Economic Underpinnings: The Economics of Telecommunications Networks, Market Power, and Vertical Foreclosure Theories

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CHAPTER I

ECONOMIC UNDERPINNINGS:

THE ECONOMICS OF TELECOMMUNICATIONS

NETWORKS, MARKET POWER, AND VERTICAL

FORECLOSURE THEORIES

A. Introduction

This chapter describes the characteristic features of

telecommunications markets and explains the economic underpinnings

for competition analysis of conduct and transactions involving the

telecommunications sector. It includes a detailed discussion of market

definition, a key element in a typical analysis of whether a firm has

market power. It also gives a general overview of the anticompetitive

effects that can result from the exercise of market power, including

horizontal competitive effects and vertical foreclosure theories.

Horizontal competitive effects include unilateral and coordinated

effects. A merger has unilateral effects if it “enhance[s] market power

simply by eliminating competition between the merging parties”

regardless of whether the merger causes a change in the way other firms

behave.1 A merger is said to have a coordinated effect if it “enhance[s]

market power by increasing the risk of coordinated, accommodating, or

interdependent behavior among rivals.”2

Vertical foreclosure generally refers to the use of vertical integration

or other vertical restraints by an input supplier to achieve market power

in an output market. Vertical foreclosure theories frequently arise in the

communications industry because a supplier of key inputs often is a

downstream competitor, which has implications for the incentives of the

vertically integrated firm and its customers and competitors. For

example, such theories partly motivated the vertical divestiture from

AT&T of the Bell Operating Companies in the mid-1980s.

1. U.S. DEP’T OF JUSTICE & FED. TRADE COMM’N, HORIZONTAL MERGER

GUIDELINES 2 (2 010) [hereinafter 2010 MERGER GUIDELINES].

2. Id.

2 Telecom Antitrust Handbook

B. An Introduction to Market Power in Communications Markets

The U.S. Department of Justice (DOJ) and the Federal Trade

Commission (FTC) are charged with preventing firms from acquiring an

increased ability and/or incentive to exercise market power and to

prevent the illegal maintenance of market power. The joint DOJ-FTC

2010 Merger Guidelines lay out their enforcement policy with respect to

mergers. The “unifying theme of these Guidelines is that mergers should

not be permitted to create, enhance, or entrench market power or to

facilitate its exercise.”3 Antitrust enforcement against monopolization or

attempted monopolization is based on core principles focused on “market

power and separating the legitimate, procompetitive ways it is acquired

and preserved, from the illegitimate, anticompetitive ways.”4

The Federal Communications Commission (FCC) also reviews

competition in the telecommunications industry. For mergers, it relies on

a public interest standard under which it considers, among other things,

whether the merger “would enhance, rather than merely preserve,

existing competition,”5 in contrast to the Clayton and Federal Trade

3. Id.

4. Joel I. Klein, Assistant Att’y Gen., Antitrust Div., U.S. Dep’t of Justice,

Rethinking Antitrust Policies for the New Econ omy, Haas/Berkeley New

Economy Forum, May 9, 2000, available at www.usdoj.gov/atr/public/

speeches/4707.htm.

5. E.g., Memorandum Report & Order, In re Charter Commc’ns & Time

Warner Cable, 31 FCC Rcd. 6327, 6338, ¶ 29 (2016) [hereinafter

Charter-TWC Order]. Pursuant to Section 310(d) of the Communications

Act of 1934, as amended, the FCC must determine whether the

Applicants have demonstrated that the proposed transfer of control of

licenses and authorizations will serve the public interest, convenience,

and necessity. 47 U.S.C. §310(d) [hereinafter 1934 Act]; see also 47

C.F.R. §25.119. In making this determination, the FCC assesses whether

the proposed transaction complies with the specific provisions of the

1934 Act, other applicable statutes, and the Commission’s rules. See

Charter-TWC Order, 31 FCC Rcd. at 6336 ¶ 26. If the transaction does

not violate a statute or rule, the FCC considers whether the transaction

could result in public interest harms by substantially frustrating or

impairing the objectives or implementation of the 1934 Act or related

statutes. Id. The FCC public interest evaluation necessarily encompasses

the broad aims of the 1934 Act, which include, among other things, a

deeply rooted preference for preserving and enhancing competition,

accelerating private sector deployment of advanced services, promoting a

diversity of information sources and services to the public, and generally

managing the spectr um in the public interest. Id. at 6337 ¶ 27.

Economic Underpinnings 3

Commission Acts, under which the DOJ and the FTC consider whether

the transaction “may be substantially to lessen competition.”6 The FCC

also considers competition in and market power in non-merger contexts,

such as when it has chosen to forbear from imposing certain regulatory

requirements (e.g., rate and entry/exit regulation) on non-dominant

carriers (that is, carriers that it has determined to lack market power).

The 2010 Merger Guidelines do not directly define market power.

Instead, the Guidelines identify the competitive concerns associated with

increased market power as encouraging “one or more firms to raise price,

reduce output, diminish innovation, or otherwise harm customers as a

result of diminished competitive constraints or incentives.”7

In antitrust economics, market power generally is defined as the

ability to profitably affect the market price of a good.8 In the economic

model of “perfect competition,” every firm is small relative to the market

and products are homogeneous, so no one firm can affect the market

price. In such markets, long-run equilibrium is achieved when prices are

equal to the marginal cost of the firms in the industry. In this stylized

setting, market power is defined as the ability to sustain prices above

marginal cost.

A key condition for firms to exercise market power is the existence

of barriers to entry.9 George Stigler defined an entry barrier as a cost for

producing a good that must be borne by a firm that wants to enter the

market, but not by firms already in the market.10 An entry barrier is

linked closely to the ability of incumbent firms to raise price above cost

and has also been defined as “the extent to which, in the long run,

established firms can elevate their selling prices above minimal average

costs without inducing potential entrants to enter the industry.” 11

6. 15 U.S.C. §18. See 1 PHILLIP E. AREEDA & HERBERT HOVENKAMP,

ANTITRUST LAW ¶ 114b (4th ed. 2013) (“In sum, antitrust policy in the

United States follows a consumer welfare approach in that it condemns

restraints that actually result in monopoly output reductions, whether or

not there are offsetting efficiencies and regardless of their size.”)

7. 2010 MERGER GUIDELINES, supra note 1, at 2.

8. See, e.g., William M. Landes & Richard A. Posner, Market Power in

Antitrust Cases, 94 HARV. L. REV. 937, 937 (1981) (“[The] term ‘market

power’ refers to the ability of a firm (or a group of firms, acting jointly)

to raise price above the competitive level without losing so many sales so

rapidly that the price increase is unprofitable and must be rescinded.”).

9. 2010 MERGER GUIDELINES, supra note 1, at 27-29.

10. GEORGE J. STIGLER, THE ORGANIZATION OF INDUSTRY 67 (1968).

11. JOE S. BAIN, INDUSTRIAL ORGANIZATION 252 (2d ed. 1968).