Today the FCC announced [PDF] the winners of the 700 MHz auction—and you can see from pp. 62-63 of this document [PDF] that Verizon won Block C. (Block C was set up in two nationwide paired blocks of 11 MHz each, which were auctioned off in very large geographic areas—12 licenses, each covering a “Regional Economic Area Grouping”. Verizon won seven of the twelve licenses, covering all of the US except Alaska, Puerto Rico, American Samoa, Guam, and the Northern Mariana Islands.)

Why does this matter?

Context. The 700 MHz auction happened at a particularly interesting time in communications history. Traditional telephone use is shrinking and the cultural sway of broadcasters is diminishing, while Internet use and cellphone use are growing quickly. Although the telecommunications industry has long been divided up into different silos (cable, broadcast, telephony, data), all of these segments are arguably converging into one packet-switched communications realm. Highspeed packetized communications are becoming the key communications medium.

The central question is which model of packetized communications will prevail: Will we converge on a set of proprietary, walled-garden networks, in which the network provider acts as a gatekeeper by deciding which communications (in terms of content, application used, protocol used, how expensive they are) move easily across its network and onto the (authorized) handsets of users (the cellphone model), or will we converge on the Internet model, in which the network provider makes available an interconnected, commodity, nondiscriminatory transport service (essentially, a utility connectivity product) on which competitive communications travel that can be introduced without the knowledge or permission of the network provider and can be accessed via any handset?

The answer. Verizon’s victory in obtaining the C block in this auction means that, for a while at least, the “cellphone” model of Internet access will hold sway—particularly as we move in greater numbers to experiencing Internet communications via mobile handsets.

More background—Verizon was already an almost unbeatable oligopolist. Verizon already had national spectrum licenses before this auction began. The commercial wireless industry in this country began in 1981 when the FCC issued two free cellular licenses in the 800 MHz range for each “cellular marketing area” (or “CMA”) in the country. There are 734 CMAs in the U.S., and this regulatory limitation to relatively-small geographic areas for the licenses (and to only two competitors for each geographic area) meant that cellular technology remained expensive and not widely used. But the operators that were handed these early free “beachfront” 800 MHz licenses retained them, and now (through mergers and sheer staying power) Verizon Wireless and AT&T have most of them.

The most important service attribute for experienced cellphone users is coverage—the availability of reliable signals. Verizon Wireless and AT&T offer the best nationwide coverage, because they held onto those “beachfront” 800 MHz licenses and snapped up smaller carriers. As a result, Verizon Wireless and AT&T experience both much lower “churn” (dropped subscriptions) and much higher rates of “net adds” (new subscriptions) than the third largest carrier, Sprint. Indeed, Sprint is rapidly losing customers. The enormous barriers to entry involved in providing nationwide service, their vast spectrum holdings, and the substantial economies of scale of wireless service generally, make Verizon Wireless and AT&T almost unbeatable oligopolists.

The myth of the “third pipe.” When it comes to highspeed Internet access, current wireless offerings from Verizon Wireless and AT&T do not compete directly in terms of speed or cost with the dominant wireline (DSL, fiber, and cable) transport offerings—which explains why 96% of all residential highspeed Internet access connections are sold by regionally dominant DSL or cable companies. Existing (pre-auction) wireless highspeed Internet access connections cost at least twice as much as a DSL or cable connection, and operate at only a fraction of the speed. Residential highspeed Internet access subscribers simply do not cancel their subscriptions in order to sign up for wireless highspeed access via handsets, because these services are not (currently) substitutable.

At the same time, the dominant existing national wireless carriers, AT&T and Verizon, (1) are controlled by the same incumbent actors that control DSL access through regional monopolies across the country and (2) offer wireless services as part of packages that tie together traditional phone services, Internet Protocol Television (IPTV) access, and internet access. In a nutshell, the leaders in mobile wireless are owned by the same companies who control the DSL marketplace and are, like their corporate parents, choosing to avoid direct competition for highspeed Internet access by bundling three or four services together (voice, video, data) and differentiating their offerings based on their voice or video elements.

Given this situation, in which 96% of residential wireline highspeed internet access is provided by regionally dominant DSL or cable companies, and wireless communications are largely provided by two oligopolist players who are in turn owned by wireline companies, the dominant providers of internet access services in this country, both wireline and wireless, have ample market power to nudge users towards the proprietary, cellphone, managed model of packetized highspeed communications. These carriers, just like all makers of potentially-commodified information goods, have substantial incentives to both lock their customers in with high switching costs and to differentiate their informational offerings from those of other companies running across their network. They obviously also have great incentives to avoid cannibalizing their own wireline highspeed internet access market dominance.

It wouldn’t have been possible to create a “third pipe” competitor through the 22 MHz available in the national C block. That much spectrum just can’t carry enough data to compete with DSL or cable. But this 700 MHz spectrum might have been able to support long-range provision of wireless highspeed Internet access in (1) areas where faster “wired” DSL or cable Internet access is not available, or (2) for personal, portable wireless uses. And it might have been able to do this while requiring far less capital expenditure for the building of transmission towers than for higher frequency bands.

Most importantly, if someone other than Verizon or AT&T had won this auction, we would have seen a test case for non-cellphone model Internet access.

But we won’t. During the wrangle over the auction rules, Google and others proposed that this spectrum be made available on a wholesale basis—so that the licensee would be obliged to sell access to its network on a wholesale basis at commercial rates. This would mean that any ISP could come and buy bandwidth and build its own business. Everyone would share the same transmitter and neutral connection, but ISPs would compete on price and the services they offered to their customers.

This kind of approach has led to dramatic competition for the provision of highspeed Internet access in Europe.

But even though the incumbents (Verizon and AT&T) could have accepted this limitation, won the auction, and then priced wholesale access at a high level (thus discouraging anyone from using it), avoiding the precedent of wholesale access—and retaining the cellphone model of access—was their central goal. And they achieved that.

Now, the FCC did mandate that any winning licensee have in place “no locking” and “no blocking” provisions conditioning its use of this spectrum:

Licensees offering service on spectrum subject to this section shall not deny, limit, or restrict the ability of their customers to use the devices and applications of their choice on the licensee’s C Block network, except:
(1) Insofar as such use would not be compliant with published technical standards reasonably necessary for the management or protection of the licensee’s network, or
(2) As required to comply with statute or applicable government regulation.

As I’ve said here before, these no-locking, no-blocking requirements are hedged in by substantial limitations: Verizon will be able to lock and block devices and applications as long as they can show that their actions are related to “reasonable network management and protection,” or “compliance with applicable regulatory requirements.” We’ve already seen how loosely “reasonable network management” has been interpreted in the Comcast fracas.

Verizon has said that all of its wireless operations will be “open” and that it will allow any device to attach to its network. But. Verizon has also insisted on retaining the ability (1) to privately “certify” applications and devices for use on its network (a process during which a great deal of mischief is possible, as we know from the pre-Carterfone days), (2) to sell heavily-subsidized handsets of its partners in its retail stores (which will make it unlikely for competing, full-price handsets to be popular), and (3) to prioritize its proprietary or charged-for content over “ordinary” Internet traffic.

The bottom line. Verizon has won spectrum it arguably didn’t even need, given its existing spectrum holdings. It retains the discretion to act as a traditional cellphone-model company—picking and choosing among applications and devices, underselling “open” devices, and discriminating against traffic that undermines its business model. This isn’t great news for the Internet model of access.

On the other hand, openness is more popular and more talked-about than it used to be. It may be that the pressure of consumer preferences makes Verizon provide a truly open Internet and truly open devices to the rest of us. (The pressure of competition won’t be doing that—AT&T and Verizon have divided the U.S. between them, and the other players in the wireless space are far behind.) The Android project, Verizon’s own words about openness, and concerns about the place of the U.S. in the international race for innovation may all push towards a more open future.

We’ll see. The results of this auction don’t suggest that we’ll be seeing such a move any time soon.