Montreal, December 2, 2007 • No 244

EDITORIAL

 

Martin Masse
is publisher of QL.
 
 

THE VALUE OF SPECTRUM*
 

by Martin Masse

 

          Canada's Industry Minister Jim Prentice announced last week the rules that will govern the auction of new frequencies taking place in the spring of 2008. The government has decided to set aside 40 Mhz of the available spectrum (out of 105 Mhz being auctioned) for new wireless players, as well as force existing carriers to open their cellphone networks and to share their transmission towers with the new entrants.

          This article was published in the National Post before the announcement and argues against a set-aside. In addition to being publisher of QL, Martin Masse was a policy advisor to the previous Industry Minister, Maxime Bernier, until last August.
 
 

          Ottawa plans to auction 105 megahertz of airwaves in 2008, and the rules governing the auction are to be announced soon by Industry Minister Jim Prentice. They could determine if hundreds of millions of dollars will be spent on the construction of a new network by players such as Quebecor/ Videotron and MTS Allstream, to compete with those of Bell, Telus, Rogers and the smaller regional carriers.

          The central argument made by proponents of setting aside part of the spectrum for a new network is that, without it, no new entrant will be able to match the incumbents' bids, assuming the rules are the same for everyone. Quebecor put it this way in its comments to the consultation held by Industry Canada in the spring:
 

          Incumbent operators not only require spectrum to provide service to their increasing base of customers, but also, acquiring additional spectrum is an effective means of blocking entry and of ensuring that no new competitors emerge. This results in higher spectrum valuations for incumbents whenever spectrum is made available, regardless of their own needs. These valuations cannot reasonably be matched by new entrants for whom the value associated with keeping competitors at bay can not be included in the net present value analysis for the spectrum.

          MTS makes the same point in a slightly different way when it writes that: "If the reason that an incumbent places a higher value on winning is to protect revenue earned on legacy spectrum and prevent or pre-empt further market entry, then this value should not be part of the social calculus."

          The argument seems straightforward enough. Both sides value spectrum because of its usefulness in providing wireless service. But incumbents value it more because they want to keep new entrants off their turfs. So they will always be willing to pay more to get all of it. The government thus has to balance forces by setting spectrum aside for new entrants. It is, however, wrong for two reasons.

          First, in trying to compare the net present value of investing in spectrum, it omits a key aspect. It is true that incumbents might be willing to buy more than they now need to block the arrival of a fourth player. This would serve to keep their business more profitable than it would be with one more competitor.

          But the entrants also have other reasons to buy spectrum. Quebecor certainly has a major one. The company now leases Rogers' network to offer wireless services to its clients, which does not afford it much flexibility. It has been saying for months that it cannot become a viable player in this field without having its own wireless network. Videotron president Robert Depatie repeated it in a La Presse interview recently: The current leasing model, he said, "is not at all viable in the middle and long term."
 

“We simply don't know the optimal number of wireless networks in a market like Canada's. The market (or an open auction that reproduces its rules) is supposed to determine these things.”


          While the incumbents only need spectrum to marginally improve their services, Quebecor says it needs spectrum to maintain its very viability as a telecom player – the implication being that without it, it may have to divest its cable telephony and television operations and do something else. Now, if that's not motivation enough to pay a few more tens of millions of dollars for 40 MHz and to match the bids made by incumbents, what is?

          The second reason revolves around the way the market allocates resources. In theory, more competition is a good thing in a free market. It forces players to lower their prices and to offer better services to attract clients. But how much more competition should we have? Would we be better off with one more wireless network, with three, five? Such networks cost billions of dollars to set up from coast to coast. Obviously, at some point, it becomes wasteful to add another one and it's better for society if these resources are spent elsewhere.

          If there is a limit to how much competition we should have, then trying to raise the cost of entry of a new player is not necessarily a bad thing.

          We simply don't know the optimal number of wireless networks in a market like Canada's. The market (or an open auction that reproduces its rules) is supposed to determine these things. The valuations of the players interacting in the market will allow us to know. Contrary to MTS's claims, factors affecting both sides of this valuation should be part of the social calculus.

          But we know one thing for sure: A set-aside would bring down the cost of spectrum for the new player wanting to buy it, thus wrecking the valuation process. It would have the same effect as a government handout by distorting the efficient allocation of scarce resources by the market.

          In the same interview, Mr. Depatie conceded that Videotron would indeed have the means to bid higher in an open auction and pay more for the needed airwaves, but that this would hinder the profitability of its wireless division. In such a case, the company would prefer to not participate at all. Which tells us that this business plan is so risky that Quebecor would prefer to abandon it, and eventually restructure all its telecom operations, instead of spending more on spectrum. Or perhaps it's only a ploy to get the handout?

          Quebecor's owners and managers certainly know what's best for them. Let's hope the federal government understands what's best for the wireless industry and for Canadian consumers.

 

* This article was first published on Wednesday, November 28, 2007. Reprinted courtesy of the National Post.
 

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