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Focus on Regulation

Sequestration Could Potentially Delay Telecom Deals and Slow Smartphone Offerings, But Should Not Affect Phone Subsidy and Auction Programs

When last year’s “supercommittee” failed to reach consensus on a plan to reduce the deficit, it set in motion $1.2 trillion in defense and non-defense spending cuts for 2013. If Congress does not act to prevent this “sequestration” by January 2, 2013, the budget axe will fall across virtually every element of the US government. The Office of Management and Budget has detailed how sequestration will affect individual government agencies. Like other agencies, the Federal Communications Commission would need to implement dramatic reductions in spending: sequestration will require the FCC to cut $28 million, or about 8.2% of its $340 million budget

The timing of sequestration, moreover, will exacerbate its effect on the FCC. Sequestration requires 8.2% in cuts for FY 2013 to go into effect on January 2, 2013. FY 2013 started, however, on October 1, 2012. This 3-month gap effectively requires the FCC to implement the 8.2% cuts in the FY 2013 budget over a 9-month period. Thus, budget cuts will have to be approximately one-third greater to make up for the 3-month difference—that is, the FCC will have to cut about 10.9% of its budget over that 9-month period to achieve an 8.2% reduction for FY 2013.

Such a large budget cut can hinder any organization’s performance, and it promises to slow an already stretched FCC. Although we can only speculate how the Commission will mete out the resources that remain if sequestration takes effect in January, the FCC has limited discretion in how it allocates its budget.

The FCC will no doubt make the least painful spending reduction first: namely less travel, less reproduction, and fewer supplies. But even in the unlikely event that the FCC suspended all travel ($2.5M), ended all printing and reproduction ($1M), stopped purchasing supplies and materials ($1.7M), delayed all purchases of federal goods and services ($2.5M), and chose not to purchase any new equipment ($2.5M), the agency would only manage to eliminate $10.2 million from its budget. These implausible cuts would still require the FCC to identify an additional $17 million to eliminate during the 2013 fiscal year.

Meanwhile, eliminating recurring costs seems to offer little opportunity for material cost savings. The FCC has committed to spend substantial sums for office space ($36M), other rents ($8M), contract services ($24M), and operation and maintenance of equipment ($16M). These recurring charges are difficult to change without incurring a substantial financial penalty.

The single largest category of FCC spending capable of offering substantial cost savings is personnel compensation. The FCC employs 1776 full-time equivalents, spending nearly three quarters ($245M) of its $340 million budget on personnel compensation and benefits. A $28 million dollar cut to personnel would require the Commission to cut its workforce by more than 10%. Although the FCC will not be required to come up with the full $28 million from personnel compensation, sequestration would likely lead to a substantial reduction in the funding available for employees. Barring extraordinary reductions in long-term, recurring expenses, the FCC likely could not meet the financial demands that a year or more of sequestration would require without furloughing employees for some period of time. Moreover, temporary furloughs may prove inadequate to the scope of the cuts that sequestration would require.  If the budget cuts persist well into 2012, the FCC may have to affirmatively reduce its workforce by laying off employees. Although the agency would incur high separation costs for each employee, layoffs may be the only way to achieve the requisite budget cuts.

A smaller, resource-strapped FCC will likely take longer to act. Fewer resources could mean, for example, that the merger review process will take longer than it does today. An extended review process could potentially delay consideration of the Sprint/Softbank transaction, the T-Mobile/MetroPCS acquisition, or AT&T’s various spectrum purchases.

Sequestration could also translate into FCC delays in processing applications for equipment authorization for new smartphones, iPads, notebooks and other computer devices. Equipment tests and certifications could be delayed. So could other laboratory tests that the FCC must complete before new devices are allowed to be sold in the United States.

The good news – to the extent there is any – is that some FCC programs would probably remain untouched, including the FCC’s auction program. Under its auction authority, the Commission can keep up to $85 million in funds raised at auction to develop, implement, and maintain the auction program. These funds cover the personnel and administrative costs required to plan and execute spectrum auctions. Retention of these funds is welcome news for the planning of the broadcast incentive auction since sequestration generally should not affect the timing of upcoming auctions.

Similarly, the $9.7 billion Universal Service Fund is effectively exempt from sequestration, so no change should occur in universal service collections and disbursements. Top recipients of the USF low-income support program, including American Movil, AT&T, Verizon, and Sprint, will welcome this news. Likewise, recipients of funds under the Universal Service for Schools and Libraries Program (commonly known as the E-Rate program) can take a sigh of relief since their funding will probably remain unchanged, too.

Although quirks of funding will exempt some FCC programs, such as spectrum auctions and phone subsidies, the FCC will face a serious challenge in conducting business as usual in the face of an effective 10% budget reduction for 2013. Unless Congress adopts a compromise by January 2, 2013 – or unless the FCC develops some fairly innovative ways of stretching its limited budget – the mandatory cuts could delay the work-a-day FCC programs on which many communications and technology companies rely.

Depending on precisely where and how the FCC implements the cuts, sequestration could mean anything from delays in the availability of cell phones and other electronic gadgets to less pricing pressure and reduced broadband deployment as a result of postponed merger-related synergies and delayed rulemakings. Hopefully, Congress will reach a compromise and the technology sector will avoid having to learn precisely what damage across-the-board FCC budget cuts could inflict. If no compromise is reached, however, the economic damage sequestration inflicts on the national economy seems unlikely to leave the communications sector unscathed.