October 26, 2015 3:08 PM

Why Is the FCC Hiding the Ball on Special Access Price Regulation?

On October 16th, the FCC issued an Order Initiating Investigation and Designating Issues for Investigation ("Investigations Order") concerning the provision of point-to-point data transmission services ("special access") by the country's largest incumbent LECs (AT&T, CenturyLink, Frontier, and Verizon).  These services, when provided by ILECs, are still subject to FCC price regulation.  Although the FCC has "de-tariffed" many of these services, much like the recently re-classified "Broadband Internet Access" service, ILEC special access services remain subject to Section 201's requirement that they be "just and reasonable."  

The Commission's Non-Price "Concern"

Superficially, the FCC's investigation is about the ancillary effects of the volume and term commitments that some CLECs have agreed to in order to receive the ILECs' lowest prices on special access services.  However, the Commission's overview and explanation of its concerns suggest that its inquiry is much broader than the competitive concerns with discount contracts that have been identified in the case law, and associated economics literature, the Commission briefly discusses.  See, Investigations Order at n. 54.

The Commission's only potentially-legitimate non-price concern is succinctly stated only once in the entire first 12 pages of the Investigations Order.  The FCC quotes a CLEC ex parte letter arguing that the term and volume commitments in the ILEC tariffs "shrink[ ] the addressable market for competitive wholesale special access providers (thereby preventing them from achieving minimum viable scale), and cause[ ] special access prices to remain higher than would otherwise be the case."  Investigations Order, Paragraph 12 [internal citation omitted].  

Everything else the Commission identifies as a question, or unresolved contention between the ILECs and CLECs, is more properly classified as "something that the CLECs don't like having to do in order to get the lowest possible prices."  The CLECs' gripes are certainly reasonable (from their perspective), but they are not competition-affecting issues; they are bargaining issues.

When Good Discounts Go Bad

One issue (out of many the FCC identifies) is that conduct that is otherwise competitively benign "may be impermissibly exclusionary when practiced by a monopolist." See, U.S. v. Dentsply, 399 F.3d 181, 187 (3d Cir. 2005).  Sometimes monopolies (firms with market shares approaching, or greater than, 80%) will use "discount contracts" as a way to limit the ability of new entrants to enter the market for the product/service being offered through the discount contracts.  The FCC references some of these cases in n. 54.  Let's take a closer look at a representative case in order to better understand situations in which these agreements can injure competition.

In ZF Meritor, LLC v. Eaton Corp., 696 F.3d 254 (3d Cir. 2012), the product market was heavy duty transmissions for big trucks, such as 18 wheelers, cement mixers, and garbage trucks.  The defendant, Eaton, was a monopolist in the U.S. heavy duty transmissions market from the 1950s until Meritor entered in 1989.  By 1999, Meritor had garnered a 17% share of the heavy duty transmissions market.  In mid-1999, Meritor and a leading European heavy-duty transmissions manufacturer, ZF AG, formed a joint venture to adapt a popular ZF AG model to the U.S. market.

In the U.S. market for heavy duty transmissions, there are 4 direct purchaser customers; these firms are the original equipment manufacturers ("OEMs").  Truck buyers, the ultimate consumers of heavy duty transmissions, purchase trucks from the OEMs by "assembling" components from the OEMs' catalogs.  It is, therefore, vitally important for a component part manufacturer to be listed in the OEM catalog--and on reasonable terms.  

From late 1999-2000, the U.S. trucking industry experienced a 40-50% decline in demand for new vehicles.  Shortly thereafter, Eaton entered into new long term agreements ("LTAs") with the 4 OEMs.  Long term agreements were not uncommon in this industry, but Eaton's new agreements were "unprecedented" in their length (the shortest were for a minimum of 5 years).

The new LTAs provided the OEMs with substantial up-front cash "rebates" of $1-2.5 million.  In exchange, the OEMs agreed to use Eaton transmissions in a very high percentage (usually, >90%) of their vehicles sold.  If an OEM missed its sales targets in any year, it was required to return in full all "advance" rebates it had received from Eaton.  Finally, the agreements required OEMs to artificially increase the price of ZF Meritor transmissions by $150-200, and to impose additional "penalties" on customers that still chose ZF Meritor transmissions.

By 2003, ZF Meritor determined that it was limited to no more than 8% of the market due to the Eaton's agreements with the OEMs.  ZF Meritor needed to get at least 10% of the market in order to remain viable, so it adopted a strategy of trying to sell directly to the end-user customers.  Nonetheless, at the end of 2005, its market share had dropped to 4%, and, in January of 2007, ZF Meritor exited the market.  Shortly thereafter, ZF Meritor sued Eaton on antitrust grounds. A jury returned a verdict in favor of ZF Meritor, which was upheld on appeal by the 3d Circuit Court of Appeals.

The Commission's Investigation of Dissimilar Discounts

Every antitrust case involving discount contracts, as well as the economic literature cited by the Commission, has several facts in common with the ZF Meritor case. First, the product or service has to be an input to the product or service the customer sells to its customers.  Second, it must be the case that only 1 firm can supply the majority of any customer's demand for the input, and, that firm almost always has a market share of 80% or greater.  Third, the primary "victim" of the contracts is not the purchaser, but rather the direct competitor, of the seller.

Finally, and this last condition is implicit, but the most important for our purposes.  In every instance where discount contracts have been found to harm competition, these contracts affect the entire relevant market for the product or service (or a very high majority of that market)If a new entrant can enter the market (for the same service the dominant firm is supplying through its "discount contracts") without selling to the same customers, then the discount contracts can have only a speculative and de minimus effect on competition--regardless of  how "unfair" they may seem to an outside observer.

Do CLECs Represent the Majority of Demand for Wholesale Data Transmission Services?

This, of course, is the first question the FCC should have addressed if it was genuinely concerned about competitive conditions in the wholesale transmission market.  To understand the importance of CLEC demand to the capital deployment decisions of competitive wholesale network service providers, let's look at a competitor that successfully entered the market after the FCC started its special access inquiry.  Zayo, according to the company history on its website,

was founded in 2007 in order to take advantage of the favorable Internet, data, and wireless growth trends driving the demand for bandwidth infrastructure, colocation and connectivity services.

So, if the ILECs have tied up the demand of some CLECs--which could otherwise go to competitors like Zayo, then who is buying from Zayo instead of the ILEC?  Fortunately, Zayo solves this mystery in a presentation to investors in May of this year.  
zayo_sales channels from pdf.jpg

What?  Zayo is selling to some of these same CLECs and those wascally ILECs?   In fact, as we can see, while wireline providers--including those same special access sellers that are under investigation--do constitute the largest group of potential customers for a new entrant, they are still only a minority of total market demand.  Moreover, it is hard to say how much the incremental CLEC demand would be--if not "locked down"--but it's doubtful that it would make the pie a whole lot wider. 

Why Does the FCC Insist on Its Ruse of an Investigation?

We've previously pointed out that "ILEC special access" is not a relevant product market.    Because "ILEC special access" is not a relevant market, it's not at all surprising that the FCC cannot point to a single, specific, direct competitor victim.  Instead, the Commission seems quite willing--perhaps too willing--to simply accept the purchasers' assurances that a victim exists; just a more "theoretical" victim than the antitrust laws protect.   

So, if the Commission's ostensible question for "investigation" is nothing more than the thinnest veneer to disguise price regulation, why is the FCC even bothering with the pretense of an investigation?  While it doesn't make much sense to price-regulate a fraction of a "market," if that's what the FCC wants to do, then it should at least regulate prices in a transparent manner.  Good government isn't always smart, but it should always be transparent to its citizens.

October 5, 2015 11:46 AM

Special Access Regulation: Always Best for Retail Customers?

The notion that extending regulation of ILEC special access could be bad for anyone (who's not an ILEC), much less retail business customers, may seem incongruous.  After all, if the competitors--who are serving real business customers--are in favor of imposing regulations on ILEC special access, then how could it possibly hurt their customers? 

Competition, Contracts, and Consumer Inertia

Last September, Chairman Wheeler described the mass market for broadband Internet access as so non-competitive that it made little difference if a customer faced a monopoly, or had a choice of service provider.  The Chairman stated,  

[c]ounting the number of choices the consumer has on the day before their Internet service is installed does not measure their competitive alternatives the day after.

Speech at 4.  The reason, he explained, is that "[o]nce consumers choose a broadband provider, they face high switching costs [like] . . . early-termination fees. . . .  Id.  Interesting observation, but is it accurate?   

Well, in April of 2010, the FCC surveyed a representative sample of broadband subscribers about their broadband purchasing/switching behavior over the prior 3 years.  The Commission found that 36% of customers had switched broadband providers in the past 3 years (compared with 19% of mobile customers switching providers over the same period). Survey at 6, 10.  Of the consumers that had switched ISPs, the overwhelming majority (86%) said the process of switching providers was either "very easy" (56%) or "somewhat easy" (30%).  Survey at 10.

Instead of describing any unique market failure in the consumer broadband Internet market, what Chairman Wheeler intuitively sensed was the phenomenon of "consumer inertia."   Consumer inertia is a behavioral tendency in markets where products are purchased through contracts--like cable TV, or insurance.  In these markets, consumers may aggressively shop for their initial service, but then neglect to continue to monitor market prices and, thereby, over time receive less competitive terms.

Consumer Inertia Is Good for Competitors, But Not Customers

The effect of customer inertia--on their service providers--is best illustrated by the fact that there are a lot of locations where competitors are serving retail customers with ILEC special access, even though competitive fiber is available.  See, e.g., T-Mobile example in last blog.  One reason that a CLEC will not automatically use competitive fiber when it becomes available is that each time a retail customer location switches to a different physical transmission line, the CLEC must physically "groom" the retail customer's premise equipment (modems/servers/PBXs) onto the new network.
groom5.jpgCarriers Hate Physical Grooms.  A physical groom is a hassle for both the CLEC and the customer.  To better understand why, let's consider a hypothetical example. 

Let's say you're a CLEC, and you're serving a customer with 5 locations in a metro area.  Your own fiber is serving 3 of the customer's locations, and the other 2 are served via ILEC special access.  To get those 2 special access locations on anyone's fiber, you (and your customer) have to physically be present to: 1) allow physical access/wiring by the new access vendor, and 2) configure/test the customer's new service.  Also, to mitigate the consequences of any service disruption, this usually happens at 3:00 in the morning, preferably on a weekend.

falling down2.jpgIf the worst happens, the business customer could temporarily lose service, lose business, or even end up causing their IT guy to turn into the Michael Douglas character from Falling Down.  The risk varies, but it's always there, and that's without the nastier risk of . . . competition. 

Customers Love New Fiber Facilities.  Physical grooms are hard on carriers, but customers love how a groom just "wakes them up!"  You see, the retail business market works kind of like Chairman Wheeler imagined the mass market for broadband Internet service to work--at least in the sense that business telecom contracts really do have high termination penalties.  See, e.g., these small business customer complaints to the BBB about tw Telecom.  Early termination penalties--after the original contract term--may even promote consumer inertia.  But, things change when the service provider wants to change the customer's physical service configuration.

In fact, nothing disrupts consumer inertia like the customer spending a lot of time on the phone with their current supplier (as a customer might do to prepare for a coordinated service cutover).  In fact, since the CLEC is only coordinating with the customer because it has alternatives, it's only a matter of time before the customer starts thinking the same thing.

So, referring back to our previous example, let's say you're the CLEC and have been serving this customer for 7 years.  And, let's say that the customer has had no disruptions/complaints in that 7 years.  You've been sending out bills and they've been sending out checks; it's every carrier's "fairy tale" customer relationship! 

Then, you try to do something nice by putting the customer's special access locations onto competitive fiber, and what happens?  The customer's eye starts wandering, suddenly nothing in your contract is good enough for them anymore, you become clingy, and, before you know it . . . the "fairy tale" unravels in tears and bitter rancor?!
groom4.jpgWell, it's not always that bad.  But, at best, if you want to keep the customer, you're probably going to have to lower their price, and stop coming home drunk (or the telecom equivalent).  So it's kind of easy to see--from the CLEC's point of view--why, if a customer's service was initiated using ILEC special access, they would need a really good reason to take the customer off that service.
*     *    *

Some carriers are lobbying for the blanket extension/expansion of special access regulation, because this service fits comfortably with the network architecture they decided on 15-20 years ago.  But, Chairman Wheeler recognizes the limiting effects of inertia on retail consumers, and he knows better than to simply assume that the outcome favored by service providers is also the best outcome for their customers.  If the effect of extending special access regulation is to keep retail customers believing that their choices are no different than "the day before they had their service installed" many years ago, do these carriers really believe the FCC will think this is the best choice outcome for consumers? 

September 24, 2015 11:10 AM

ILEC Special Access: Is It a "Relevant Market?"

I was troubled to see the FCC, in its Technology Transitions Order, tell ILECs that they would not get the full benefit of their new fiber deployments until the Commission concludes its "review" of competition in the "special access market."  Order, paras. 101-143. Then, last Thursday, the FCC announced that it had taken a "major step" in its review of competition in the special access "market" by making its collected data available to the parties.  And, that made me feel a lot better.  (just kidding!)

The FCC should be moving forward with its review, if only because it's been 14 years since AT&T first petitioned the FCC to revisit its 1999 Pricing Flexibility Rules.  However, the fact that the FCC has not, more recently, focused on the threshold question of whether ILEC special access service is even a distinct "relevant market" should give the public doubts about how quickly this matter will conclude.

You see, the FCC can never justify economic regulation for the benefit of "consumers" if the regulation does not apply throughout the entirety of a rationally-defined market.  For example, last September, Chairman Wheeler explained in a speech that he believed cable to be dominant over the most important part of the consumer broadband market (25Mbps and above), yet the FCC's Open Internet rules applied much more broadly.  Likewise, the last time the FCC made rules affecting ILEC special access, point-to-point data transmission was only widely available from the ILEC.

As a rational matter, unless the Commission's rules cover (at least the majority of) an entire relevant market, its rules cannot possibly provide benefits to consumers in that market.  Here's why it's doubtful that "ILEC special access" services constitute a relevant product market in most parts of the country.   
It's Not a Market If Similarly-Situated Customers Don't Use It

Several years ago, the FCC had a "forum" on special access, and you know what?  Everyone was old!  And, so are the companies and carriers that buy a lot of ILEC special access.  The next time you see a story about special access, look at the age of the companies complaining.  I guarantee you that they all started before 2000.

Why aren't there any "young" companies complaining about special access?  Well, probably for the same reason there's no young Bingo players:  it's not that fun, and younger gamblers had better alternatives when they picked up the habit.

bingo lady1.jpg
switchboard operator1.jpgBandwidth Intensive Customers Don't Need ILEC Special Access.  If this isn't obvious, just look at the blog where I explained why Google (and other content delivery companies) took Netflix's "interconnection service" candy at the 11th hour of the net neutrality proceeding.  Netflix was trying to obtain--through regulatory pan-handling--the same benefits that these companies had invested so much capital to create through their own networks. 

The appendix at the end of the blog shows network investment by companies that were new enough to not need special access, but yet old enough to have purchased high-bandwidth transmission capacity at "rock bottom" prices in the wake of the 2002 telecom meltdown.  These companies would never have invested that kind of money to build their own networks if they were destined to be dependent on ILEC special access.

Small/Medium Retail Customers Have Non-Special-Access Competitive Alternatives.
One might argue that it's unfair to just look at the most bandwidth-intensive customers, because CLECs often rely on special access to serve fairly small (in terms of number of locations) business customers.  I couldn't agree more.  That's why it was interesting that just last week, Comcast Business Services announced that they are able to serve multi-location business customers throughout the country through wholesale agreements they have struck with other large regional incumbent cable companies.   

While Comcast's announcement focused on the fact that it could now (with out-of-region wholesale agreements) serve large national multi-location customers, the more interesting point was that it's in-region business unit (small/medium customers) has been the fastest growing part of its business for the last several years.  Similarly, the success of "bring your own access," web-based business providers, like RingCentral and ShoreTel is further testament to the fact that small and medium business customers generally do have choices for competitive phone service--regardless of whether the customer's existing CLEC provider can use these substitutes as wholesale inputs for their retail service.

The bottom line is that it's not a "market" if not everyone needs it--then it's just a brand.  But, even old customers of old brands can find it in themselves to switch brands . . .  

It's Not a Market If There Are Substitutes

You know what's interesting if you compare who filed comments in this proceeding 10 years ago with the companies that are still active now?  It's who's missing.  Any guesses?  Hint: what's different between these two?

John_Legere1.jpgchristopher_walken1.jpgNo matter what your lyin' eyes are telling you, these are not a "before and after" picture of the same guy.  One is T-Mobile Chairman John Legere (before he became a hippie), and the other is John Legere look-alike Christopher Walken.  

When the FCC kicked off its special access review, in 2005, T-Mobile filed essentially the same special access comments as Sprint.  But, after the introduction of the iPhone in 2007, it became clear (to everyone not named Sprint) that mobile data was the future of wireless, and bandwidth constrained cell-sites would not satisfy, or attract, customers for long.

Hence, T-Mobile took its first major step in quitting special access in the Fall of 2008, when it named 6 new vendors of advanced fiber backhaul solutions.  By February of 2010, it was reported that T-Mobile had replaced copper backhaul with fiber in 7% of its towers, with plans to raise that number to 25% of its towers by the end of 2010.  Finally, in August of 2012, T-Mobile announced that it had upgraded all of its cell sites to advanced backhaul services, 95% of which were served by fiber.

The T-Mobile example is indeed dramatic.  But, just as T-Mobile switched tens of thousands of locations to fiber, there are other successful wireless competitors that entered the market after T-Mobile, like Cricket and Metro PCS (acquired by AT&T and T-Mobile, respectively), that never used ILEC special access (or at least never complained about it to the FCC).

*    *    *

Some CLECs have pointed out that there are always going to be some significant number of buildings that will only be accessible via ILEC facilities. But, this fact does not make those locations a "market,"  because, there is no evidence that the ILECs price services to these locations any differently than they do for the bulk of their customers that do have access to competitive alternatives. 

Thus, the FCC cannot rationally conclude that there is a separate "market" for a subset of an ILEC's customers (that the ILEC does not treat differently) for a service that not all of the ILEC's competitors, or retail customers, need to use.  And this is why this proceeding will not conclude anytime soon.

May 29, 2015 2:20 PM

The Historical Evidence Supporting the ISP Discrimination Theory

The primary justification for "strong" net neutrality rules is always that there is insufficient competition in the infrastructure services market.  The theory that insufficient competition in an Internet access market enhances the ISP's incentives/ability to discriminate against "off-net" traffic sources (content, applications, or interconnection facilities of smaller rivals) is a foundational premise of the Commission's recent Net Neutrality/Broadband Reclassification Order

Today, we're going to look at the origins of this theory--in competition law--and whether there is any historical evidence to validate this concern.  This may seem risky, because if historical evidence isn't conclusive, it can be claimed as "support" for a lot of different theories. 

giorgio-wheeler meme3.png         
For example, "ancient astronaut theorists" (as the History Channel calls the UFO crowd) point to surprisingly-advanced ancient wonders throughout the world (e.g., pyramids, or other very large inland structures) as "evidence" that aliens were responsible for these accomplishments.  While some [non-History-Channel-viewers] will be inclined to dismiss ancient astronaut theories, these theories cannot be disproved, either.  On the other hand, if the historical evidence is conclusive, it can rule out inconsistent theories.  Is "ISP market share=interconnection degradation" theory at least as viable as ancient astronaut theories?

WorldCom "Will . . . Become the Internet"

The quote above was from an antitrust complaint, filed by one of WorldCom's smaller rivals in the Internet backbone market, in 1998.  GTE Complaint at ¶2.a.  (emphasis in original)  The smaller rival was no beginner, it was GTE--the country's largest integrated local/long-distance telephone company (at a time when virtually all Internet traffic was carried on telephone company facilities). 

Moreover, GTE wasn't crazy to be concerned.  If you had a crystal ball, you could not have positioned yourself better than WorldCom did through a series of acquisitions from '94-'96, which--you may recall--was when the commercial Internet took shape.  By the end of 1997, WorldCom was the largest provider of Internet backbone capacity in the country. 

So, when WorldCom sought to acquire the second largest Internet backbone--MCI--in November 1997, the DoJ was concerned that the post-merger firm would control between 40-70% of the Internet backbone market.  In early 1998, the Economic Policy Institute estimated that 62% of the entire Internet's revenue would need to traverse the MCI WorldCom backbone, and 50% of all ISPs would be dependent on access to the firm's backbone network. 

A Flawed Theory Takes Root

GTE believed so strongly that the MCI-WorldCom merger threatened its ability to compete in both the Internet backbone, and long-distance, markets that it filed its own private antitrust suit to enjoin the MCI-WorldCom merger in May 1998.  In GTE's Complaint, the company explains its concerns:

all of the major backbones . . . are . . . dependent upon each other for interconnection. They thus find it in their independent interests to cooperate to maintain and upgrade the capacity of interconnection among their networks in order to offer their customers ubiquitous, high-quality access to the whole Internet. . . .  By concentrating . . . the two largest Internet backbone networks to create one dominant national network, the merger will give MCI-WorldCom a stranglehold over the burgeoning Internet and the incentive and ability to stifle competition from all other rival Internet backbone operators, including GTE.
GTE Complaint, at ¶2.a.  Interested readers should look at GTE's full Complaint, as (I promise) you'll find it all sounds very familiar. 

GTE's case never made it to trial, because the facts of the Complaint would soon become less clear.  In July of 1998, MCI agreed to spin off its own Internet backbone to Cable and Wireless; after which the DoJ cleared WorldCom's pending acquisition of MCI with a press release.  The FCC issued its Order clearing the transaction soon after the DoJ's Press Release. 

"So Much for Grand Efforts by Regulators to Dictate Outcomes"

MCI's divestiture of its Internet backbone didn't work out as the DoJ and FCC had hoped.  There were soon allegations that MCI had "pulled a fast one," and had not provided C&W much more than the physical assets of its Internet backbone business.  C&W sued MCI WorldCom in March of 1999. 

Undeterred, WorldCom announced it was buying Sprint for $115B in October of the same year.  In November of 1999, C&W aired its grievances at a Congressional Hearing on the Sprint/WCOM merger.  A little over a month later, Carleen Hawn wrote an incredibly insightful short piece for Forbes, entitled "Swimming with Sharks."   

In her article, Ms. Hawn recounts C&W's complaints, but notes significant industry disagreement about which side was to blame.  According to Jim Crowe, founder of Level 3, the divestiture would never have worked as expected by DoJ, because C&W lacked a domestic U.S. network with which to interconnect the MCI backbone network.  C&W would, therefore, have had to purchase domestic Internet transit capacity.  (Note: this would have been right before Internet transit prices began a swift, steep, and inexorable, period of decline.  See, Dr. Peering table of Internet transit prices.)  

Thus, post-merger MCI WorldCom's market position was unaffected by the divestiture, as its share of the backbone market continued to grow faster than rivals.  In January 2000, Hawn states, "MCI WorldCom is simply more dominant than ever," concluding, "so much for grand efforts by regulators to dictate outcomes."  

A Dominant Gatekeeper . . . Isn't Abusive?

But, if the MCI backbone divestiture did nothing to diminish MCI WorldCom's dominance in the Internet backbone market, what was the outcome?  If GTE's theory was correct, MCI WorldCom would now have "both the incentive and the ability to act opportunistically to degrade the quality of interconnection and increase costs for its rivals."  GTE Complaint ¶23. 

Apparently, though, even with 60% of the revenue-generating traffic on the Internet being dependent on its network, MCI WorldCom never found it profitable to act on its incentives/ability to degrade rivals' interconnection terms.  Indeed, there's no evidence they--or any other ISP (either with respect to access or backbone transit)--has ever acted on such an incentive.  But it would take more than a decade for a court to make this finding.  

The Theory Goes to Court

There are two lasting legacies of GTE's theory of dominant ISP discrimination: 1) the general justification for the FCC's current Net Neutrality/Broadband Reclassification Order, and 2) Cogent's peering strategy.  Beginning with its very first ISP peering dispute, with AOL in 2002, Cogent has been the torch-bearer for GTE's never-tested (at the time) theory.  In fact, Cogent has wheeled out this argument every time it's been de-peered (which is a lot--partial list here), and most of the time it files something new at the FCC, or speaks to the press.

So, it was only a matter of time before Cogent tried to really test the GTE theory in an adjudicatory proceeding.  In 2011, Cogent filed a complaint with the French competition authority, alleging, among other things, that France Telecom's peering ratio (of 2.5X) constituted anticompetitive discrimination, as was France Telecom's refusal to unilaterally add capacity in violation of the firm's prior peering agreement.  Customers of France Telecom experienced congestion when downloading content from Cogent client, Megaupload

In many ways the French competition authority was the most sympathetic forum for this claim.  European competition law--with respect to dominant firm behavior--gives much more weight to preserving opportunities for smaller, and mid-size, firms (U.S. antitrust laws tend to focus primarily on economic efficiency).  See here at pp. 5-6/16.  French competition law is more favorable (than E.U. law) to smaller firms versus dominant rivals, and includes the notion of "abuse of a situation of economic dependence."     

But, Cogent could not make the theory overcome its facts; real-life ISPs simply don't discriminate as predicted.  The French competition authority ruled against Cogent.  See summary here.  Cogent appealed the decision, and a French appellate court affirmed, noting that peering was not an "essential facility," and is in no way functionally different from, or inferior to, transit.  See summary here.    

It Costs More $$ to Believe a Theory than Our Own Lyin' Eyes

In May of 1998, the commercial Internet had only been around for a few years.  At the time, GTE's concern that a "dominant" firm would abuse its position to degrade access to, and raise prices of, interconnection facilities needed by its smaller rivals was not an unreasonable concern. 

However, GTE's concern was immediately put to the test in actual market conditions, and it proved inaccurate.  More recently, as noted, Cogent failed to convince a regulator, under the most lenient standards, that it was harmed by the dominant firm's observance of international peering standards.  A French appellate court agreed, and confirmed this finding.

giorgio_my meme2.png
Yet the "dominant ISPs will harm consumers/competitors" theory--unlike the ancient astronaut theories--continues to pick up traction from sources that should be more skeptical.  But, unlike the ancient astronaut theories, continued belief in the GTE theory is not harmless.  Last week, in a policy memo, Hal Singer of the Progressive Policy Institute describes some of the many costs--in terms of services and innovations foreclosed, and investments forgone--of continuing to believe in the possibility of a theory that our "own lyin' eyes" have never seen happen.

May 22, 2015 3:23 PM

The FCC Should Not Use the AT&T-DirecTV Merger to Weaken Internet Interconnection

Over a year ago, I explained why the Comcast-TWC merger may present regulators with concerns.  On the other hand, I also explained that the AT&T-DirecTV merger presented consumers with nothing but opportunities.  As noted earlier this week, those opportunities have only expanded with ISP/MVPD competition and increased pressure on the programming bundle.  The post-merger AT&T-DirecTV would be a tempting target that may well give some programmers an incentive to "cheat" the industry-standard distribution agreements, and finally let go of the Bundle.

But, recently, news reports have said the FCC may require AT&T to accept "interconnection conditions" as a prerequisite to granting its approval to AT&T's acquisition of DirecTV.  This would be a mistake, because it would also undermine the careful restraint the Commission showed in its (still overly-broad-for-the-purpose) Open Internet Order

In a general sense, all regulations distort economic incentives; and overly broad regulations create more profoundly-distorted incentives.  Still, the FCC did show some restraint--with respect to Internet interconnection--in its ultimate Order.  The Commission should decline invitations to undo its previous well-considered reservations, as it will only promote moral hazard and careless network practices by those it has been asked to "help." 

Regulations Shouldn't Distort Market Discipline--Lessons from the Mortgage Crisis

Overly-broad regulations--designed to minimize one market risk--can easily distort incentives in adjacent markets (or market participants) in ways that create worse problems than the one the regulation was supposed to address.  This was the message of Charles Plosser, the President and CEO of the Federal Reserve Bank of Philadelphia, as he reflected on the role of prior government regulations in contributing to the mortgage crisis.   

In a speech entitled, "Responding to Economic Crises:  Good Intentions, Bad Incentives, and Ugly Results," Plosser considers why we continue to see financial crises, despite the fact that each crisis inevitably brings its own new regulations.  He concludes that, it's "[b]ecause the public and our lawmakers seldom recognize that attempts to insure against bad economic outcomes can sometimes be counterproductive."

Plosser (quoting economist Allan Meltzer) says, "Capitalism without failure is like religion without sin. It doesn't work."  He explains that regulations cannot insure "all manner" of market participants against bad outcomes (or limit the ability of firms to take risks); because while such rules might reduce market volatility, they would also limit innovation and economic growth. 

Plosser offers a number of examples where regulations undermined market discipline, making the overall system more vulnerable.  For example, in the decades preceding the crisis, the government provided numerous implicit and explicit subsidies to financial firms (Fannie/Freddie) and others that became "too big to fail."  By limiting these firm's risk, the subsidies gave lenders the impression that the government would always bail these firms out.  Thus, those lending the money to these firms had little incentive to limit the amount of debt they allowed the firms to accept.   

Plosser concludes that better regulations, and not simply more regulations, are the proper response to market failures.  He cautions,

If regulation distorts incentives, it can create moral hazard problems whereby firms don't bear the costs they impose on others. Such regulations can have unintended consequences that interfere with achieving the regulations' goals. 

The Commission's Invitation to Create Moral Hazard

Of course, there aren't perfect parallels between the financial system and the Internet, but there are enough similarities to draw some useful lessons.  The financial markets function best when they keep money flowing to efficient uses from efficient sources.  Similarly, the Internet, especially the market for Internet interconnection, has become the world's most efficient system for the routing and delivery of data traffic. 

As we have explained previously (see, here and here), the market for Internet interconnection works well, and has its own market discipline, which serves consumers well.  Where the financial markets efficiently reward accurate risk evaluation, the market for Internet interconnection rewards those firms that invest in the most efficient networks to provide valuable traffic routing to prospective interconnection partners. 

Thus, the FCC wisely decided not to regulate Internet interconnection as a separate "service," despite being heavily lobbied to do so by a tiny minority of firms."  In its recent Open Internet Order, the Commission, also wisely, declined to impose any specific interconnection obligations on ISPs, choosing to "rely on the regulatory backstop prohibiting common carriers from engaging in unjust and unreasonable practices." Order ¶ 203.

Recent events have vindicated the Commission's restraint.  Some of the same firms requesting regulation have, indeed, been able to reach fair terms with large ISPs.  Level 3 and Comcast, as well as Cogent and Verizon, have recently been able to reach mutually-beneficial, long-term agreements. 

Unfortunately, though, a few parties, including one (Cogent) that has had found itself on the "disciplined" end of  Interconnection market discipline more than any other (see, e.g., problems with Level 3, Sprint, generally, going back to AOL as a dial-up ISP), and another best known for recently gaming the Commission's own competitive bidding system, have asked the FCC to supplant competitive market discipline with extraordinary relief in the form of conditions to an otherwise pro-competitive merger.  These parties have nothing to lose by asking for relief

However, if the FCC accedes to these demands, AT&T's broadband Internet consumers can only lose.  Because, notwithstanding any evidence that AT&T is acting unjustly or unreasonably with respect to Cogent or Dish, these firms are asking the Commission to impose different terms on AT&T than other ISPs.  It is, therefore, more than likely that the FCC--if it agreed to do so--would be imposing a weaker link (through non-competitive interconnection terms) into some retail customers' supply chain.  This is no way to ensure consumers have the best end-to-end broadband Internet access.  It will, however, ensure that the FCC gets more requests to regulate outcomes best decided by a more efficient market.