3 Authorizing Competition

AuthorScott Hempling
3.A. Historical summary
3.A.1. Electricity
3.A.2. Gas
3.A.3. Telecommunications
3.A.4. Three variables
3.B. Eliminating the legal monopoly at retail
3.B.1. Exclusive franchise
3.B.2. Obligation to serve
3.B.3. Consent to regulation
3.B.4. Quality of service
3.B.5. Power of eminent domain
3.B.6. Limited liability for negligence
3.C. Constitutional questions
3.C.1. Denitions: “Sunk costs” and “future prots”
3.C.2. Shareholder expectations of future prots
3.C.3. Shareholder expectation of sunk cost recovery
3.C.4. Concluding constitutional thoughts
Authorizing Competition
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The “central, continuing responsibility of legislatures and regulatory commissions” is
“nding the best possible mix of inevitably imperfect regulation and inevitably imper-
fect competition.”1
Long-distance and local telephone service, wholesale natural gas supply, wholesale electric
generation, retail electric and gas service, energy efciency and demand management: All
are services, historically provided by franchised monopolies, that some jurisdiction has
subjected to competition. These competition experiments continue, for those services and
new ones. Federal and state policymakers today are debating appropriate market structures
for broadband, gas and electricity storage, distributed generation, energy conservation,
“smart grid,” and other new services.
A forty-year ow of statutory change, agency action and court review reveals several
common steps. Each competition experiment starts with questions: For each candidate
product or service, will competition be physically feasible and economically efcient? Will
investors risk their dollars on the new competitors? Will competition lower prices, while
increasing quality and inducing innovation? How will those benets compare to poten-
tial losses in economies of scale and scope? How will we manage the risk that effective
competition does not develop, leaving incumbents with market power in unregulated mar-
kets? These are the non-legal questions, requiring the expertise of engineers, economists,
accountants, nancial analysts, technologists, marketing specialists, investors, consumers
and the market players themselves.
Once policymakers identify the products and services appropriate for competition, they
face three main legal steps, addressed in the three chapters that follow.
Authorizing competition: The six legal features of the traditional franchised monopoly,
discussed in Chapter 2, require revision for a market served by competitors. The exclu-
sive franchise protected the franchisee from competition. Utilities’ consent to regulation
allowed the government to constrain the franchisee’s actions without facing constitutional
challenges. The obligation to serve and quality of service standards ensured that all eli-
gible customers received satisfactory service. Eminent domain powers allowed the utility
to take private property when necessary to serve the public. Limited liability protected
the utility from lawsuits for ordinary negligence. Adapting these concepts to competition
requires legal changes. Those changes are the subject of this Chapter.
Making competition effective: Authorizing competition does not ensure effective com-
petition. It makes entry legal but not necessarily feasible. The policymaker still must
1. 2 A E. K, T E  R: P  I, at xxxvii, 114
(1970, 1988).
Chapter Three70
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address “entry barriers”—the difference in entry cost between incumbent and newcomer.
If new entrants are deterred by high entry costs, merely authorizing competition will not
protect consumers from excess prices and inadequate service. (Even with effective com-
petition, consumers still need protections against deceptive advertising, unsafe practices
and indecipherable contract terms.) One type of entry barrier is a physical facility that
is necessary for competition but owned or controlled by the incumbent. Examples are
electric transmission and distribution facilities, gas pipelines and distribution systems, the
telephone company’s “last mile,” and radio-frequency spectrum. Known as “bottleneck
facilities” or “essential facilities,” these assets cannot be economically duplicated by the
new entrant, yet are necessary for market entry. Then there are non-physical entry barriers
derived from the incumbent’s rst-mover advantage: economies of scale and scope, and
customer characteristics like loyalty, inertia and shopping inexperience. The legal steps
to mitigate these factors are discussed in Chapter 4.
Monitoring competition: The preceding steps change market structure by identifying
products and services appropriate for competition, authorizing competitive access and
reducing entry barriers. The nal step, once competition has been authorized and made
effective, is to monitor the market. Optimism about “competition” stimulates policy but
it does not guarantee results. Not every competitor plays fair—the rational incumbent
resists competition, while the new competitors can cut corners. These tendencies under-
mine the competitive forces freed by the prior two steps. Descriptions of these behaviors
and the regulatory responses are the subject of Chapter 5.
Experience being the best teacher, we begin our three-chapter tour with brief histories
of structural change in the electricity, gas and telecommunications industries.2 We then
turn to the main subject of this chapter: how policymakers have adjusted the incumbent’s
six legal characteristics to make room for newcomers.
3.A. Historical summary
Policymakers considering competition have wrestled with these questions: For which
products and services will competition likely help the consumer? How must we revise the
2. “Brief” and “tour” are the key words. These discussions are not substitutes for in-depth study of the
industries, for those who seek to specialize. Readers wishing more historic detail should consult works
specic to the industries of interest. See, e.g., T R T  T-
 (Eli Noam ed., 1983); Warren Lavey, The Public Policies That Changed the Telephone Industry
into Regulated Monopolies: Lessons from Around 1915, 39 F. C. L.J. 171 (1987); William Byrnes,
Telecommunications Regulation: Something Old and Something New, in T C A:
A L H   M A, at 31, 90–99 (Max Paglin ed., 1999); R-
 P & E G, R I   N (1999); J T &
R C, E L   N (2011); S B, C L
 P § 5.01[4] (2012); S M B, H A. S, J B. S &
P J. W, T L  P, chs. 4–5, 8–12 (3d ed. 2012); E L
 T (William A. Mogel & David J. Muchow eds., 2012); W A. M, R-
   G I (2012).
71Authorizing Competition
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