&T are losers. I previously noted that the DOJ spectrum plan (1) inconsistent with its own findings in recent merger proceedings and the intent of Congress, (2) inherently discriminatory, and (3) irrational as applied. Additional analysis indicates that it isn’t supported by economic theory or FCC factual findings either.

Economic Theory

The Phoenix Center published a paper with an economic simulation that exposes the fundamental economic defect in the foreclosure theory underlying the DOJ recommendation. The DOJ implicitly recognizes that the “private value” of spectrum (the amount a firm is willing to pay) equals its “use value” (derived from using spectrum to meet consumer demand) plus its “foreclosure value” (derived from excluding its use by rivals). In its application of this theory, however, the DOJ erroneously presumes that Verizon and AT&T would derive zero use value from the acquisition of additional spectrum – a presumption that is inconsistent with the FCC findings that prompted the auction.

The Phoenix Center notes that  all firms – including Sprint Nextel and T-Mobile – derive a foreclosure value from the acquisition of spectrum due to its scarcity. When considering the benefits to consumers, it is the comparative use value of the spectrum for each provider that is relevant. If the use value of the spectrum to Verizon and AT&T exceeds that of Sprint Nextel and T-Mobile, economic theory says Verizon and AT&T would maximize the potential consumer benefits of that spectrum irrespective of its foreclosure value.

Of course, determining the differing use values of spectrum to particular firms is what spectrum auctions are for, which brings the DOJ’s argument full circle: If government bureaucrats at the DOJ and the FCC could accurately assess the use values of spectrum, we wouldn’t need to hold spectrum auctions in the first place.

The circularity of the DOJ theory explains its reliance on an unsubstantiated presumption that Sprint Nextel and T-Mobile have the highest use value for the spectrum. If the DOJ had instead (1) conducted a thorough factual investigation, (2) analyzed the resulting data to assign bureaucratic use values for the spectrum to each of the four nationwide mobile providers, and (3) compared the results to determine that Verizon and AT&T had lower use values, the DOJ would have engaged in the same failed “comparative hearing” analysis that Congress intended to avoid when it authorized spectrum auctions. Given the Congressional mandate to auction spectrum yielded by the broadcasters, the FCC cannot engage in a comparative process to pick winners and losers, and it certainly cannot substitute an unsubstantiated presumption for an actual comparative process in order to avoid the legal prohibition.

FCC Factual Findings

The foreclosure theory and DOJ presumption are also inconsistent with the auction experience and current factual findings of the FCC. The DOJ foreclosure theory has been presented to the FCC before and has proved invalid by the market.

When the FCC was developing rules for the 700 MHz auction in 2007, Frontline Wireless sought preferential treatment using the same foreclosure theory as the DOJ. Frontline submitted a paper (prepared by Stanford professors of economics and management) that relied on the same types of information and reached the same conclusion as the DOJ – that Verizon and AT&T were dominant “low-frequency” wireless incumbents with “strong incentives” to acquire and warehouse 700 MHz spectrum, and that their participation in the 700 MHz auction must be limited in order to “promote competition” and prevent “foreclosure.” Frontline predicted that, if Verizon and AT&T were not prevented from bidding in the 700 MHz auction, it would “inevitably lead to higher prices, stifled innovation, and reduced diversity of service offerings.”

The FCC rejected Frontline’s foreclosure theory. The FCC concluded that, “given the number of actual wireless providers and potential broadband competitors, it [was] unlikely that [incumbents] would be able to behave in an anticompetitive manner as a result of any potential acquisition of 700 MHz spectrum.”

The last five years have proven that the FCC was correct. Though Verizon and AT&T acquired significant amounts of unfettered 700 MHz spectrum, the auction results have not led to the “higher prices, stifled innovation, and reduced diversity of service offerings” predicted by Frontline. In its most recent mobile competition report, the FCC reported that:

• Verizon used its 700 MHz spectrum to deploy a 4G LTE network to more than 250 million Americans less than four years after Verizon’s 700 MHz licenses were approved (i.e., it didn’t warehouse the spectrum).

• Mobile wireless prices declined overall in 2010 and 2011, and the price per megabyte of data declined 89% from the 3^rd quarter of 2008 – a few months before Verizon received its 700 MHz licenses – to the 4^th quarter of 2010 (i.e., industry prices decreased).

• The number of subscribers to mobile Internet access services more than doubled from year-end 2009 to year-end 2011 (i.e., industry output increased).

• Prepaid services are growing at the fastest rate, and new wholesale and connected device services are growing significantly (i.e., providers continued to provide new and diverse service offerings).

• Market concentration has remained essentially unchanged since 2008 (the population weighted average of HHIs increased from 2,842 in 2008 to 2,873 in 2011 – a change of only 1 percent).

Remember: Frontline relied on the DOJ foreclosure theory to predict that the lack of eligibility restrictions in the 700 MHz auction would “inevitably” increase prices, stifle innovation, and reduce the diversity of service offerings as Verizon and AT&T warehoused the spectrum. In reality, the exact opposite occurred. Verizon and AT&T did not warehouse the spectrum, industry prices decreased while output increased, diverse new service offerings exhibited the strongest growth, and market concentration remained essentially unchanged. And, while competition thrived, consumers reaped the benefits.

So, why would the DOJ make the same failed argument for the 600 MHz auction (other than crony capitalism)? Some might say, “Even the boy who cried wolf was right once.” But, even if one were inclined to give the DOJ the benefit of the doubt, the theoretical possibility that the foreclosure theory could adversely impact the 600 MHz auction must be weighed against the potential harm of limiting participation in the auction.

The harm is well documented and could prove particularly problematic in this auction. A paper coauthored by Leslie Marx, who led the design team for the 700 MHz auction when she was the FCC’s Chief Economist, demonstrates that excluding Verizon and AT&T would have even more severe consequences in the incentive auction than in previous auctions.

A paper published by economists at Georgetown University’s Center for Business and Public Policy attempts to quantify the severity of these consequences. It estimates that excluding Verizon and AT&T from the auction could reduce revenues by as much as 40 percent ($12 billion) – a result that would jeopardize funding for the nationwide public safety network, reduce the amount of spectrum made available for wireless Internet services, and adversely affect more than 118,000 U.S. jobs. That is a steep price to pay for the privilege of seeing whether the boy is crying wolf again.

As the “real-world” continues its inexorable march toward our all-IP future, the FCC remains stuck in the mud fighting the regulatory wars of yesteryear, wielding its traditional weapon of bureaucratic delay to mask its own agenda.

Late last Friday the Technology Transitions Policy Task Force at the Federal Communications Commission (FCC) issued a Public Notice proposing to trial three narrow issues related to the IP transition (the transition of 20^th Century telephone systems to the native Internet networks of the 21^stCentury). Outgoing FCC Chairman Julius Genachowski says these “real-world trials [would] help accelerate the ongoing technology transitions moving us to modern broadband networks.” Though the proposed trials could prove useful, in the “real-world”, the Public Notice is more likely to discourage future investment in Internet infrastructure than to accelerate it.

First, the proposed trials wouldn’t address the full range of issues raised by the IP transition. As proposed, the trials would address three limited issues: VoIP interconnection, next-generation 911, and wireless substitution. Though these issues are important, the FCC proposals omit the most important issue of all – the transition of the wireline network infrastructure itself. As a result, they would yield little, if any, data about the challenges of shutting down the technologies used by the legacy telephone network.

Second, the proposed trials are unlikely to yield significant new information. As Commissioner Pai noted in his statement last week, all three issues are already being trialed in the “real-world” by the industry, consumers, and state regulators.

Finally, and perhaps most importantly, all three issues are already the subject of ongoing FCC proceedings and don’t raise any new issues (e.g., issues that would implicate FCC regulatory forbearance).

If the FCC truly wanted to accelerate the transition to all-IP infrastructure, why would it propose studies of three limited issues that it is already addressing? I expect the FCC was unwilling to propose a comprehensive trial that could jeopardize its assertion of regulatory jurisdiction over the Internet, especially its potential authority to impose Title II regulations if it loses the net neutrality case pending in the DC Circuit. The language in the Public Notice indicates it is no coincidence that the narrow issues the FCC intends to study do not implicate its forbearance authority or (at least directly) the scope of its jurisdiction. For example, the Public Notice states that VoIP interconnection involves, among other things, “pricing” and “quality of service” issues, and that the FCC wants to structure any trial to provide it with “data to evaluate which policies may be appropriate” for VoIP interconnection. This language clearly indicates that the FCC is contemplating Title II pricing regulation of VoIP interconnection.

The Public Notice also seeks additional comment on the more comprehensive approach to the IP transition originally proposed by Commissioner Ajit Pai in July 2012, but in a way that sends all the wrong signals to investors.

When Commissioner Pai proposed the establishment of a Task Force for the IP transition nine months ago, his intent was the removal of regulatory barriers to infrastructure investment, including unpredictability at the FCC. He suggested that the FCC send a clear signal that new IP networks built in competitive markets will not be subject to “broken, burdensome economic regulations” designed for monopoly telephone networks.

Last Friday’s Public Notice does just the opposite. It signals that even the worst excesses of legacy telephone regulation are still an option for the Internet. Specifically, the Public Notice “invites” telephone companies that are interested in comprehensive trials to submit a comprehensive plan listing, at a minimum:

(1) all of the services currently provided by the carrier in a designated wire center that the carrier would propose to phase out; (2) estimates of current demand for those services; and (3) what the replacement for those services would be, including current prices and terms and conditions under which the replacement services are offered.

It is telling that none of these enumerated questions are aimed at the potential technical issues posed by the IP transition (which is a forgone conclusion economically). They are aimed at economic issues relevant to the FCC’s traditional Title II price regulation of communications services.

In the nine months since Commissioner Pai began leading the IP transition, the FCC has signaled nothing more than its intent to continue bureaucratic business as usual. As the “real-world” continues its inexorable march toward our all-IP future, the FCC remains stuck in the mud fighting the regulatory wars of yesteryear, wielding its traditional weapon of bureaucratic delay to mask its own agenda. There it will remain until the FCC has a Chairman with a vision for the future, not the past.

If broadband Internet infrastructure had been built to the same extent as public water-supply systems , more than twice as many Americans would lack fixed broadband Internet access.

After abandoning the “information superhighway” analogy for the Internet, net neutrality advocates began analogizing the Internet to waterworks. I’ve previously discussed the fundamental difference between infrastructure that distributes commodities (e.g., water) and the Internet, which distributes speech protected by the First Amendment – a difference that is alone sufficient to reject any notion that governments should own and control the infrastructure of the Internet. For those who remain unconvinced that the means of disseminating mass communications (e.g., Internet infrastructure) is protected by the First Amendment, however, there is another flaw in the waterworks analogy: If broadband Internet infrastructure had been built to the same extent as public water-supply systems, more than twice as many Americans would lack fixed broadband Internet access.

Advocates who would prefer that the government (whether local, state, or federal) own and operate the Internet often use the lack of broadband access in rural America as a justification. They point to an FCC report finding that 19 million Americans (6% of the population) lack access to a fixed broadband network and that less than 1% of Americans lack access to a mobile broadband network. Government broadband advocates fail to acknowledge, however, that more than twice as many Americans lack access to public water-supply systems. According to the most recent report from the US Geological Survey,* 43 million Americans (14% of the population) lack access to public water-supply systems and instead must self-supply their own water (e.g., they have to drill a well on their property).

Self-supplied water systems are common in rural areas and neighborhoods that lie outside the jurisdictional boundaries of a municipality. The Virginia Department of Health notes that the “majority of households in 60 of Virginia’s 95 counties rely on private water supply systems” and that in “52 counties, the number of households using private wells is increasing faster than the number of households connecting to public water supply systems.” For example, my neighborhood in northern Virginia, which is served by two fixed broadband providers and several mobile broadband providers, has no access to a public water-supply system. In my neighborhood, every homeowner must drill their own well (at a cost ranging from $3,500 to over $50,000 depending on geological conditions and local regulations).

The jurisdictional limitations of municipal water-supply systems can be overcome by self-supply in most areas of the United States because the value of a water system to a particular household is not directly increased by interconnecting it with another water system. In contrast, the Internet is a network of networks (the term “Internet” was shortened from internetwork) that exhibits both positive and negative direct network effects – i.e., its value for all users is affected by the addition of new users or content to the internetwork. By definition, an individual homeowner cannot self-supply Internet access without interconnecting with at least one other network.

This fundamental difference between waterworks and the Internet is critical to understanding why state legislatures often treat municipal waterworks differently than municipal broadband networks. In addition to the First Amendment issues that are involved when local governments own and control the primary means of mass communications, many states have recognized the potential for municipal broadband networks to result in a form of “cherry picking.” If every municipality built its own broadband network, substantial portions of most states would still lack access to broadband, but the ability of private broadband network operators to profitably serve those areas would likely be reduced. As noted above, public water-supply systems cover significantly less population than private broadband networks.

Of course, advocates who would prefer that the government own and operate the Internet typically don’t mention the jurisdictional limitations of municipalities or the potential impact of municipal broadband networks on citizens who don’t live in a municipality. Some of these advocates actually imply that cronyism must be the primary motivation for state legislation governing municipal broadband networks. Fortunately, state legislators representing citizens who lack access to municipal services have a better understanding of the needs of their citizens than some urban lobbyists and bureaucrats living in Washington.

*                      *                      *

*Note that the broadband data in the FCC report is current through mid-2011, and the public water-supply data in the US Geological Survey report is current only through 2005. The US Geological Survey releases its water use reports every five years, but does not intend to release its 2010 water use report until fiscal year 2014. Based on previous trends, however, it is unlikely that the percentage of Americans who have access to public water-supply systems has increased significantly in the last six years, if at all. The percentage of Americans that self-supplied their water dropped only three percentage points in the twenty-year period from 1985 (17%) to 2005 (14%).