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Competition

by on September 15, 2010 · 0 comments

I’m in front of a non-TiVo-enabled television this evening, which has permitted me to see ads for a search site called YP.com. It’s a rebranded YellowPages.com, affiliated with AT&T, and it’s organized to be a search engine for the things in your life—dining, travel nightlife—distinguished from Google’s utilitarian-tech web search. Meanwhile Microsoft’s Bing has overtaken Yahoo! as the number two search engine. I was surprised to learn that “undisputed search king” Google has only 65 percent of the search market. Google is doing well, of course, but it can’t be comfortable with all these well-funded rivals circling it.

This is good news for consumers. These competitors are driving Google to improve, and they can pull consumers away from Google by serving search niches such as lifestyle search (as YP does), more privacy protective search, and so on. Competitors will threaten and cut into Google’s advertising profits, too.

Television ads also remind us that HughesNet is offering broadband Internet via satellite. It’s mostly aimed at moving rural Internet users off of dial-up, but it’s an outlet for consumers anywhere who are unsatisfied with cable or DSL service. Critics will point out that it’s not very fast, kind of expensive, and includes daily usage caps. But this doesn’t deny HughesNet’s role as competition for cable and DSL.

Internet service provided badly enough by the major ISPs would make satellite broadband a viable competitor. If HughesNet’s investors were confident that they could sign up enough customers, they would make the investments that bring satellite broadband to the economy of scale it needs to be price-, speed-, and usage-competitive.

The spur of competition does not have to pierce the horse’s belly to have its effect.

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Cable Franchise Deregulation and Broadband Deployment

by on May 5, 2010 · 3 comments

A recent study by Cecil Bohanon and Michael Hicks at Ball State University’s Digital Policy Institute found that statewide cable franchising has increased broadband deployment.

Half of the US states have now enacted legislation that creates statewide cable franchising. These laws allow new entrants into the video business (principally the phone companies) to get permission to offer video from the state, instead of having to deal with local governments to get cable franchises. Previous research, much of it cited here, found that cable competition reduces cable rates and expands the number of channels available to subscribers. Local franchising often delayed or prevented new competitors from entering the market.

Since the same wires get used to transmit video, telephone, and broadband, Bohanon and Hicks reasoned that opening up entry into cable would also increase competition in broadband and hence increase broadband subscribership. And that’s precisely what their econometric study finds. After controlling for other factors, broadband subscribership is 2-5 percent higher in states that have statewide video franchising. Based on this finding, Bohanon and Hicks estimate that statewide video franchising increased broadband subscribership by about 5 million.

Their study covers the years 1999-2008. Maybe some of these 5 million would eventually have gotten broadband anyway. At worst, this study shows that 5 million subscribers got broadband sooner than they otherwise would have.

The study does not test whether the increase in broadband subscribership occurred because statewide video franchising sped up investment and deployment of infrastructure, or if it simply spurred competition in places where phone and cable companies already had the relevant infrastructure deployed.  I don’t know how one would get the confidential data on broadband investment in order to test this.  But given the large amount of new investment related to broadband, I’d be willing to bet that statewide franchising encouraged both new broadband deployment and more intense competition where infrastructure was already in place.

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Shortcuts That Don't Save Time

by on April 29, 2010 · 0 comments

The Washington Post carried an article earlier this week by Cecilia Kang that noted the Federal Trade Commission could gain enforcement power over online businesses as a result of the financial services legislation under discussion in Congress. Ms. Kang contrasted the possibility of an empowered FTC issuing fast-track regulations against the recent experience of the Federal Communications Commission, which has become bogged down in its search for legal authority to issue net neutrality regulations. 

The comparison is insightful, but not for the reasons you might expect. Part of the debate over the FTC revolves around language in the House financial services bill that would repeal the “Magnuson-Moss” provisions that govern FTC promulgation of consumer protection regulations. (The name comes from the fact that these restrictions on FTC rulemaking were included in the Magnuson-Moss Warranty Act, which got the FTC into the business of regulating car warranties.)

If the FTC wants to regulate some type of general business practice under the FTC Act, it has to establish a factual record substantiating that there is actually a systemic problem that regulation can solve, hold a public hearing, allow cross-examination on factual matters, and conduct an economic analysis of the regulation’s effects.  In short, the commission has to do the homework necessary to demonstrate that its proposed regulation will actually solve a widespread problem that actually exists.

When Tim Muris directed the FTC’s Bureau of Consumer Protection in the early 1980s, he authored an article in Regulation magazine pointing out that when the FTC does careful analysis before issuing a rule, the rule is more likely to benefit consumers, more likely to be upheld in court, and more likely to be issued expeditiously. He contrasted the evidence-based eyeglass rule, which took three years to issue, with the anecdote-based funeral rule, which took ten. Muris noted wryly, “Some critics of my position charge that it is revolutionary to ask a body of lawyers and economists not to impose its own view of proper regulation on the world without first systematically evaluating the problem.” Muris went on to serve as chairman of the FTC between 2001-04, and last month he defended the Magnuson-Moss restrictions in testimony before Congress.  

What does this have to do with the FCC?  The FCC lost its case against Comcast on appeal, precisely because the FCC tried to take shortcuts. The FCC tried to promote net neutrality by enforcing a set of “principles” that originated in a former chairman’s speech and were never promulgated in a notice-and-comment rulemaking. The FCC commissioners endorsed these principles without investigating whether there was a systemic problem (ie, more than a few anecdotes of misbehavior). Indeed, Chairman Martin’s Notice of Inquiry on “Broadband Industry Practices” that was launched around the same time the FCC took its enforcement action against Comcast turned up no evidence of a systemic problem. If the FCC now tries to impose net neutrality by reclassifying broadband as a “Title II” common carrier, it will have to do the difficult but necessary work of demonstrating, with real factual evidence, that broadband is more like a common carrier than like the lightly-regulated “information service” the commission previously decided it was.

We don’t need Congress to free the FTC from Magnuson-Moss. Instead, Congress should impose the same requirements on the FCC. Sometimes, taking the time to do your homework leads to better decisions, sooner.

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The Sideways, Alcoholic Commerce Clause

by on April 21, 2010 · 1 comment

Wine (and beer) lovers who want to order hard-to-get vintages online have benefited greatly from federal court decisions that say state alcohol laws cannot discriminate against out-of-state sellers. Federal legislation introduced last week could threaten electronic commerce as it further entrenches middlemen who normally profit from every bottle of alcohol that passes from producers to consumers.

To understand what’s going on, you have to know something about Commerce Clause litigation. I’m not a lawyer, though I once played the teetotaling William Jennings Bryan character in a high school production of Inherit the Wind.  This proves my motives are pure. And since a lot of lawyers practice economics without a license, I figure I’ll return the favor.

The Commerce Clause of the US Constitution says that Congress, not the states, can regulate interstate commerce. A longstanding judicial interpretation, the “dormant” Commerce Clause, holds that if Congress has not chosen to regulate some aspect of interstate commerce, that means Congress doesn’t want the states to regulate it either.  So, normally a state can regulate interstate commerce only if Congress has given explicit permission.

If state law discriminates against out-of-state sellers who compete with in-state sellers, the state is regulating interstate commerce.  A state is not allowed to do this unless it can prove the discrimination is necessary to accomplish some clear state purpose that cannot be accomplished in some other way. States have to present evidence that proves these points, not just make arguments. 

The 21st Amendment, which repealed Prohibition, gave states the right to regulate alcohol.  Recent court cases involving direct wine shipment clarified that when states regulate alcohol, they must still obey the Commerce Clause. This makes good sense. Imagine if the 21st Amendment freed states from the rest of the Constitution when they regulate alcohol. The police could break into your house without warning if they imagined you might give your 20-year-old a beer, but they’d still need a search warrant if they thought you were cooking meth. 

In Granholm v. Heald (2005), the Surpeme Court said that states could either allow in-state and out-of-state sellers to ship wine directly to consumers, or prohibit it for both, but states couldn’t ban direct shipment for out-of-state sellers and allow it for in-state sellers. In response, most states have liberalized their direct shipment laws rather than making them more restrictive. In Family Wine Makers of California v. Jenkins (2008), federal courts said that an ostensibly neutral law that had a discriminatory effect on out-of-state sellers was also unconstitutional. Massachusetts had enacted a law that allowed only wineries producing 30,000 gallons or less to ship directly to consumers; the production cap was large enough to allow all in-state wineries to direct ship but small enough to exclude 637 larger out-of-state wineries that produce 98 percent of all wine in the United States.  The judge’s opinion essentially said, “By their fruits you shall know them,” and it reserved special grapes of wrath for the blatantly protectionist motives voiced by advocates of the law. Massachusetts appealed this decision to the First Circuit Court of Appeals, lost, and on April 12 decided not to appeal to the Supreme Court.

On April 15, Massachusetts Rep. Bill Delahunt introduced federal legislation that would turn alcoholic Commerce Clause litigation sideways. The legislation makes four big changes in the rules of the game:

  1. It says that states may not “facially discriminate without justification.” This standard might reverse Granholm, because the state laws were clearly discriminatory but the states offered justifications. It would likely reverse Family Wine Makers, because the law was “facially” neutral but had discriminatory effects. (Of course, if this thing passes, I’d be delighted to see a consumer or winery plaintiff prove me wrong.)
  2. It repeals the “dormant” Commerce Clause for alcohol by stating that congressional silence on interstate commerce in alcohol should not be interpreted as a prohibition on state regulation of interstate commerce in alcohol.
  3. It shifts the burden of proof by requiring that anyone challenging a state alcohol law must prove “by clear and convincing evidence” that the law is invalid. Normally, states have the obligation to present evidence that a discriminatory law accomplishes a state purpose and is no more discriminatory than necessary.  
  4. Any state law that burdens interstate commerce or contradicts any other federal law (!) would be upheld unless the person challenging it proves that the state law has no effect on temperance, orderly markets, tax collection, the structure of the distribution system, or underage drinking.  Since there’s plenty of economic evidence that state alcohol laws increase prices, a state could argue its laws reduce consumption and promote temperance, and the law would be upheld.  In other words, any state alcohol law that harms consumers by increasing prices would automatically be OK, even if it blatantly conflicted with other federal laws (such as antitrust laws, which are intended to protect consumers from the high prices associated with monopoly) or the Commerce Clause.

Word on the street is that the biggest pushers of this legislation are the beer wholesalers. Since most of this litigation has involved wine, what’s going on here?

The real goal of this legislation is not harrassing wineries that want to ship a few bottles to out-of-state customers. The real goal is to preserve anti-competitive state laws that force brewers, wine makers, and distillers to market most of their product through beer, wine, and spirits wholesalers, instead of marketing directly to retailers and restaurants. The proposed legislation would effectively insulate these state laws from challenge under the Commerce Clause, federal antitrust laws, or any other federal laws that might give alcohol producers and consumers some leverage to break the wholesalers’ lock on the market.

Call it states’ rights kool-aid with a chaser of economic protectionism.  A strange brew indeed.

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Broadband and Title II Regulation: An Economic Primer

by on April 16, 2010 · 4 comments

Last week the D.C. Circuit Court of Appeals ruled that the Federal Communications Commission cannot impose net neutrality rules on broadband providers under its “ancillary jurisdiction” under the Communications Act.  If it wants to impose net neutrality, the FCC must first reverse previous decisions and reclassify broadband as a “Title II” common carrier.

Whoa!  The previous two sentences prove that this economist has been spending way too much time around telecom lawyers.

In almost-plain English, the court decision means the FCC cannot impose net neutrality regulations unless it publicly changes its five-headed mind and decides that broadband is much like an old-fashioned telephone monopoly and should be regulated much the same way. 

A lot of regulatory economists pretty much gag at this idea, or worse. Non-economists wonder what triggers this visceral reaction.

Let me explain.  As the recipient of 8 years of excellent Jesuit education, of course I have three reasons.

First, anyone who follows the scholarly literature on economic regulation generally knows that this form of regulation has a pretty checkered track record. In a wide variety of industries, economic regulation has increased prices, inflated costs, stunted innovation, and/or created shortages. In addition, because this regulation transfers enormous amounts of wealth — $75 billion annually in the case of federal telecommunications regulation — it creates enormous incentives for firms to lobby and litigate to bend the rules in their favor. While big corporations may feel they benefit from these expenditures, from a society-wide perspective the fight over wealth transfers is pure waste because it rarely produces anything of value for consumers. 

Utility regulation works best in relatively stangant industries where a company makes a big capital investment, pays a few employees to run it, and doesn’t need to innovate much.  In those kinds of situations, it’s easier for regulators and other outsiders to determine costs, set some rates that let the utility earn a reasonable rate of return, and keep the regulated company from gaming the system too much. If you think this describes broadband, well, good luck. A local water utility is probably the best example.

Second, anyone knowledgeable about the economic theory underlying utility regulation (which includes most economists who specialize in the area, and some lawyers) understands that regulation is supposed to be a last resort for “natural monopoly” industries where it’s cheaper to have one firm serve the entire market. A monopolist protected from competition could increase prices, degrade service, or do other things that increase its profits while harming consumers; economic regulation seeks to prevent those behaviors. But if competition is possible, competition is preferable. 

When phone, cable, wireless, and satellite companies bombard us continually with solicitations to switch to their broadband services, and I can see multiple wires running down the street outside my house when I go up on the roof to adjust the satellite dish, it’s pretty darn obvious that broadband is NOT a natural monopoly, even if competition isn’t “perfect.”  Therefore, broadband lacks a key prerequisite for public utility regulation to possibly increase consumer welfare.  Indeed, the most anti-consumer results of economic regulation have occurred when government created monopolies, cartels and/or shortages by imposing this regulation on industries where competition is possible, such as cable TV, trucking, railroads, airlines, oil, and natural gas.

Third, recent economic studies find that the FCC’s decision to classify cable, DSL, and fiber broadband as a less-heavily-regulated “information service” generated a tsunami of investment and spurred competition. See, for example, this study by my GMU colleagues Thomas Hazlett and Anil Caliskan. Some more cites are available on pp. 17-18 of this comment to the FCC. If you don’t believe economic studies, just keep in mind that the aggressive marketing of dirt-cheap entry-level DSL tracks pretty closely with the FCC’s decision that DSL is an information service not subject to Title II regulation.  Coincidence?

So, please excuse those of us regulatory economists who vomit when the subject of Title II comes up. If you check out the links above, perhaps the reaction will be more understandable.

I have not addressed the question of whether it’s realistic to think that reclassification of broadband under Title II could be a workable mechanism to impose just a limited, targeted, surgical, light-handed, smart, data-driven, evidence-based, transparent, transformative, sustainable, green, hybrid, itsy bitsy teenie weeny yellow polka-dot bikini smidgen of net neutrality regulation to prevent only certain forms of anti-consumer discrimination, without imposing the customary broad panpoly of public utility price and service regulation. Whether that’s possible in theory, or likely in real-world political practice, is a different issue for a different day. (Whether the other name for that kind of regulation is “antitrust” is also a different  issue for a different day.) For the moment, I just wanted to provide some context on the broader Title II issue.

And now I’ll go clean off my shoes.

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FCC Releases Executive Summary of Broadband Plan

by on March 15, 2010 · 0 comments

The FCC today released an executive summary of its National Broadband Plan, which is supposed to be delivered to Congress tomorrow.  Of course, executive summaries by their nature are brief and usually don’t explain the underlying logic and evidence supporting the conclusions. Here are a few highlights, some possible interpretations, and things to look for when the full plan gets released tomorrow:

Recommendation: “Undertake a comprehensive review of wholesale competition rules to help ensure competition in fixed and mobile broadband.” This could signal that the FCC plans to re-impose “unbundling” or “line sharing” regulations, which would require broadband companies to let competitors use their lines and other facilities at regulated rates. Such initiatives would likely undermine broadband deployment and investment.  Economic research by my GMU colleague Tom Hazlett and others finds that broadband investment, competition, deployment in the US took off only after the FCC eliminated line-sharing requirements. Christina Forsberg and I summarized a lot of this research here.

Recommendation: “Make 500 Mhz of spectrum available for broadband within ten years … Enable incentives and mechanisms to repurpose spectrum.” This is a fantastic recommendation. A Mercatus Center review of the costs of federal telecommunications regulations found that federal spectrum allocation, which prevents spectrum from being reallocated to uses that consumers value highly (like broadband), is by far the costliest federal regulation affecting telecom and the Internet. This recommendation indicates the FCC leadership would like to auction a lot more spectrum and share the proceeds with existing users (like broadcasters) in order to overcome resistance to reallocation. It’s not quite a market in spectrum, but it might be the closest the FCC can come.

Recommendation: “Broaden the USF contribution base to ensure USF remains sustainable over time.” Uh-oh. I’m not sure what this means, but if means that broadband subscribers will have to start payng into the FCC’s universal service fund (USF), watch out! Most economic studies find that consumer demand for broadband is very price-sensitive. That means if the FCC slaps broadband with universal service fees (which currently exceed 10 percent), we’ll see a big drop in broadband subscribership — maybe by 4-7 million subscribers. This is , of course, precisely the opposite of what the FCC wants to accomplish!

Recommendation: “Reform intercarrier compensation, which provides implicit subsidies to telephone companies by eliminating per minute charges over the next ten years…” Another excellent idea.  “Intercarrier compensation” refers to payments phone companies make when they hand traffic off to each other. Small, rural phone companies usually receive the highest per minute payments — as much as 15-30 cents per minute! This is a huge markup on long-distance phone service — another price-sensitive service!

Recommendation: Provide subsidies so that rural areas can have broadband with download speeds of 4 MB.  It will be interesting to read in the full plan where this 4 MB figure came from. Does it reflect the speed of service that a lot of Americans currently have, so these subsidies are just supposed to help equalize opportunities for rural residents? Or does it reflect some balancing of the costs and benefits of subsidizing broadband in rural areas?  Or is this a magic number experts believe subscribers need, regardless of the choices consumers actually make in the marketplace and regardless of what it costs?

The executive summary also lists a set of goals, such as ensuring that every American has the ability to subscribe to “robust” broadband service, having 100 million households with access to 100 MB broadband, and ensuring that the US has the fastest and most extensive wireless networks of any nation.  When the full plan comes out, look carefully at whether or how the FCC plans to measure accomplishment of these goals.  More importantly, look to see whether the FCC explains how it will quantify how much its own policies actually contribute to these goals over time. The FCC is famous for NOT doing these kinds of things, so let’s see if the broadband plan signals a new era in accountability.

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Broadband as a Public Utility

by on February 23, 2010 · 2 comments

Debate over the regulatory status of broadband heated up this week as trade associations and major broadband companies sent a letter to the Federal Communications Commission arguing strenuously against reclassification of broadband as “telecommunications service” subject to regulation under Title II of the Communications Act. One implication of Title II regulation is that broadband could be regulated like a public utility. Comparisons of broadband to services like electricity or railroads, which I discussed last week, also raise the prospect of public utility regulation. 

Classic public utility regulation restricts entry and regulates prices to prevent firms from charging excessive prices.  It’s typically used in situations where competition is believed to be impossible (or, where pre-existing policy decisions have created monopolies that aren’t going to go away very soon).

Broadband is not a monopoly; it is an oligopoly. Contrary to popular perception, that is not synonymous with “evil.” Although both monopoly and oligopoly end in “-opoly,” that doesn’t mean broadband competitors will charge monopoly prices, or even somewhat excessive prices.  The only firm conclusion that emerges from economic literature on oligopoly is, “anything’s possible, depending on the specific facts and circumstances.”

But there are also firm conclusions that emerge from economic literature on public utility regulation.  Just about every time the federal government has tried to impose public utility regulation on an oligopoly, it has ended up enforcing a cartel.  This is what happened in the past with railroads, trucking, airlines, and brokerage firms. There are a few times federal price regulation did not enforce cartels in oligopolistic or competitive industries. In those cases, it usually created shortages  — most notably gasoline and natural gas in the 1970s.

Title II regulation is not necessarily synonymous with public utility regulation. Title II could be used to impose some “nondiscrimination” requirements, without necessarily directly regulating broadband providers’ prices or profits.

But anyone who actually wants the FCC to regulate broadband providers’ prices and profits needs to read the peer-reviewed economics literature on the actual effects of public utility regulation in practice on the federal level. (More literature is cited here.) Then they need to explain why the results in broadband would be different.  And the explanation needs to be better than “We know better now, we’re smart, and we promise.”

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Competition and patience

by on February 22, 2010 · 2 comments

Until recently, Amazon and its Kindle were the only real e-reader game in town. This allowed them to force on publishers an arguably arbitrary (and low) price of $9.99 for bestsellers. With the introduction of Apple’s iPad, however, publishers now have a viable competitor to which they can defect. The result will likely be higher e-book prices in the near term, and this has prompted some point out that this is a case where more competition resulted in higher prices for consumers.

The key phrase in the previous paragraph, however, is “near term.” It’s interesting to see that five years after it began offering video in the iTunes store, Apple is apparently pushing TV producers to lower their prices by half from $1.99 an episode to 99¢. Market processes–especially those surrounding new technology and distribution channels–can be less than instantaneous, but they have a way of ultimately conforming to economic reality.

Reporting on the ongoing negotiations with Apple, the New York Times says, “Television production is expensive, and the networks are wary of selling shows for less.” But the economic reality they’re missing is that TV production is a fixed cost, and as my friend Tim Lee has pointed out many times, the marginal cost of digital distribution is basically zero. As a result, I wouldn’t be surprised if five years from now, we’ll see Apple badgering book publishers to cut their prices in half.

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Railroading Broadband?

by on February 18, 2010 · 0 comments

FCC Chairman Julius Genachowski’s comparison of broadband with electricity in a speech this week has generated mixed reviews in the blogosphere. Manny Ju says that this shows Genachowski “gets it” — that he understands the transformational power of broadband and how it will come to be regarded as a ubiquitous necessity in the years ahead. Scott Cleland is more alarmed: “The open question here is electricity transmission is regulated as a public utility. Is the FCC Chairman’s new metaphor intended to extend to how broadband should be regulated?”

It may surprise some technophiles, but this kind of discussion even predates electricity. The advent of the railroads in the 19th century brought similar arguments.  Railroads were usually a heck of a lot cheaper way of hauling goods and people across land than the next best alternative at the time: wagons. Railroads were “The Next Big Thing” that no town could do without — especially if the town lacked access to navigable waters. Lawmakers handed out subsidies (often in the form of land grants), then regulated railroads to control perceived abuses, such as discriminatory pricing for different kinds of traffic or traffic between different locations. Henry Carter Adams, the godfather of economic regulation in the U.S., said all shippers deserved “equality before the railroads.” Even today, commentators lament the rural towns that people abandoned because they lacked rail access. Deja vu all over again! 

As long as we’re deja-vuing, let’s remember a few little problems America encountered down the railroad regulatory track:

  1. Subsidies created “excess capacity” — that is, more capacity than customers were willing to pay for. In some cases, subsidies attracted shady operators into the railroad business whose main goal was to get land grants or sell diluted stock offerings to the public, not build and operate railroads. 

  2. Regulation ended up caretlizing railroads and propping up rail rates, which faced downward pressure because of the excess capacity.

  3. When another low-cost, convenient alternative (trucking) came along in the 1930s, truckers got pulled into the cartel when they too were placed under Interstate Commerce Commission regulation to keep them from undercutting rail rates.

  4. Despite cartelization, by the late 1970s, 21 percent of the nation’s railroad track was operated by bankrupt railroads, even though the railroads had shed unprofitable passenger service to Amtrak earlier in the decade. Part of the reason was excessive costs: Because access to freight rail service was still considered a right, regulation prevented railroads from abandoning money-losing lines. Part of the reason was restraints on competition: The regulatory passion for “fair” pricing kept railroads from competing aggressively with each other or with truckers. When the Southern Railway introduced its 100-ton “Big John” grain hopper cars in the 1960s, for example, it couldn’t offer shippers lower rates in exchange for high volume until it appealed an Interstate Commerce Commission all the way to the Supreme Court.

By the late 1970s, a Democratic president, a bipartisan majority in Congress, and economists across the political spectrum agreed that railroad regulation needed a radical overhaul. Regulatory reforms made it easier for railroads to abandon unprofitable service, in many cases turning track over to new, lower-cost short lines and regional railroads. Prices for more than 90 percent of rail traffic were effectively deregulated. At the same time, Congress deregulated rates and entry on interstate trucking routes. This encouraged rail-truck competition and also allowed each mode to specialize in serving those markets it could serve at lowest cost.

Rail rates fell, and railroads came out of bankruptcy. The current system is hardly perfect, but most economic research suggests that most consumers, shippers, and railroads are much better off now than they were under the old regulatory system.  (For reviews of scholarly research on this, check out Clifford Winston’s paper here  or my article here.)

Will we repeat the cycle with broadband? I don’t know, but to this railfan, the current broadband debate is looking soooo retro — as in 19th century!

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Regulatory Whack-A-Mole, Part II

by on January 21, 2010 · 0 comments

Congress and the Federal Communications Commission periodically get upset over wireless phone early termination fees. The latest uproar has occurred during the past couple months in response to Verizon’s doubling of the early termination fee on “smart” devices. The fee falls by $10 per month, leaving s $120 early termination fee in the last month of a two-year contract.

Policymakers still have not gotten the message that they cannot really do much about this “problem” unless they comprehensively regulate wireless rates and terms of service. (I would not recommend this, since a competitive wireless market has brought us rate reductions that even perfectly-functioning regulation would be unlikely to achieve. ) Attempts to poke and prod early termination fees are like the carnival game “whack-a-mole.”  As soon as you whack one mole with a stick, another one pops up out of another hole.

Sen. Amy Klobuchar (D-MN) is taking another whack.  In 2007, she introduced legislation requiring wireless companies to prorate early termination fees “in a manner that reasonably links the fee to recovery of the cost of the device or other legitimate business expenses.”  Coincidentally, the major carriers promised to prorate their fees at about the same time her bill got a hearing.  Then last November, up popped a mole from Verizon’s hole. Early termination fees for smart devices are prorated, but doubled. Now the good senator is whacking away at that mole with legislation that requires wireless companies to prorate early termination fees AND mandates that the early termination fee cannot exceed the size of the subsidy the carrier is giving the consumer on the phone.

Smart whack, huh?  Doesn’t cost-based regulation of early termination fees eliminate the loophole (oops, mole-hole)?

Not necessarily. In the first place, the legislation could create an accounting nightmare with plenty of opportunities for companies to game the system, especially if they offer different subsidies on different phones. Recall that the original impetus for breaking up the old AT&T landline monopoly was that AT&T was gouging consumers by charging them inflated prices to lease equipment manufactured by its subsidiary, Western Electric. With the AT&T breakup, the government essentially gave up on managing that problem and completely prohibited the monopoly local phone companies from manufacuring equipment. I think George Santayana just left me a voice mail. Even if the game board is restricted to early termination fees, we’ll soon see uglier, nastier moles emerge from uglier, nastier holes.

But the wireless phone contract is about more than early termination fees. Even if policymakers succeed in imposing effective,  cost-based regualtion on early termination fees, wireless companies can still change other terms of the contract to compensate for any revenue losses. The law must have a truly long arm to reach the diverse array of rodents that will scurry forth from diverse orifices.

Stay tuned for the next whack.

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