Deregulation and market concentration: an analysis of post-1996 consolidations.

• Author: Noam, Eli M.
• Position: Telecommunications Act of 1996: Ten Years Later Symposium

1. THE ISSUE II. THE CHANGING INDUSTRY STRUCTURE III. EMPIRICAL FINDINGS A. Vertical Concentration. B. Local Concentration IV. INTERPRETATION OF RESULTS V. OUTLOOK I. THE ISSUE

   For several decades, U.S. policy in telecommunications and electronic mass media focused on the encouragement of competition. This policy, usually known as deregulation but more accurately described as liberalization, is aimed at an opening of the market to competitors and a reduction of market power. There were numerous elements and proceedings to this policy by the Federal Communications Commission ("FCC"), the states' public service commissions and legislatures, the courts, and Congress. Of these actions, none was more comprehensive than the Telecommunications Act of 1996 ("1996 Act").

   What has been the impact of this policy? In this Essay, I will focus on one dimension: the impact of liberalization on market concentration.

   This question has acquired some urgency in light of the meltdown in the telecommunications sector following the boom years of the 1990s. That downturn may be temporary, and the industry will recover. But the more fundamental issue is that the telecommunications industry may have entered into a pattern of boom-bust cycles.

   While business cycles are traditional to many industries, in telecommunications they are a new phenomenon. Telecommunications used to be less volatile than the economy as a whole. It grew steadily, with long planning horizons hardly ruffled by the business cycle. But today, in sharp contrast, the telecommunications sector is potentially more volatile than the economy, more like the airline business and less like water utilities.

   Perhaps the major reason for instability has been the fundamental economic characteristic of many network industries with high fixed costs and low marginal costs. The telecommunications industry is characterized, on the supply side, by huge investments followed by tiny costs of serving additional customers, plus positive network externalities on the demand side. This creates economies of scale, scope, and networking. The resultant incentives are to be large and to expand early, which in the aggregate creates industry-wide overcapacity. Price competition then drives down prices to unprofitable levels. In telecommunications, price differentiation and asset redeployment are difficult, much harder than for airlines. Bust cycles follow. We have encountered the first of these cycles, but surely not the last, because the factors of instability will remain: low marginal costs, high fixed costs, inelastic demand, positive network externalities, lags in supply, disinvestment and regulation, and a Wall Street short-term perspective that amplifies industry cycles.

   If instability will be part of the environment, what will telecommunications companies do? The textbook responses are to cut costs, lower prices, differentiate products, and increase innovation. But these strategies can be expensive and will quickly be matched by competitors, which will leave every supplier firm even worse off.

   The other major strategy will therefore be to raise prices above competitive levels, and to reduce competition and the commodification that lowers profitability and future investments. To do so requires market power by a single firm or an oligopoly.

2. THE CHANGING INDUSTRY STRUCTURE

   We have, so far, concluded that industry concentration is a likely response to competition. Let us now turn to the empirical evidence for such concentration in telecommunications and related information industries. To provide an empirical answer, we looked at the market concentration trends...