The role of efficiencies in telecommunications merger review.

Author:Goldman, Calvin S.

    1. The Rise and Fall of the Telecom Industry

      In the last decade, the telecommunications industry has experienced significant growth and consolidation in response to such external factors as deregulation and liberalization, technological change, and global market forces. (1) In addition, industry consolidation has occurred to achieve greater economies of scale and scope through more efficient deployment of network infrastructure.

      Moreover, the desire of large, multinational customers to obtain fully integrated, end-to-end global telecommunications services from a single source (a "one-stop" telecom shopping experience, if you will) has created the impetus for telecom firms to offer multiservice broadband and seamless worldwide telecommunications networks. However, a major barrier to achieving this goal is the significant capital required to construct and deploy a global network and to develop innovations necessary to provide advanced services. In order to overcome this barrier, telecom companies typically adopt cooperative approaches to network building--such as mergers and acquisitions, joint ventures, legal partnerships, and strategic alliances (collectively referred to as "M&A")--that combine complementary skills, technologies, and geographic reach, and achieve greater economies of scale and scope. As a telecom company expands its network and customer reach, its attractiveness as a potential global partner is also enhanced. A broader capacity and customer reach creates internal efficiencies that can result in lower costs for subscribers.

      The telecom industry consisted traditionally of legally mandated monopolies that were regulated by governmental authorities. Technological advances, including the development of alternative infrastructures and new services, have dramatically altered the economics of telecom services and have made possible the potential for competition to replace regulation in at least part of the services provided. The deregulation of the industry during the last decade has allowed telecom firms to achieve economies of scale and scope by (1) expanding into new product or geographic markets or gaining market entry across traditional industry lines and (2) integrating network infrastructure and content. In a deregulated environment, telecom firms may seek to provide a "bundle" of products and services, particularly with the technological convergence of the telecom and cable industries.

      New technologies also stimulate M&A activity. For example, the provision of broadband access services in the homes of consumers and the ability to combine content with transmission were key factors behind many telecommunications mergers. Further, the erosion of trade restrictions and other international regulatory barriers facilitated increased cross-border telecommunications activity as well as the number of mergers and joint ventures among international firms.

      While rapid growth contributed to industry consolidation during the last decade, the recent downturn in the telecom industry may also result in further industry consolidation during the next several years. For example, in anticipation of a huge global demand for high-speed broadband transmission capacity, network owners and operators invested considerable capital in global fiber-optic networks only to discover that actual demand levels remained a fraction of built capacity. As a result, a glut of transmission capacity exists globally, leaving network owners and operators struggling to "fill their pipes." These network assets are now prime for acquisition by the larger and more stable carriers seeking to expand their networks. Further, while deregulation efforts in the North American telecommunications industry were aimed at promoting and facilitating competition in all areas, the state of real competition in some sectors remains questionable with many participants, including long-distance providers, competitive local exchange carriers ("CLECs"), and wireless providers, experiencing financial difficulties. (2) Again, the network assets of these companies may be seen as attractive to those companies seeking to expand their geographic reach or service offerings.

      Finally, in Canada, the anticipated removal or relaxation of the foreign ownership restrictions relating to facilities-based telecom carriers and broadcasting distribution undertakings will provide further opportunities for international consolidation. (3)

    2. The Evolution of Efficiency Analysis

      The focus of competition policy on the promotion of efficiency has not always been clearly understood and remains controversial. Historically, U.S. competition authorities and U.S. courts were hostile to M&A that significantly increased market share concentration, regardless of whether they produced efficiencies. Today, there remains under U.S. antitrust laws a cautious hesitancy toward permitting efficiencies to trump concentration concerns in all but close cases. Moreover, telecom M&A activity involving U.S. operations adds an additional layer of complexity in that most telecom transactions are also subject to approval by the U.S. Federal Communications Commission ("FCC"), which applies a broad public interest standard that gives due consideration to efficiencies benefits when determining whether, on balance, the transaction is in the public interest.

      Although the European Union appears to have recognized the advances made in economic and financial theory during the latter half of the twentieth century in drafting the European Community Merger Regulation ("ECMR"), (4) to date, efficiencies have been more of a detriment than a benefit to merging entities. In contrast, not only has the Canadian Government adopted legislation that expressly authorizes the consideration of efficiencies, but the courts in Canada have also applied the legislation so as to permit full consideration of efficiencies. As the marketplace continues to evolve globally, convergence among the major enforcement authorities on fundamental competition principles, such as the role of efficiencies, will be critical.

      It is not surprising that the treatment of efficiencies remains controversial, if not confused. There exist several difficult and determinative factors and policies surrounding the implementation of efficiencies, including: (1) what type of efficiencies should count, (2) what welfare standard should be applied, (3) what standard of proof should be imposed, and (4) how efficiencies should be factored into the analysis. As discussed later in this paper, there are neither easy nor consistent answers.

      This paper is divided into four parts. In the first part, we explore some of the efficiencies-based motivations and rationales for telecom M&A. In the second part, we review the procedures and regulatory authorities responsible for telecom merger review in the United States, Europe, and Canada. In the third part, we examine the treatment of efficiencies in the context of merger review in the three jurisdictions. Finally, we discuss some of the outstanding policy issues relating to the treatment of efficiencies.


    1. Introduction

      Traditional "production-based" theories posit that the primary motivations for mergers are the acquisition of market power and the achievement of economies of scale. In combining resources and customers, firms hope to create market power by eliminating actual competition or potential competition. In addition, because many television firms are still subject to substantial economic regulatory oversight, some mergers are undertaken to enable a firm to avoid effective regulation or facilitate the company in leveraging its existing monopoly power in the regulated market into another unregulated market. (5)

      Ignoring goals of market power, which of course do not sit well with competition authorities, M&A in the telecom sector can allow firms to increase geographic reach or expand small-scale operations into large-scale ones. Following the completion of a merger, some firms find that they can offer a less expensive, more efficient, and broader range of services to consumers through joint production, while others can leverage their existing networks for better capacity utilization. In particular, operating efficiencies may result from combined networks through reduced leased-line costs, the avoidance of expensive termination charges internationally and domestically, the combination of infrastructure assets, and the sale or redeployment of redundant assets.

    2. Production-Based Theory and Economies of Scale and Scope

      In general, whenever a merger expands a network, cost savings associated with production efficiencies may result through conventional economies of scale and, to a lesser degree, economies of scope and density. As firms seek to achieve optimal scale, inefficiently scaled firms will be driven from the market by exit or acquisition. Merging the operations of two firms may reduce duplication, allow fixed expenditures to be spread across a larger base of output, and permit firms to reorganize services across their combined networks.

      Production efficiencies include savings that flow from specialization, elimination of duplication, reduced downtime, smaller base of spare parts, smaller inventory requirements, and avoidance of capital expenditures that would otherwise have been required. Further savings can arise from the rationalization of research and development ("R&D") activities and various administrative and management functions (e.g., sales, marketing, accounting, purchasing, finance, and production). In addition, M&A can bring about efficiencies in relation to distribution, advertising, and capital raising. (6)

      Companies also can increase productive efficiency through economies of scope. Such savings result from the cost savings of providing two products or services together rather than separately. Potential sources of scope...

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