DSL Prime: Politics at the End

Many readers like to avoid politics, so we leave it for last, but as long as there are telecom monopolies and subsidies, politics will matter in this business.

by Dave Burstein of DSL Prime and Future of TV [May 9, 2008]

Four is Not Enough For Ideal Competition
Is France in danger of losing the broadband lead as it drops to four or possibly three main companies? The evidence from the U.S. is that falling from six to four in wireless has been very costly to consumers. Wireless prices may even have gone up since then. Investment in down. Service quality remains well below international norms.

Broadband history has been made where competition is fierce. The first leader was the U.S., with 6 companies fighting in most cities in 1999-2000 (cable, the telcos, and typically four CLECs.) The CLECs died in 2000 and 2001, and the United States began falling behind. Korea took the lead, with Hanaro followed first by KT and then four or more other companies. By 2002, the President of SBC was saying "don't compare us to the Koreans."

Japan followed, as Masayoshi Son proved dropping prices could double the market amid a battle between NTT and five other ISPs. Nine major companies pushed France to European leadership and Free.fr was the first CLEC to drive their country to fiber. Today, Cegetel Neuf consolidated four of them and Telecom Italia Alice is being auctioned off. That leaves four, and Cegetel and Free.fr were talking merger.

Competition doesn't work without competitors, Kevin Martin once said. A senior VP of one of the world's largest carriers explained, "we don't have to meet to fix prices anymore. We all know the system. One of us makes a well publicized investor comment that prices are likely to rise, then we all listen for the others to publicly say something similar. If they do, one begins the price rise and watches to see if the others match. They usually do, and everyone now has higher margins."

Mike Armstrong of AT&T, then the biggest cable operator, set off a round in 2001 by telling Wall Street "This year, we're going to concentrate on higher profit margins instead of winning market share." SBC took the hint, and soon after raised prices. Verizon and the cablecos followed quickly after, despite previous plans to cut prices to expand the market. U.S. broadband prices stayed high. U.S. wireless carriers proved they know the game, when all of them raised text messages from 5 cents to 10 cents at about the same time. Texting costs the carriers a small fraction of a penny, so the increase strongly suggests the carriers are not experiencing "the discipline of the market."

The French know that three carriers typically aren't enough. The three wireless carriers have been hit with hundreds of millions in competition fines but still generally believed to collude. The previous government decided a fourth carrier was absolutely necessary. Nicholas Sarkozy may have put plans for a fourth carrier on hold because one of the favored three is owned by his "best friend," billionaire Martin Bouygues. Bouygues was a witness at Sarkozy's wedding, provided crucial support throughout his career, and even gave Sarkozy a job while he was briefly out of politics.

There's another way to look at this, from Eli Noam. He calls countries with 2 main competitors and some minor ones as 2 ½ (U.S., Canada). Noam finds 2 ½ countries do significantly better than 1 ½ countries, with one dominant carrier. (Italy, Spain, Mexico.) That will especially be true if the 2 ½'s include cable, because DOCSIS 3.0 is so much faster than ADSL that it should drive the telcos to upgrade in turn. There's no conflict with what I'm saying. Six competitors are better than four (if sustainable.) Four is better than 2 ½ or 3, which in turn is better than the 1 ½, a single leader. Looking at broadband take rates and prices confirms this.

Editorial: Just Say Nein to Deutsche Telekom-Sprint
It's time for Kevin Martin to say, "A T-Mobile-Sprint deal would require a very careful examination." That's a true and sensible statement. After all, nearly everyone in D.C., including Kevin, spoke of their hope the recent auction would bring in more competition. It can't be right to accept less competition shortly afterwards. Neither company wants to get tied up in an FCC negotiation that will linger into a possible Democratic regime, so any suggestion of a long process would probably be enough to kill the deal. predecessor, Reed Hundt, killed the SBC/AT&T proposed in 1997 by calling it "unthinkable."

The high price that the U.S. paid for dropping from 6 to 4 wireless carriers should be a warning to countries like France where broadband providers are now dropping towards four as well. France became a world model because eight carriers invested to win the market (and because of Xavier Niel). After the imminent sale of Telecom Italia Alice, there will only be Free.fr, FT/Orange, Cegetel Neuf, and cableco Numericable. Newspapers report Free.fr and Cegetel were talking a merger, bringing the players down to three. Danger, Nicholas Sarkozy. The U.S. experience shows four carriers are unlikely to compete with the vigor that made France the model for the West. France has levied hundreds of millions in competition fines against the three wireless carriers, to little effect. It's surely a mistake to let the wireline competition sink to that level.

The evidence is overwhelming that Martin made a mistake in allowing the Cingular/AT&T and Sprint/Nextel mergers. Prices have actually gone up, according to a careful survey by Bank of America. The U.S. remains far behind in wireless data and visitors can't believe how poor U.S. wireless voice quality is. The mergers were urged because "the larger companies could invest more," but investment in wireless is down. Lynch calculated the increased margins from less competition at $2 billion to $4 billion per year, and that almost certainly understates the costs today. Less wireless competition and rates hikes in many states is the key to AT&T's recent profitability when you look at the numbers. They just got a major rate hike through in Missouri. Verizon hasn't been quite as efficient at raising rates, but Tobin says she's looking at every opportunity.

The primary reason for the merger would be to bail out investors who overpaid, and to allow managers to exercise tens of millions in "golden parachutes" despite obvious failure. Sprint as a company is not failing, so rigorous antitrust review is required. The company has earned $1 billion per year for most of the last several years despite some of the most appallingly bad management in the business. Their sales are $40 billion per year, and their spectrum is worth almost as much as the market cap. A month ago, with Sprint at $16 billion, I suggested someone should buy them because the price is a bargain. Their WiMAX build has a natural 2 year advantage over AT&T and Verizon 4G, so they may actually surprise. But it should be unthinkable for Verizon, AT&T, or Deutsche Telekom to take over.

Evan Newmark in the WSJ provided the "Just Say Nein" headline. He points out that mergers rarely live up to the hype. "The cost synergies and economies of scale that can be realized in a merger are almost always exaggerated. And they always take longer than expected." Newmark knows the subject far too well. At Goldman and then Vodafone, he saw firsthand the Airtouch and Mannesman deals, eventually resulting in a $50 billion writedown and the biggest one year loss in British corporate history.

The 2+2=5 crowd always claim that merged companies will be stronger, but the evidence is the other way. Sprint/Nextel is the latest failed merger, with AOL/Time Warner, AT&T/TCI and some other classics in recent memory. The SBC/Ameritech disasters apparently taught them; AT&T/BellSouth is going remarkably smoothly compared to past merger disasters. Bill Smith, the respected BellSouth CTO, is now running AT&T's networks, while Ralph de la Vega, once BellSouth's DSL guy, is running AT&T wireless.

Copyright 2008 Dave Burstein.
The DSL Prime Newsletter is reprinted with permission.

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