The Google Spectrum Gambit

Things have turned quite interesting in the upcoming Federal Communications Commission auction of new spectrum. Google announced today that it was willing to bid at least $4.6 billion in the upcoming 700 MHz auction, so long as the spectrum was sold subject to four open platform requirements. At first glance, that must seem odd: why does Google want restrictions imposed that it could simply implement as the auction winner? The point of course is that Google wants these requirements imposed on any winner, not just itself. Google might be happy to go into the spectrum business but it clearly believes that it benefits if open-platform spectrum is created. Google has effectively offered the FCC a price floor for the spectrum, so long as it gets the rules that it wants. What should the FCC do?

Adding the open-platform requirements will almost certainly reduce the revenues that the FCC will collect in the auction. Many of the incumbents may be discouraged from bidding under the open-platform requirements. But revenue maximization shouldn’t be the government’s chief concern: the government should be in the social welfare business and it should be willing to accept reduced revenue if it can buy enough telcom competition.

We need to take a step or two backwards. We are at the intersection of the fight over open vs. closed platforms and the role of the government in managing spectrum. If you have been reading this blog, you know that we see the open/closed fight frequently. The recent kerfuffle over the iPhone is the most recent example, where many are gnashing their teeth over the fact that the iPhone is available only with an AT&T wireless package. No iPhone for me as a Verizon customer (can you hear me now?). For some, open versus closed is almost a matter of religion, but there is no simple approach on this (see my recent book review of Invisible Engines and my published paper on copyright and technological contracts).

What does this mean for how we should auction the 700 MHz spectrum? We should start with auction revenues. If I own an unpainted barn, should I paint it red or blue before auctioning it? The answer is that I shouldn’t paint it, but should instead offer to paint it whatever color the winner likes. If I paint it red, some blue-lovers will drop, and the same is true if I paint it blue. Imposing the condition reduces the value of the auctioned item for someone who would prefer not to be subject to it.

In this case, imposing the four open-platform conditions sought by Google will discourage others from buying. That presumably is one of Google’s goals, as it frankly acknowledges in a July 9 filing that the unencumbered spectrum is probably more valuable to the incumbents. Part of what the incumbents undoubtedly invest in in buying additional spectrum is keeping out other competitors.

But revenue maximization shouldn’t be the government’s main goal in running the spectrum auctions. Switch to taxicabs and consider a toy model. Assume that we have an incumbent monopoly provider who will earn $100 profits in the next period. Assume consumer surplus of $10. Suppose that the government considers auctioning off a second taxicab license and that if we have a new entrant, we get an outcome of $40 in profits to the incumbent, $40 profits to the entrant and $40 in consumer surplus. What will happen in the auction for the license?

A potential entrant would be willing to pay up to $40 for the license. But the incumbent would be willing to pay more. If the incumbent paid $41 and put the license on the shelf, it would then earn $59 in profits in the next period. Far better to have the $100 to be sure, but if the government moves forward with another license, the incumbent would be better to buy it than to allow competition to emerge. The social welfare is higher if we actually create a second competitor, and yet the auction process won’t do that.

This is not just back-of-the-envelope analysis. Well it was, but Tom Hazlett and Roberto Munoz have looked at these issues more systematically in a paper doing a welfare analysis of spectrum allocation policies. They note the conflict between auction revenue enhancement and increasing competition and conclude that the government should often invest more heavily in competition even if that comes at the price of lower auction revenues. That doesn’t answer the open versus closed question, but it does tell me that the government needs to be critically aware of how auction design affects the overall level of competition.

Comments

[Doug Lichtman]

Randy -

Why do you think Google is willing to pay so much just to get open access? Your post implies that open access might be good for consumers. Maybe that's right, maybe not. But shouldn't we at least wonder what is in it for Google? I know that Google tries to sell itself as if it is just in the business of doing good things in the world, but we (current and former) Chicago guys tend to expect a motive, no?

Curious for your thoughts on that.

Doug Lichtman
Professor of Law
UCLA

[Doug Lay]

I would think "what's in it for Google" is pretty obvious. The objective is to see the norms of the Google-era Internet extended into the mobile communications space, at the expense of incumbent visions that might look more like cable TV. Google wants to see more Wikipedia and YouTube, and less Comedy Central, on your next cell phone.

I wonder if (and how) significant parts of the content industry will align with incumbent carriers like AT&T to fight Google.

I also wonder why Mr. Lichtman feels the need to call Prof. Picker out on some sort of clan loyalty. Don't forget to stay down wid da Chicago Boyz, Randy.

[Doug Lichtman]

Doug Lay -

I'm still a little puzzled. I hear your point that Google has tended to support "open" norms in various places, but in those other settings we can tell stories about how Google can easily capitalize on those norms by using its existing technology and content advantages. I don't see that so clearly here. Indeed, almost the opposite, in that Google is well positioned to just buy up spectrum and use that as an advantage, just like Google has been quietly buying up dark fiber so as to better compete with the more established Internet backbone entities.

So: can you unpack your intuition more for me? What advantage does Google have that would let it then capitalize on an open spectrum outcome? Are you just thinking that an open spectrum outcome would lead to open content, which would then need search and advertising services? But if that's it, doesn't that seem an odd way for Google to invest its money today, given how far down the road all that is at best? (If Intel were doing this, I'd understand, as someone will ultimately make a lot of money desiging and selling devices that can efficiently use open spectrum. But Google seems much further removed, no?)

Thanks,
Doug Lichtman

[Pubby]

Obviously Google will use spectrum to furher expand its ad business but giving complete authority to one company over open wireless is simply senseless.

we don't want any single company to monopoly open wireless market. But who cares Neither Governament nor companies care for the people all they want is their money.

[Doug Lay]

>> Are you just thinking that an open spectrum outcome would lead to open content, which would then need search and advertising services?

Yes.

>> But if that's it, doesn't that seem an odd way for Google to invest its money today, given how far down the road all that is at best?

Why is this so far down the road? I doubt the technological innovations required are especially radical.

[Anonymous]

"Adding the open-platform requirements will almost certainly reduce the revenues that the FCC will collect in the auction. "

This makes no sense. If Google's offer didn't up the ante it would have no force. If other parties were willing to bid something more than 4.6 billion for a closed system, Google would be spitting in the wind.

As to what Google's real motivation is, I don't think it's simply a matter of boosting advertising revenue. Google does more than just sell ads - it also collects data on users through browser cookies. Google would like you to use their email system, their "checkout system," and a host of other free services that compel you to submit personal information that can presumably be linked to your IP and used for who knows what. Combine this with Google's impressive mapping capabilities and you have the makings of a sophisticated geolocation system that could conceivably be used to identify and track a large chunk of its user base.

What is Google doing with this information? We can only speculate. Its willingness to capitulate to China's censorship demands are one indication that it is not entirely benign.

We can only speculate about what an open 700 MhZ band would look like, but it would almost certainly allow users to access Google's services from a wide variety of electronic devices. What information is Google collecting on its users and what, besides generating targeted ads, is it doing with it? These are questions we should be asking.

[Jeff Schiller]

Google recognizes that the mobile web is not where it could be in terms of users and activity. Just like the "desktop web", there's a lot of money to be made if the platform is open and everyone uses it without feeling locked into a carrier's sandbox.

[Michael]

Rather than impose more rules to correct the market power that existing rules have caused, why not eliminate the original offending rules that require licenses to use spectrum, as Ikeda Nobuo suggests at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=309980? An article at http://www.businessweek.com/print/technology/content/jan2005/tc2005014_6520.htm?chan=tc& argues the same point in layperson's terms.

[Randy Freeman]

In offering to bid 4.6B, with its four open platforms in place, Google has simply notified the FCC that it is willing meet the reserve price set by Martin's auction plan.

The FCC says that if no one meets the reserve, the spectrum will be withdrawn, re-allocated, and re-auctioned without any of the existing requirements for open access.

Google has put the FCC (and AT&T) on notice that the spectrum is at least that valuable, with open platform requirements that exceed the existing requirements.

Google seems to be after the extension of net neutrality to the next frontier. When I can surf the web on my iPhone, from anywhere, without being locked into AT&T or Verizon, Google will be happy if I use their free services to the maximum extent possible. After all, that's how they got their current valuation.