Consolidation of the wireless industry into two or three mega-carriers is a dream come true… if you are one of those carriers (or Wall Street). But for everyone else, it’s a competition wasteland, where innovation and disruptive marketing wane into comfortable and predictable businesses where participants learn not to rock the boat. If they did, a lot of their accumulated money could fall overboard.

AT&T believes consolidation is already upon us, despite their setback in failing to acquire T-Mobile USA.

John Stephens, AT&T’s chief financial officer, tried to calm Wall Street’s fears that the government has signaled its intent to preserve robust competition.  At yesterday’s Nomura investment conference, Stephens said a reduction in the number of wireless companies in the United States is part of the natural order:

I think it is just logical that the industry is going to consolidate in some form or fashion. I think the marketplace has spoken to that with what it has done to pricing in the valuations on some of the companies. From an economic perspective and a highly CapEx-intensive business, I think it is logical to assume you’re going to have two or three and certainly not six and seven competitors in any marketplace. So I think consolidation is logical.

We’ve heard this argument before. It is commonly trotted out in opposition to community broadband initiatives when existing phone and cable companies fear a third player will ruin the market for everyone. AT&T joins the chorus with the same old excuses: the costs to build and run networks are too high for several players to comfortably compete. Consolidation reduces that pressure as customers are forced to choose among one or two providers, giving each a larger market share and healthier revenue to cover upgrades.

What companies like AT&T always obscure to their customers is the resulting pricing power, where price increases from one often lead to price increases from others. But Stephens has no trouble letting his investors know:

We are going to grow margins year-over-year. Last year’s margins were about 38.5% in wireless and our guidance says we are going to grow. I have said publicly, and some of my peers and coworkers have said publicly we expect we are going to have north of 40% margins this year in our wireless business and still believe that.

Margins = profits. In the absence of aggressive competition which forces companies to invest more in their networks, provide more value in their service offerings, or reduce pricing, increased profits are always the result.

Unfortunately, ZDNet’s editor in chief Larry Dignan seems to buy AT&T’s arguments and talking points, telling readers:

[…] It’s hard to argue against the idea. All industries boil down to two or three players eventually. The big question for wireless consolidation is timing. When will get to two or three carriers? And if so will this consolidation lead to price increases or will the mergers occur after wireless services is commoditized?

Stephens

It is actually very easy to argue against the idea, and the evidence is plainly visible if Dignan would take a look.

First, there is no evidence “all industries boil down to two or three players eventually.” Auto companies, banks, retailers of all kinds — even cell phone manufacturers all compete with more than just one or two other players in the market. A germinating monopoly or duopoly in any market is a signal federal regulators have failed to do the job assigned to them since the days of trust-busting railroads, oil, steel, and the securities business.

The drive to consolidation can be found first on Wall Street, where every industry is under pressure to cut costs, reduce profit-eroding competition, and return higher profits. The drumbeat for consolidation in the wireless industry starts there, is echoed in the executive offices of the cell phone companies themselves, and results in powerhouse deals that have picked off one competitor after another. That is why Cingular, Alltel, Cellular One, and Centennial Communications are no longer familiar names in wireless. They have all been swallowed nearly whole by AT&T or Verizon Wireless.

AT&T would argue that consolidation is a good thing, because through their willingness to sell, those companies indicated they wanted to exit the business. AT&T’s buyout of T-Mobile would have done everyone a favor because the company had lost interest in competing in the United States and wanted out.

The industry has held all of the cards of wireless consolidation until recently, primarily because supine regulators refused to provide a critical “check and balance” on industry pressure, accepting just about any premise to approve whatever wireless carriers wanted. Sure, a few companies had to divest certain assets, as Verizon Wireless did in certain Alltel markets. But AT&T ended up acquiring the majority of those divested territories. When AT&T bought Centennial Wireless, it had to divest a few markets in the southern United States. Verizon Wireless bought most of them. Customers were left in the middle, as always.

A remarkable thing happened when the federal government said no to AT&T over T-Mobile. Predictions of the smaller carrier’s imminent demise and its slow bleed to irrelevance has not happened. In fact, Deutsche Telekom picked its American asset up, shook the dust off, and is now investing in upgrades to keep the competition coming. At least $4 billion in improvements and some major network upgrades are on the way, and the company has even refreshed its marketing in a new, get-tough campaign against AT&T, Verizon Wireless, and Sprint. Now all three of those companies are watching to see what T-Mobile pulls next.

That is exactly the point.

The wireless world and Wall Street wants you to believe that consolidation is the only way the mobile phone marketplace of 2012 can work. Dignan has thrown in the towel, conceding they are likely right. But T-Mobile is proving they are exactly wrong. Instead of abandoning its asset, which DT still sees as valuable, it is investing in it to compete. Had the merger been approved, AT&T would never answer T-Mobile’s disruptive competition again. Rural America would still be waiting for better service. AT&T would have less pressure to keep prices down and upgrades up, and Wall Street would have turned its attention to the next targeted carrier ripe for the picking by AT&T or Verizon Wireless’ emerging duopoly.

Stephenson: Payback time.

Six weeks after AT&T’s colossal $39 billion dollar merger with T-Mobile USA fell apart, AT&T CEO Randall Stephenson opened his checkbook and donated $30,800 (the maximum allowed under federal law) to the Republican National Committee.

That contribution dwarfs Stephenson’s largest previous donation over the past twenty years: $5,000, according to the Center for Responsive Politics.

Bloomberg reports that Stephenson took a credibility and pay hit from the merger debacle, forcing AT&T to turn over $4 billion in deal penalties to its rival, T-Mobile, including precious wireless spectrum. The deal’s collapse personally cost Stephenson more than $2 million in bonus pay.

Although AT&T is not commenting, Wall Street analysts are, and they suspect Stephenson is sending the Obama Administration a clear message that he is upset with the decision to challenge the merger. The rest of AT&T appears to be following suit, with nearly two-thirds of political contributions, mostly from company executives, going to the Republican party which has traditionally maintained a much more friendly relationship with the communications giant.

Several Republicans criticized the Justice Department and Federal Communications Commission for interfering with the merger deal which consumer advocates argued would reduce competition and raise prices for wireless services. Republicans have also expressed near-universal support for AT&T’s policy positions on Net Neutrality, community broadband, usage-based pricing, spectrum and price deregulation, removal of state oversight of telecommunications services, and marketplace consolidation.

AT&T is a major sponsor of this summer’s Republican National Convention in Tampa, Fla. Several former lobbyists for AT&T are now working with the Romney campaign and its money bundling operations on behalf of the Republican presidential candidate.

The center reports no personal political contributions from the heads of either Verizon Wireless or Sprint.

Roger Entner, an analyst with Recon Analytics in Dedham, Massachusetts, notes AT&T was still trying to make nice with Obama Administration officials as late as last December, sending ornate cupcakes to various administration officials, including those at the FCC.

Entner noted it didn’t work.

Hesse

Sprint CEO Dan Hesse believes the march to a consolidated wireless world in the United States will carry on, despite last year’s failed attempt by AT&T to buyout Deutsche Telekom’s T-Mobile USA.

Hesse told an investor conference Sprint may be among the buyers, but would prefer to wait until the company’s network upgrades are finished in 2013. Other players in the market may not wait that long, and Hesse said the company would pull the trigger sooner if a consolidation frenzy appears imminent.

“It’s not an ideal time for our equity because of the big investments we’re making now,” Hesse said.

Sprint already attempted a buyout of regional carrier MetroPCS in February, but the company’s board of directors nixed the deal at the last minute.

Wall Street has been calling for additional industry consolidation to reduce duplication of networks, and the amount of money spent to construct them.  Investors also believe a more consolidated marketplace can lead to higher prices, which will drive revenues… and profits higher.

Hesse believes both the Federal Communications Commission and the Department of Justice are amenable to consolidation deals, as long as the buyers are not AT&T or Verizon Wireless, which together dominate the market.

Hesse rejects contentions the federal government wants at least four national carriers competing for America’s wireless business.

“I honestly don’t believe there’s a magic number of four at all,” Hesse said.

Among the most likely targets for consolidation: Leap Wireless’ Cricket, MetroPCS, U.S. Cellular, C-Spire (formerly Cellular South), Alaska Communications, General Communication (GCI), and regional units of Cellular One.

Growing questions are being raised about whether Comcast is violating FCC and Department of Justice policies that prohibit the cable company from prioritizing its own content traffic over that of its competitors.

Comcast’s Xfinity Xbox app offers Comcast customers access to Xfinity online video content without eating into their monthly 250GB Internet usage allowance. Netflix has called that exemption unfair, because its content does count against Comcast’s usage cap. New evidence now suggests Comcast may also be prioritizing the delivery of its Xfinity content over other broadband traffic, a true Net Neutrality violation if proven true.

Bryan Berg, founder and chief technology officer at MixMedia, believes he has found proof the cable company is giving its own video content preferential treatment, in this somewhat-technical finding published on his blog:

What I’ve concluded is that Comcast is using separate DOCSIS service flows to prioritize the traffic to the Xfinity Xbox app. This separation allows them to exempt that traffic from both bandwidth cap accounting and download speed limits. It’s still plain-old HTTP delivering MP4-encoded video files, just like the other streaming services use, but additional priority is granted to the Xfinity traffic at the DOCSIS level. I still believe that DSCP values I observed in the packet headers of Xfinity traffic is the method by which Comcast signals that traffic is to be prioritized, both in their backbone and regional networks and their DOCSIS network.

Berg also contends Comcast’s earlier explanation that its Xfinity content should be exempt from its usage cap because it travels over the company’s private Internet network is also flawed:

In addition, contrary to what has been widely speculated, the Xfinity traffic is not delivered via separate, dedicated downstream channel(s)—it uses the same downstream channels as regular Internet traffic.

Berg

Broadband traffic management is of growing interest to Internet Service Providers, who contend it can be used to manage Internet traffic more efficiently and improve speed and time-sensitive online applications like streamed video, online phone calls, and similar services. But manufacturers of traffic management equipment also market the technology to ISPs who want to favor certain kinds of content while de-prioritizing or even throttling the speed of non-preferred content. The technology can also differentiate traffic that counts against a monthly usage cap, and traffic that does not.

Quality of Service (QoS) technology can be used to improve the customer’s online experience or help a provider launch Internet Overcharging and speed throttling schemes that can heavily discriminate against “undesirable” online traffic.

Berg further found that when he saturated his 25Mbps Comcast broadband connection, traffic from providers like Netflix suffered due to the bandwidth constraints.  Because he flooded his connection, Netflix buffered additional content (slowing his stream start time) and reduced the bitrate of the video (which can dramatically reduce the picture quality at slower speeds). But when he launched Xfinity video streaming, that traffic was unaffected by his saturated connection. In fact, he discovered Xfinity traffic was exempted from his normal download speed limit, allowing his connection to exceed 25Mbps.

While that works great for Xfinity fans who do not want their videos degraded when other household members are online, it is inherently unfair to competitors like Netflix who are forced to reduce the quality of your video stream to compensate for lower available bandwidth.

According to the consent decree which governs the merger of the cable operator with NBC-Universal, prioritizing traffic in this way is a no-no when the company also engages in Internet Overcharging schemes, namely its arbitrary usage cap:

“If Comcast offers consumers Internet Access Service under a package that includes caps, tiers, metering, or other usage-based pricing, it shall not measure, count, or otherwise treat Defendants’ affiliated network traffic differently from unaffiliated network traffic. Comcast shall not prioritize Defendants’ Video Programming or other content over other Persons’ Video Programming or other content.”

This graph shows Berg's artificially saturated 25Mbps Comcast broadband connection. The traffic in red represents Xfinity Xbox traffic, which is given such high priority, it allows Berg to exceed his usual download speed limit.

Comcast sent GigaOm a statement that denies the company is doing any such thing:

“It’s really important that we make crystal clear that we are not prioritizing our transmission of Xfinity TV content to the Xbox (as some have speculated). While DSCP markings can be used to assign traffic different priority levels, that is not their only application – and that is not what they are being used for here. It’s also important to point out that our Xfinity TV content being delivered to the Xbox is the same video subscription that customers already paid for and is delivered to their home over our traditional cable network – the difference is that we are now delivering it using IP technology to the Xbox 360, in a similar manner as other IP-based cable service providers. But this is still our traditional cable television service, which is governed by something known as Title VI of the Communications Act, and we provide the service in compliance with applicable FCC rules.”

Our View

Comcast, as usual, is talking out of every side of its mouth. In an effort to justify their unjustified usage cap, they have pretzel-twisted a novel way out of this Net Neutrality debate by paving their own digital highway on a Comcast private drive.

Comcast argues their 250GB usage cap controls last-mile congestion to provide an excellent user experience. That excuse completely evaporates in the context of its new toll-free video traffic. In fact, their earlier argument that its regionally-distributed streaming traffic should not count because it does not travel over the “public Internet” at Comcast’s expense does not even make sense.

Berg provides an example:

A FaceTime call from my house to my neighbor’s—which never leaves even the San Francisco metro area Comcast network, given that both of us are Comcast customers—goes over the “public Internet.”

Yet Comcast’s Xbox streams, which pass from Seattle to Sacramento to San Francisco through all of the same network elements that handle my video call (and then some!) are exempt from the bandwidth cap?

You can’t have it both ways, guys.

DOCSIS 3 technology has vastly expanded the last mile pipe into subscriber homes. If Comcast can launch their own private pipe for unlimited IPTV traffic that travels down the same wires their Internet service does, they can comfortably handle any additional capacity needs to support their “constrained” broadband service without the need to limit their customers’ use.

Usage caps remain an end run around Net Neutrality. Consumers given the opportunity to view content under a usage cap on the “public Internet” or using the “toll-free” traffic lane Comcast created for content from their “preferred partners” will make the obvious choice to protect their usage allowance. Comcast is certainly aware of this, and it is a clever way to discriminate through social engineering. It’s also less obvious. You don’t have to de-prioritize or block traffic from your competition to have an impact, you just have to limit it. Customers who repeatedly exceed their usage allowance face suspension of Comcast broadband service for up to one year. That’s a strong incentive to follow their rules.

Netflix is fighting to force Xfinity traffic to fall under the same arbitrary usage cap regime Netflix endures — a truly shortsighted goal. The real issue here is whether Comcast should be capping any of its Internet service.

Comcast has given us the answer, launching the very bandwidth-intense video streaming it used to decry was contributing to an Internet traffic tsunami.

It’s time for Comcast to drop its usage cap.

Deutsche Telekom AG is in talks to acquire MetroPCS in a stock-swap transaction that would give T-Mobile USA control over the upstart regional carrier.

MetroPCS shares jumped nearly 30 percent on the news, reported by Bloomberg.

MetroPCS operates a CDMA and LTE 4G network incompatible with T-Mobile USA’s GSM service, but would be an asset to T-Mobile’s prepaid phone unit, which could co-exist with T-Mobile’s existing network. MetroPCS primarily operates in the Boston-New York-Washington corridor, Southern California, Florida, southern Michigan, northern Georgia, and northeastern Texas. It is best known for delivering aggressive pricing on no-contract service plans, much like Leap Wireless’ Cricket.

Analysts predict T-Mobile would have little trouble winning approval for a merger between the two carriers. MetroPCS maintains an inconsequential 2.7% market share in the wireless industry. Speculation immediately increased that Leap Wireless’ Cricket unit could be the next target for a merger, potentially with Sprint or T-Mobile.

If T-Mobile sought to assume control of MetroPCS’ spectrum for its own operations, it would have to supply existing MetroPCS customers with new phones that operate on T-Mobile’s network standard.