Components of a Mobile Phone System. Mobile phones are low-powered radio transceivers (a combination radio transmitter and receiver) that use radio waves (spectrum) to communicate with base stations. These include traditional voice-only cellular phones, as well as “smart” phones that generally have large viewscreens, along with enhanced data and messaging capabilities. Wireless phone service carriers deliver mobile phone service by subdividing large geographic areas into smaller overlapping sections called cells. Each cell has a base station equipped with an antenna to receive and transmit radio signals to mobile phones within its coverage area. This area can vary in size from under a mile to 20 miles from the base station. A mobile phone’s communications are generally associated with the base station of the cell in which it is presently located. When a call is initiated, the base station assigns a radio frequency to the mobile phone from among the group of frequencies that the station controls. The number of frequencies available at a base station will depend primarily on the amount of radio frequency spectrum obtained by the carrier from FCC, the number of base stations in the carrier’s service area, and the type of technology that the carrier uses. Each base station is linked to a mobile phone switching office, which is also connected to the local wireline telephone network. As a result, the majority of wireless traffic actually flows over the wireline telephone system, with only the last segment—traveling to and from mobile phones to towers—operating wirelessly. The mobile phone switching office directs calls to the desired locations, whether to another mobile phone or a traditional wireline telephone. This office is responsible for switching calls from one cell to another in a smooth and seamless manner as consumers change locations during a call. Special access services are used to provide backhaul, the wireline infrastructure that, among other things, connects cell phone towers to switching stations and, ultimately, to other phones. Special access services employ dedicated facilities that run directly from cell phone towers to wireline networks. Figure 1 illustrates the components of a mobile phone system. Wireless Industry Background. In the wireless phone industry, four large national wireless phone service carriers—AT&T, Sprint, T-Mobile, and Verizon—currently operate alongside small and regional carriers of various sizes. The four large, national carriers serve more than 90 percent of wireless subscribers, though no single competitor has more than one- third of the market share of the national market. According to industry data, currently more than 140 companies offer wireless services. Many carriers, such as AT&T and Verizon, are considered “facilities-based” in that they both own and operate elements of their wireless network. In addition to these facilities-based carriers, the wireless industry includes mobile virtual network operators (MVNO), such as TracFone. While many wireless carriers acquire spectrum licenses from FCC, MVNOs are resellers of wireless services; they do not hold spectrum licenses, but lease network space wholesale from other providers. According to FCC, there are currently at least 60 MVNOs in the United States. To subscribe to wireless phone service, a consumer must select a wireless phone service carrier and either sign a contract and choose a service plan or purchase prepaid minutes and buy a phone that works with the prepaid service. Most consumers sign contracts that specify the service plan, the number of voice minutes, and the number of text messages the consumer is buying for a monthly fee; consumers can also purchase data plans which allow them to access the Internet for a monthly fee. New consumers who sign contracts for wireless phone service sometimes pay upfront fees for “network activation” of their phones and usually agree to pay an “early termination fee” (ETF) if they should quit the carrier’s network before the end of the contract period. In return for signing a contract, consumers often receive wireless phones at a discount or at no additional cost. Some carriers also permit consumers to purchase their own handsets without requiring that they enter into long-term contracts. While there are a variety of handsets consumers can purchase, some are exclusively linked to one carrier. Regulatory History. When establishing the rules for cellular service in 1981, the commission decided that it would only grant two licenses to carriers in each cellular market to build facilities and offer cellular telephone service. One license was reserved for the existing local telephone company and the other was initially reserved for applicants that were not affiliated with any wireline telephone carrier. The commission relied on comparative hearings and lotteries to assign these licenses to new carriers. However, in our 1992 report, we noted that this market structure provided only limited competition. We recommended that FCC consider establishing a policy that supports new entrants into the wireless market by giving first preference to firms not offering cellular telephone service when allocating spectrum. Later, when the FCC allocated more spectrum, it opened the wireless market to more carriers. In the 1990s, Congress enacted two laws—the Omnibus Budget Reconciliation Act of 1993 (1993 Act) and the Telecommunications Act of 1996 (1996 Act)—that sought to increase competition among carriers through a deregulatory framework. The 1993 Act preempted state and local governments from regulating the entry of or the rates charged by commercial mobile service carriers. In addition, the 1993 Act gave FCC authority to set up spectrum auctions for the distribution of licenses, replacing the lottery system. The purpose of the auction system was to award licenses to those who would use them most efficiently. The 1993 Act also required FCC to provide annual mobile wireless competition reports to Congress. In the 1996 Act, a law that deregulated various aspects of the telecommunications industry, the Congress provided FCC with additional tools that could be used to promote competition in the mobile phone service industry. In order to enhance competition, the 1996 Act authorized FCC to exempt telecommunications carriers, including wireless carriers, from any requirements that are not necessary to protect consumers, ensure that service provided be just and reasonable, and not unjustly or unreasonably discriminatory. The 1996 Act also required that every 2 years FCC engage in a review of its rules, including those related to mobile phone service, to determine whether any of them are no longer necessary as a result of meaningful competition among carriers. Ahead of the first spectrum auctions, FCC decided to introduce caps on the amount of spectrum any one carrier could hold in a market (spectrum cap) to ensure that a number of carriers would be able to compete in a given market and that no one carrier would thereby gain dominant market share. In 2001, the Commission decided to end the practice of spectrum caps—phasing it out completely in 2003—in part, because it believed there was general competition in the marketplace and that a case-by-case approach to proposed transactions could protect competition while also enabling greater economic efficiencies, which would benefit consumers. Instead, the FCC began a practice of applying, on a market-by-market basis, a two-part “screen”—examining (1) market concentration and (2) the input market for spectrum—to determine whether a particular proposed transaction required more in-depth, case-by-case review to assure that no competitive harm would result (or to require divestitures where necessary). The 1993 and 1996 Acts led to other FCC actions as well. FCC has traditionally regulated the rate ILECs can charge for special access services. In 1991, FCC moved the Bell Operating Companies and GTE from rate-of-return regulation to price-cap regulation and gave other ILECs the option of moving to price-cap regulation. As noted earlier, wireless carriers are one consumer of such special access services. These services are generally provided by incumbent telecommunications companies, which can be large, multistate firms (e.g., AT&T, Qwest Communications, and Verizon). These incumbent firms have an essentially ubiquitous local network that generally reaches all of the business locations in their local areas. Because the 1996 Act encouraged a deregulatory approach to telecommunications, the commission implemented the Pricing Flexibility Order in 1999, which permitted the deregulation of special access rates in metropolitan areas where local firms could show that certain “competitive triggers” had been met and that there was competition for special access services. FCC granting either partial- or full-pricing flexibility to the price-cap incumbent carriers depends on the extent of competitive co- location of special access facilities in a particular metropolitan area. A number of quantitative metrics demonstrate the evolution of the wireless industry. Data show that the biggest changes since 2000 have been consolidation among wireless carriers and increased use of wireless services by consumers. Industry consolidation has created some challenges for small and regional carriers to remain competitive; these challenges include securing subscribers, making network investments, and accessing handsets. While the industry has consolidated since 2000, consumers have seen some benefits, such as lower prices and better coverage. Consolidation of Carriers. The primary change in the wireless industry since 2000 has been the consolidation of wireless carriers. The Herfindahl- Hirschman Index (HHI) is a commonly accepted measure of market concentration used by both the Department of Justice Antitrust Division and FCC. The average HHI score for the wireless industry, as calculated by FCC, has increased by over 30 percent since first reported by FCC in 2004. This suggests that the market shares of the largest national carriers generally have increased. In addition to changes in market shares, there are other factors that could explain changes in the HHI score, including a decrease in the number of carriers through mergers or other exits from the market. Over the past 10 years, consolidation in the wireless industry has generally been accomplished through a series of mergers and acquisitions. Figure 2 illustrates the major mergers and acquisitions among some of the major wireless carriers since 2000.