Network Industry Markets: Telecommunications

• Pages: 411-436

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CHAPTER X

NETWORK INDUSTRY MARKETS:

TELECOMMUNICATIONS

A. Introduction

What is unique about a telecommunications network? One author

observes, “[t]he crucial defining feature of [such] networks is the

complementarity among the various nodes and links. A service delivered

over a network requires the use of two or more network components.

Thus, network components are complementary to each other.”1 This

complementarity also extends to the relationship that exists among users

of the network (i.e., its customers). In most markets, the value of a

product or service to any given purchaser is generally unaffected by the

extent to which it is purchased by other consumers. In the special case of

a network-based market, the extent to which other consumers participate

in the same network directly affects its value and, ultimately, the demand

for the services it offers. Since the purpose of telecommunications

service is to provide real-time connectivity among individual users, the

more users (members) of the network, the greater its value to each user.

As one article notes, “[i]n a communications network . . . each user

desires to link directly to other users. Consequently . . . the demand for a

network good is a function of both its price, and the expected size of the

network.”2

1. Nicholas Economides, Public P olicy in Network In dustries, in

HANDBOOK OF ANTITRUST ECONOMICS 469, 470 (Paolo Buccirossi, ed.,

2006), availa ble at

http://www.stern.nyu.edu/networks/Economides_Public_Policy_In_Netw

ork_Industries.pdf.

2. Michael I. Katz & Carl Shapiro, Systems Competition an d Network

Effects, 8 J. ECON. PERSP. 93, 96 (1994) (citation omitted), a vailable at

http://socrates.berkeley.edu/~scotch/katz_shapiro.pdf; see also Verizon v.

FCC, 535 U.S. 467, 490 (2002) ( “A mininetwork connecting only some

of the users in the local exchange would be of minimal value to

customers, and, correspondingly, any value to customers would be

exponentially increased with the interconnection of more users to the

network.”).

412 Market Definition in Antitrust

The benefits that each network customer realizes when additional

customers use the network—demand-side economies of scale—are

known as network effects.3 Large telecommunications networks thus

benefit from both demand-side and supply-side effects—the former

increases the overall value of the network, and the latter decreases the

cost of its operation.

Not all industries with networks exhibit network effects. Consider,

for example, a water distribution network that delivers water to

consumers’ homes or other premises. Typically, only one water utility

serves a local area because of the extremely high fixed costs associated

with such distribution infrastructures. The consumers in that area,

however, do not care which or how many other locations are being

served by that same infrastructure. Indeed, even if the water consumer

requires service at multiple premises, there is little or no reason for that

consumer to prefer that each of those premises be served by the same

water utility because, with respect to water delivery, each location is

independent. Similarly, retail chains (a form of networks) may realize a

variety of supply-side scale and scope efficiencies not available to

independent retailers, but there is little inherent benefit to an individual

consumer if a retailer with a store in her neighborhood also has locations

across the country or if her next-door neighbor also shops at the same

chain. These types of networks affect the supply of the firm’s products

or services, but have little direct impact on the demand for those

products.4

This chapter focuses principally on the demand effects of

telecommunications networks. It first describes market definition issues

in traditional telephone service, then discusses these issues in the context

of a much newer network, the Internet.

3. In some ca ses, networks may serve more than one type of customer, and

customers of one type may b enefit from the presence of more customers

of the other type. For example, credit card companies market to

merchants and shoppers, and shoppers prefer a card accepted by more

merchants. See Chapter XI for further discussion of two-sided markets.

4. Such firms may, nevertheless, seek to increase the value of their products

or services by developing demand-related network effects. Lo yalty

marketing (e.g., frequent flyer, frequent hotel guest, etc.) programs

achieve this outcome by linking what are o therwise unconnected

purchases from the consumer’s perspective. Pharmacy chains that offer

consumers the ability to fill prescriptions at any store location similarly

translate broad network coverage into increased value of each stor e

compared to nonconnected independent pharmacies.