Commentators in the US are jumping up and down about the wrong thing when they talk about putting a stop to handset exclusives, and by characterizing the recently revealed Department of Justice (DoJ) investigation as about handset exclusivity it shows they have a complete misunderstanding of how these things work. The news of a DoJ Telecommunications general investigation broke in the Wall Street Journal this week but was mostly tied to complaints about the AT&T iPhone exclusivity deal.
Very simply this is about the backlash after the ‘Big Money’ loving administration of Bush, brought on by a relatively sane and balanced administration that is not intent on doing favors for the rich and famous.
AT&T as it is today is more or less an abomination which should have been killed at birth, in anti-trust terms. We all knew that at the time it was suggested ‘ the tripartite merger of the long distance and enterprise business of AT&T, with SBC and Bellsouth ‘ because those of us old enough to remember how those businesses came about, know it was because AT&T agreed with the US government to unravel an earlier consent decree, by getting rid of its 22 local operating companies in 1984. They almost immediately became 7 major operating companies, an act that across the US separated long distance from local phone activity, allowing AT&T to chase what it thought were bigger opportunities in information technology, the internet and open systems.
Without putting too fine a point on it AT&T screwed those opportunities, along with almost every investment it made post 1984. It got into Unix computers, bought NCR and sold it again. It spun off Lucent, which in turn spun of Avaya, before its merger with Alcatel. It created AT&T Broadband from buying TCI, MediaOne, Prime Cable and some cable areas from Comcast ‘ then sold the whole lot back to Comcast after disastrous mismanagement ‘ a deal that in itself has made a dangerous US cable leader, which today is scaring the modern AT&T. AT&T then got permission to go back into the phone business using VoIP and finally gave up the ghost and allowed itself to be acquired by SBC.
So over the last 25 years AT&T was shown that it cannot operate without local operating phone businesses, and that model of separation failed. In a way, SBC rescued the remnants of AT&T and in the process got control of the biggest and best set of US wide backhaul lines imaginable.
Those original 22 Bell operating companies had become Ameritech, Bell Atlantic, BellSouth, Nynex, Pacific Telesis, Southwestern Bell (which became SBC) and US West, plus a few companies that AT&T kept ownership in, Cincinnati Bell and Southern New England Telephone. Eventually through more mergers they became Qwest, which nobody wants to own, Verizon and SBC, which has now changed its name to that of its new subsidiary, AT&T.
In effect this means that all the operating companies were separated from the long lines business, and now 11 of them are remerged with it. We are almost, but not quite, back where we were in 1984, but a number of other moves by SBC have meant that the fixed line business is even less competitive.
Through government campaigns and threats and counter threats AT&T has killed off network neutrality laws, it has introduced packet sniffing and said openly that it wants to charge the Google’s of this world for ‘preferential’ treatment over its network (which the FCC has said it cannot do) and it has also said it wants to continue sniffing all packets on its network (which are almost all US packets) for evidence of intellectual property theft.
At the same time AT&T had up until 2005 completely failed to invest in fiber or its local networks until it got a rock solid concession out of the FCC that it would not have to share most of its networks and that even if it did, the FCC would not be able to set a price for such CLEC connectivity. In a single regulator affirmed strike it got rid of all of its CLEC rivals. Not through competition, but through control of connectivity pricing at the local exchange.
These maneuvers have left the US miles behind in broadband penetration ‘ something it is finding exceptionally hard to catch up with the rest of the world.
So we have the US standing out like a sore thumb globally, where instead of using connection at the local exchange as the basis for creating competition within telecommunications, it tried a geographical experiment which had been tried before and found wanting, and has now finally (though not completely) abandoned it.
So what has this got to do with AT&T having exclusive phone deals, you might ask? And we might answer, nothing at all. The telecommunications situation in the US is a grotesquerie, a back-water, a system that has gone wrong, a dead evolutionary line. And it went wrong not because telecommunications naturally leans towards a monopoly, a position that has long been ‘established fact’ in US folklore, but BECAUSE of inappropriate government intervention. The problem is what to do about it now. Does it need more government intervention to fix the monster it has made?
You may argue that the cellular businesses of both AT&T and Verizon, are not distorted by any of this. They may have had a little extra money to throw around due to their strong positions in US fixed telecommunications, and that may have led them to acquiring (and often not using) massive chunks of spectrum and other local cellular businesses.
But for once the US regulator accepted the industry position that spectrum caps will prevent monopoly in wireless, and lead to more effective competition, and so far that single barrier has kept US cellular markets competitive. But there remain problems.
The ownership of an extensive backhaul network makes it easier for AT&T to build out a cellular network and we know of no obligation for its backhaul services, used by almost all cellular networks in the US, to be charged out internally to AT&T Mobility, at the same rate it is charged to other players.
This means that as cellular grows AT&T can write its own check for backhaul connectivity and ensure its profitability. Of course there ARE other backhaul options and in many cases this makes AT&T competitive. But in other countries, particularly in Japan and Europe, and parts of the Asia Pacific, in order to keep backhaul pricing down, this is the sole point where regulators have intervened, valuing networks, collecting evidence of the cost of running such a network, and then setting maximum wholesale price limits.
This type of activity is anathema in the US. Telling a company what it can charge for its products goes against everything that is natural for a nation of entrepreneurs, but this was originally a US idea, one that AT&T has campaigned against with the FCC, and in US courts, to kill. But it is one which has worked outside of the US. Another way is to ensure that there are at least three sources of backhaul available across large swathes of the country and that, right now is the only thing that is keeping AT&T vaguely honest on backhaul pricing, the presence of a handful of rivals, including Sprint.
Neither are easy paths, and in some countries the incumbent has laid down protectionism hurdles (such as in Germany) which are corrosive of this type of strategy, and the regulator has to be given significant teeth with which to police this. It is not perfect, but it has been seen to work.
In fact although we feel that US has to get to grips with sharing of access lines and backhaul, as a country it has an opportunity to create something hugely beneficial to citizens, with open wireless networks and this brings us to the issue that has brought it all to light, the exclusive handset deals of AT&T and Verizon.
An exclusive of the nature of Apple and AT&T is only possible if the margin on data delivery is significant. Apple gets some of the data revenue that AT&T charges to customers, and yet this does not cut into the profitability of AT&T generally. If data services were a natural and open market, there would be little or no margin there to trade.
In the end the market’s response has been for other carriers to offer their own exclusives and for the world’s handset makers to copy both the iPhone device and its innovation of an App Store. This may not be enough due to the huge lead Apple has here, and that’s entirely down to its own bravery and innovation, but it may well be enough to settle the market down and eliminate much of the benefit of offering exclusives. In other words, all other things being equal, exclusives are short term market aberrations, which are self defeating. If Verizon carries through with its open access wireless promises and Android becomes a major platform, then everyone can take their phone to whichever network they fancy, and everyone will have access to Android class applications ‘ which should be roughly equivalent to Apple applications.
But we have heard promises of open access before from cellular operators and they tend to talk about it and then fail to deliver on it. If the US does deliver then we believe that before the Justice Department can gets its ducks in a row and actually come out with some form of correction for anything it perceives in the cellular or fixed line market, openness will have already supplied the remedy. If it doesn’t happen, then there will be a need for a decision from the Justice Department, followed up with policing by the FCC.
Remedies cannot go as far as getting AT&T once more to divest itself of local operating companies and be broken up. That’s been tried and it doesn’t work. In the same way it can’t really be forced to divest itself of its cellular network ‘ there’s not enough profit in the fixed line network on its own and would be denied the benefit from a full quadruple play. That would make the cable companies inordinately strong and that would be just as bad.
In effect the US has this one chance, where the dominance of AT&T (not monopoly, but dominance) has created a situation that consumers do not like ‘ the fact that a service is tied to a device and they have to take both together. This is what Apple has done ever since the invention of the iTunes Music Store in 2004 ‘ through the application of a simple digital rights management piece of software, it has tied a device to a service. People didn’t like it but they lived with it. Now it has tied a device to a set of services and tied that to an operator, and that has brought popular attention behind the fact that this is unnatural.
What consumers really want is some form of service neutrality law (like net neutrality) so that services cannot be tied to devices ‘ so iTunes and the Apple App Store cannot be tied to Apple devices, which in turn cannot be tied to the AT&T network. Similarly Nokia Ovi could not be tied to Nokia devices ‘ but then again Nokia doesn’t sign long term device exclusives with operators.
Another area is always going to be the emergence of VoIP and whether or not services like Skype can be banned on the AT&T network. It can be banned as part of contract negotiations with suppliers like Apple, for as long as there are exclusives in the mix. And Apple can just agree that it cannot use AT&T cellular connections to make Skype connections, only Wi-Fi.
We can see that both AT&T and Apple are proprietary in their nature and that throughout AT&T’s existence it has first used patent ownership, then government sponsored agreements and acquisition in order to gain ascendancy. It has never been very competitive. On multiple occasions, in the 1890s, again in the 1900s it used these types of tactics to eliminate rivals and the US government has always been its unwitting pawn in establishing a monopoly, against competition which has always been abundant and innovative. If you add to that the competitive design capabilities of Apple, then suddenly AT&T has the best of all worlds, and covers the gap it has always had in being genuinely competitive.
So this is not about enshrining everyone’s right to have an iPhone, although everyone will see it that way. This is about correcting the tendency of large telecommunications organizations to seek to carve out monopolies any way they can and government laying down just enough resistance to give other innovators a chance.
The Wall Street Journal says that this review that it revealed is in its early stages at the behest of the new Justice Department’s antitrust chief, Christine Varney, who wants to reassert the policing of anticompetitive behavior which wasn’t present in the Bush administration. This was always going to happen, and the Apple AT&T exclusive is simply a peg to hang it on.
Most commentators have said that you need a national monopoly to get the Justice Department involved, but market dominance in European Commission cases has been established on market shares as low as 33%, and if you take the operating area of AT&T and only measure how dominant it is in those states and regions, then you can view the US as two major monopolies, with something close to 60% dominance each, in AT&T and Verizon. So this idea of there being no dominance would not hold water against a determined legal assault.
The chances are that what we will actually have is a case of bluff and counter bluff. With the Justice Department sniffing around, it makes it easier for the FCC to get on and do its job, with less lobbying from the two biggest US telcos, and it takes resources and career breaking determination to bring an anti trust case in the US. Eventually there might be some ‘minor’ behavioral adjustments agreed by AT&T in particular, rather than going to war with a government that has its cards on the table, as against anti-trust. Otherwise the legal war that will be started will last more than the lifetime of this administration.
On the other hand AT&T’s nightmare scenario is 5 years of a government collecting evidence against it, and consulting on its position, followed by it winning another election and walking in and saying, ‘right we’ve done the preliminary work, now let’s go to war,’ with a fresh mandate and another five years to run. Either way, expect something to give.