DOJ May Investigate Telco Market Power: The Dawn of a New Paradigm For Antitrust?

Although the Department of Justice Antitrust Division (DOJ) has not confirmed it, the Wall St. Journal reported that DOJ is internally considering whether or not companies “such as AT&T and Verizon” have abused their market power. Most traditional antitrust lawyers I’ve seen quoted don’t think it likely the telcos have market power — especially given the hostility that courts have recently shown to antitrust. Indeed, in a world where even potential competition is supposed to be part of the market analysis, how can a modest 60% of the wireless market shared by the two companies, with no evidence of price fixing or coordinated behavior, support any sort of antitrust action?

Welcome to the more grown up and sophisticated view of market power in the more complex real world. After more than 25 years, U.S. antitrust authorities may be ready to reexamine the underlying limitations of antitrust in light of a new generation of economic scholarship on the subject of market power and the exercise thereof.

So are we at the dawn of a new age of antitrust, one that recognizes such modern economic phenomena as network effects, the power to constrain choice through non-disclosure agreements that create information asymetry, and the power of vertical integration to eliminate traditional geographic and product market distinctions? Will Christine Varney and John Lebowitz do to the the U of C worshipers of the gods of the marketplace as Copernicus and Galileo did to Ptolmey and his fanatics who preferred to reject the evidence of their eyes in favor of ever more complex theories of deferents and epicycles? Or will the judicial activists of the D.C. Circuit and the political might of the incumbents once again force regulatory agencies to abjure, curse and detest such heresies?

E pur si muove below . . . .

Brief Disclaimer First

I gotta say up front that while I’m always up for rooting out market power, it annoys me that the ILECs repeatedly get nailed while the Cablecos get away with competitive equivalent of murder. So while I’m happy to hear about the DOJ getting psyched up for a look at telco market power in multiple markets, I do hope this doesn’t put the FTC off of investigating TV Anywhere (or, as I am such the classics wonk today, I suppose I should phrase it Cableco delenda est). The unfortunate side effect of addressing only telco market power while ignoring cable market power in video creates an imbalance which weights the competitive field heavily to cable. If we want really competition, we need to stop treating this as a telco v. cable game and start going after market power wherever it rears its ugly head.

How Modern Antitrust Became An Impotent Backwater filed With Contented Incumbents and Bitter Would-Be Competitors

Most antitrust lawyers I’ve talked to in the last few years are either extremely bitter about what has happened to antitrust law or happily content, depending on whether they represent plaintiffs or defendants. Increasingly, the idea of antitrust law as being a means of preserving a competitive market has gone out the window in favor or a doctrine that requires not only explicit conspiracy, but a showing that the conspiracy couldn’t somehow end up being good for consumers in some imaginary universe dreamed up by a bunch of Federalist Society judges on a three-day bender. Mind you, at the end of the Bush Administration, the DOJ went so far as to declare antitrust enforcement illegal and contrary to the public interest, which tells you everything you need to know about how the Bush Administration squeezed the life out of this once vibrant area of law while the courts simultaneously raised the bar on private enforcement to make it damned difficult to bring a private antitrust action.

But this alone does not explain why antitrust law and its current practitioners seem so astounded at the notion of an antitrust investigation into telco market power. After all, in the last 8 years, we saw the wireline telecom market devolve into three major incumbent local exchange carriers (ILECS), two of whom gobbled up their largest competitors back in 2005 when Verizon swallowed MCI and SBC devoured the old AT&T and assumed her mantle as “Ma Bell.” Simultaneously, we’ve seen the wireless world drop to four national competitors with AT&T and VZ wireless controlling about 60% of the wireless customers, and, as a byproduct of absorbing MCI and AT&T, Verizon and AT&T also control 90% of the special access connections. So why is it that traditional antitrust lawyers are genuinely astounded at the notion that there might be some competition issues here for an antitrust agency to investigate?

The answer lies in the nature of antitrust analysis over the last 25+ years and how it has remained ossified while economic theory advanced. The core of current antitrust analysis goes back to 1982, when the DOJ and FTC adopted the Herfendahl-Hirschman Index (HHI) as the means of measuring market concentration and thus the cornerstone of antitrust enforcement. The HHI relies on defining specific product markets, geographic markets, and counting the number of suppliers of the product in the definied geographic market. As explained in the 1992 Horizontal Merger Guidelines, only if a market is “highly concentrated” will there be even a consideration of a possible antitrust violation.

To determine if your specific product and geographic market are “highly concentrated,” the HHI assumes that ten roughly equal sized firms are a competitive nirvana, and four equal-sized firms as “mildly concentrated.” Only if a firm has massive market share, or if the market drops to three or fewer players, does HHI analysis acknowledge the possibility of a dominant firm with market power. Otherwise, the theory goes, people will switch from one provider to another and a single dominant firm, or a group of firms without explicit coordination, will be unable to exercise market power.

Critical to this analysis are two ideas that really do not stand up very well when exposed to the real world. First, HHI assumes you can isolate the relevant markets with precision as to both product and geographic scope. Second, it assumes that all markets behave alike– so one can apply the HHI metric to any merger and determine based on the analysis (a) whether a market is concentrated, and (b) what divestitures or other steps are necessary to reach the right HHI result.

As time went on, and the policy world became ever more “free market oriented” (or, as I like to say “believing in the competition fairy instead of economics and regulation to promote competition”), courts and regulatory agencies weakened this analysis further. The Bell system reconstituted by narrowing the geographic scope of the analysis so that it became “local monopoly + local monopoly = no change in concentration and ignored the national market.“ Product markets were defined narrowly to make them more competitive, and ”potential“ anticompetitive impacts might be offset by ”synergies“ and other ”pro-consumer benefits.“ At last, even the potential for competition became enough to undermine the evidence of existing market share.

Meanwhile, Back In The Real World, Economists Got Tired of Epicycles And Developed New Theories

But while Washington D.C. remained frozen, economic theory evolved. The concept of network effects not even formally defined until 1985 (three years after DOJ adopted HHI as the standard) in papers by Farrell & Soloner and (separately) Katz and Shapiro has increasingly shaped economic study as networks have become ubiquitous and the power of network effects and switching costs to lock in customers and enhance market power have increased exponentially. The use of interlinked networks for a variety of commercial markets of potentially unlimited geographic scope has also created more complex market structures than the simple geographic market/product market paradigm employed by the HHI and — by extension — the DOJ, FTC and the courts.

The infusion of a new generation of antitrust enforcers, schooled in the new economics and witnesses to the increasing failure of the traditional HHI-based antitrust paradigm, may well see things very differently than the traditional antitrust bar. Empirical evidence all points to the ability to raise prices and shut out competitors with market share significantly lower than that considered highly concentrated by HHI standards. But whereas the previous generation dismissed such contradictions with approved University of Chicago orthodoxy with the same vigor as the Catholic Church suppressing Copernicus in favor of Ptolmey, the new generation applies a different framework. Network effects and switching costs can create lock-in that allows the exercise of market power at much lower levels of concentration, because these things make it much harder for customers to switch. The ability to suppress needed market information through non-disclosure agreements likewise allows for the exercise of market power by limiting choice. Vertical integration may confer significant advantages, particularly in complex markets.

For example, a competing wireless carrier might pay AT&T for roaming and for backhaul from its cell towers in the same market, two expenses AT&T will not incur for its own wireless service. The competing carrier will have no way to determine whether AT&T has charged it a fair price for either service, since the ubiquitous use of non-disclosure agreements prevents it from comparing the prices it pays with the prices AT&T charges others. At the same time, AT&T may limit the availability of desirable handsets because the millions of customers it does control provide it with an attractive enough customer base to demand an exclusive as a condition of reaching its customers at all. This exercise of market power further weakens the competitive position of the would be rival, which must pay higher prices for less attractive equipment.

So Now The Jedi Overthrow The Evil Empire And Restore The Republic? Ummm… Not Yet

Mind you, at this stage, everything is extremely tentative. While economics might characterize these market impacts as ”market power“ or ”monopoly/monopsony rents,” it is not at all clear that the D.C. Circuit will accept a new theory of antitrust enforcement any time soon. Nor is it even clear that the the DOJ or FTC will chose to pursue these new antitrust paradigms through enforcement action. Although the DOJ has no rulemaking authority (and FTC is barred from regulating common carriers), the agencies may use this investigation (and others, such as the investigation into Google’s connection with Apple) to issue policy statements that would set the course for future enforcement action. Or this might just fizzle out on its own.

But for now, I applaud the DOJ apparently making good on Christine Varney’s pledge to reinvigorate antitrust and her recognition of how important antitrust enforcement is to the digital economy. And if traditional antitrust lawyers find this difficult to swallow, I advise them to consider that there are perhaps more things in economics and in antitrust than are dreamt of in their jurisprudence.

Stay tuned . . . .