Government Regulation

This paper has five parts: an introduction, a description of the industry and its key members, a description of public policies to date, and a prescription for public policy going forward. The second and third parts are revisions of the papers you submitted for Assignments 3 and 4. The modern voice communication industry can trace its early roots in 1876 from Alexander Graham Bell’s telephone, the first ever device that enabled people to verbally communicate over incredible amounts of land.

The industry has developed from devices like the early telephone to be a luxury, to what is today is an absolute necessity for the average person. Mobile phones have exploded and have begun to make the landline in some countries obsolete. “Smartphones” have become the common term for mobile phones with specific extra feature offerings such as text-based web browsing and a QWERTY keyboard. Because the smartphone is still relatively young and constantly being innovated, there is no clear consensus on how to define what phone is a smartphone or not.

The smartphone industry will be extremely significant as to how the entire voice communication industry’s landscape turns out. So, I will be evaluating the current structure of the smartphone market in the voice communication industry in the United States by analyzing which products should be included, the relevant geographic market, market structure, seller concentration, and barriers to entry. After developing an industry-wide analysis, I will look at the major public policies that have been influential, and then offer a prescription for public policy going forward.

Smartphone development has grown so rapidly over the past ten years that it has become difficult in deciding which of these cutting-edge phones from only a few years ago is still considered a smartphone. Additionally, cell-phone manufacturers still produce cell phones without many of the extra features such as a QWERTY keyboard or built-in camera. Even though there are many definitions of the various categories of mobile devices, I will separate them into three commonly used categories: “dumb-phones”, “feature-phones”, and “smartphones”.

Many times the dumb-phone and feature phone can be used synonymously, but I will define dumb-phone has a cell-phone with only phone call and texting capabilities. Many of these phones can be purchased pre-paid, like the LG Revere or Motorola A455-Rival. A feature phone however, is seen more as a mid-range device. Smartphones and feature phones have many overlapping characteristics, but I will define a feature phone as a mobile device without an advanced API (application programming interface), and typically highlighting one or two functions very well like music storage (Samsung Juke) or high quality photos (Nokia 808).

It is easy today to dismiss the feature phone as becoming obsolete, but in 2011, still 37% of the market share was feature phones and global smartphone penetration is still only at 27%. Smartphones will be defined as mobile devices with the following features: telephone calls, operation system, apps, web access, QWERTY keyboard, and messaging. All of these features have been a progression, as it was only recently that open-source apps have become a staple. It would not be surprising if within a couple years touch screen will be a basic definition of a smartphone as well.

Even though this is our current definition of a smartphone, we must consider other categories that will be considered part of the relevant product market. In order to determine which products are in the relevant market for smartphones, I will use cross product elasticity of demand. Cross product elasticity of demand is the change in demand for product due to a change in the price of another product. We can see the how large of a change in the price of a smartphone will change the demand of feature phones, for example, and if it is significant enough, then we must consider that product in the relevant market of smartphones.

It appears that price is one of the main reasons why people choose to purchase a smartphone over a feature phone. Galen Gruman cites a 2010 Google survey where “of those who didn’t buy a smartphone, 53 percent cited the high cost of data plans as the reason, while 28 percent concluded they didn’t need the features. Given the high price of smartphones and their data plans…they cost too much. ” It seems reasonable then, that if smartphones were to become cheaper, the demand for feature phones would decrease significantly.

And the current trend is moving in that direction, as smartphones innovation is in such high demand that once touted cutting-edge phone technology can become outdated in the span of a year. According to Gartner Inc. “Worldwide sales of mobile phones to end users reached almost 428 million units in the third quarter of 2012, a 3. 1 percent decline from the third quarter of 2011. Smartphones sales accounted for 39. 6% of total mobile phones sales” For the time being, feature phones will be considered part of the relevant market because it is seriously considered s a substitute for smartphones, but it does not seem like for too long. The relevant geographic market will be contained for the United States. The voice communication industry is harder to define by location because there are national operators along with cell-phone manufacturers. This is especially pertinent when public policy becomes involved because the U. S. government regulation for the cell phone industry is much different than in other countries. In the United States, there are four companies that offer nationwide service: Verizon Wireless, AT&T Mobility, Sprint Nextel, and T-Mobile USA.

Some of the notable mobile phone manufacturers are Apple, BlackBerry, HTC, LG, Samsung, amongst many others. Additionally, phone manufacturers have various commands of the market share The market structure for smartphones can be defined as an oligopoly. Some of the characteristics for an oligopoly are that the market is controlled by a small number of firms, and that the best response from firms is to take into consideration what the other major players are doing. In 2012, Samsung had 31. 8% of the United States mobile phone market share, Apple with 26. 2%, LG 12. 3%, and the other 29. % split up amongst all the other phone manufacturers. 12 Another way to look at the top firms in the United States could be the operation system share for smartphones; three months ending in January 2013, iOS had 45. 9% of the market share and Android with 49. 4%. 13 Even though the iOS operation system is unique to Apple, Android can be on many different smartphones so it is clearer to define seller concentration based on manufacturers.

According to NPD, the four firm concentration ratio for smartphones is 78% in the 1st quarter of 2012 (Apple with 29%, Samsung 24%, HTC 15%, Motorola 10%). 3 The Herfindahl-Hirschman Index for that same quarter was calculated to be approximately 1816. Public policy has been a chief influence on the voice communication industry as well, specifically for smartphones. Much of the regulation that takes place is accredited to the Federal Communications Commission. The FCC’s work includes “promoting competition, innovation, and investment in broadband services and facilities” and “supporting the nation’s economy by ensuring an appropriate competitive framework for the unfolding of the communications revolution” (FCC, 2013).

I will address the implications of Auction 73 and the Google campaigned openness regulations to see its effects on the landscape for the voice communications industry and analyze what could be done better. In 2008, the United States began to transition from analog to digital television broadcasts, where in 2009 the last analog station went off the spectrum air. Analog televisions previously occupied the 700 MHz spectrum and because of the Digital Television Transition, much of the spectrum was available (Stelter 2009). The FCC needed to reallocate the 700 MHz, so in 2008, the FCC began an auction licenses.

Since the spectrum can be used for radio and cellular coverage, most of the bidders were mobile wireless service providers. The frequency spectrum were separated into blocks, A through E, where if a minimum reserve is met, licenses will be awarded to the highest bidder. Verizon Wireless and U. S. Cellular were the main winners for Block A, AT&T for Block B, Verizon Wireless, Triad Broadcasting, and Small Ventures USA L. P. with 7, 2 and 1 licenses respectively for Block C, none sold for Block D, and EchoStar purchasing most of Block E. Almost $20 billion was raised from the auction for the U.

S. Treasury, and the vast majority of the money ($16. 3 billion) came from Verizon Wireless and AT&T. Interestingly enough, Sprint and T-Mobile decided not to participate in the auction (Reardon 2012). There were greater implications for the smartphone market after auction 73. It was very clear even before the auction happened that wireless providers wanted a piece of the 700 MHz in order to provide high-speed broadband networks. Cell phones with data services were becoming more and more popular as internet features on phones were steadily becoming more available.

In fact, the number of smartphone users in the U. S. has continued to grow, with 62. 6 million users in 2010 and 93. 1 million users in 2011(Gartner 2012); the increased speed in data services has made a strong contribution to the growth in smartphone users. Verizon Wireless released a statement after the Auction that the spectrum is a “critical piece of its overall broadband strategy to take advantage of the enormous opportunity for growth of data services in the future” (Higginbotham 2008).

In 2011, the Samsung Galaxy Indulge was actually the first LTE smartphone that was sold commercially. Since then, almost every smartphone has 4G capabilities, with downloading speeds comparable to broadband Wi-Fi speeds (Stern 2011). Even though the end consumer has benefited from Auction 73, it is still unclear as to how the competitiveness of the market structure has improved. In regards to Auction 73, Congress released a statement on goals: “In designing auctions for spectrum licenses, the FCC is required by law to meet multiple goals and not focus simply on maximizing receipts.

Those goals include ensuring efficient use of the spectrum, promotion economic opportunity and competition, avoiding excessive concentration of licenses, preventing the unjust enrichment of any party, and fostering the rapid deployment of new services, as well as recovering for the public a portion of the value of the spectrum” (Rose 2006) One of the FCC’s goals was to promote competition in a highly concentrated market. According to NPD, the four firm concentrations for smartphones is 78% in the 1st quarter of 2012, comprising of 29% from Apple, 24% Samsung, 15% HTC, and 10% Motorola (Gartner 2012).

The Herfindahl-Hirschman Index is then calculated to be approximately 1816, which the U. S. Department of Justice defines as a moderately to highly concentrated marketplace (Investopedia 2013). The cell phone industry is currently dominated by a small number of firms, which can be viewed as an oligopoly and such view was further strengthened by the results of Auction 73. In almost 25% of the auctions, the top five bidders won an average of 100 licenses each whereas the rest of the bidders only acquired less than one license each.

The mean for the top five firms was almost 86 licenses whereas the rest averaged a little over 3 licenses each. The results of Auction 73 do not indicate that the HHI will decrease (Whiteaker 2008). The FCC did make attempts to have Auction 73 be more competitive. For example, for this auction the bidders had to be anonymous in order for smaller businesses with fewer funds to bid can have a fair shot. In previous auctions, larger firms like AT&T and Verizon were able to match and beat whatever prices smaller firms would place and drive them away.

Once the smaller companies left the auction, the few firms in control would become price setters, leaving the end consumers with fewer surpluses because of monopolistic price setting (Brusco, 2009, 101). Also, the FCC helped what they considered “small” and “very small” businesses. Small business that had an average annual gross income of $15-40 million over the last three years would receive a 15% discount on their winning bids while “very small” companies with less than $15 million would receive a 25% discount. Lastly, a winning bid could not cause them to exceed 85% share of the telecommunications market (Whiteaker 2008).

Patrick Riordan, CEO of Cellcom says, “The FCC needs to get this one right. We all need spectrum too much. It has to be a level playing field” (Reardon, 2012). Aside from the market in general becoming more concentrated at the top, there are other concerns. Even the top service providers were upset at the results of the auction, as there were two very clear winners: AT&T and Verizon. Together, they won 336 licenses when there were a total of 101 bidders winning 1090 licenses. This is further troubled by the fact that 168 of those licenses were won by DISH network and ALLTEL, Leap, Sprint, and T-Mobile did not participate.

There was also inefficiency because the D block minimum reserve requirement was not met, so even though Frontline Wireless and Cyren Call made competing offers, it was not enough and potential surplus was lost (Whiteaker 2008). We can conclude that Auction 73 has only increased market concentration and market power for those top firms. Even though Google did not participate in Auction 73 in order to actually win part of the spectrum, they had other intentions to improve their future in smartphones.

Wireless providers that used the spectrum would incorporate data plans and Google wanted those devices to have open platforms for any wireless network or application. Previously, certain smartphones could only be obtained through a certain provider, like the iPhone that originally was only through AT&T. In order for the FCC to agree to those conditions, Google bid the minimum of $4. 6 billion to make sure that it would be met. Google did not actually win the block, but ensured that another party would pay at least that amount (Gardiner 2008).

Google believed that allowing open platforms caters greater competition and ultimately innovation. The FCC agreed and stated that “wireless service providers are blocking or degrading consumer-chosen hardware and applications without an appropriate justification; we believe that it is appropriate to take a measured step to encourage additional innovation and consumer choice at this critical stage in the evolution of wire broadband services” (Brusco, 2009, 102). Companies such as Samsung and Apple will now have to improve their software much more earnestly, since an open platform lends itself towards lower barriers of entry.

Smartphone apps have taken advantage of the FCC’s new policy in recent years as the revenue generated in the US from apps have exploded in 2009 with $1. 94 billion to $15. 65 billion projected in 2013 (Jahns 2010). Furthermore, an open platform for devices will cause a wider gap between smartphones and what is considered feature phones – mobile devices with minimal web browsing features. As application innovation is being sped up, operating software on mobile phones must keep up in technology so differences in smartphones and feature phones are becoming more distinct.

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