Results tagged “wholesale competition”

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.

April 1, 2013 12:04 PM

Wholesale Wireless Competition Is Important: The FCC Should Care More

About a week and a half ago, the FCC released its 16th Wireless Competition Report.  Among the significant data collected and presented in this Report, there is one important, and growing, indicator of wireless competition that the FCC desperately needs to better understand: wholesale wireless competition.  

Based on my experience at COMPTEL, I know that a healthy wholesale market is one big indicator of effective retail competition.  Because, hey, anytime a retail competitor doesn't have to rely on regulatory compulsion to obtain wholesale access, that's a pretty good indicator that the facilities-based carrier doesn't think it has a whole lot of market power to protect.

The good news is in this Report is that the wholesale wireless segment is getting "healthier" at a faster rate than any market segment.  While still a relatively small number of total wireless connections, wholesale connections grew at the fastest rate of any service type measured by the Commission--almost tripling in the 2 year period 4Q 2009-4 Q 2011. Rpt. para. 250.

The FCC's numbers are telling us that wholesale competition is on fire.  But when you try to figure out what this really means, well . . . the Commission doesn't seem too sure.   

Understanding Wholesale Wireless Competition

The FCC introduces us to the wholesale market in paras. 29-36, and it explains how it uses wholesale data for purposes of calculating market concentration in paras. 53, and 57.   The largest use of wholesale wireless service is by mobile virtual network operators (MVNOs).  These service providers rely on the facilities of other carriers for their mobile service, but handle every other aspect of the customer's account themselves.  

Because wholesale wireless relationships are voluntary, we have to presume that both the buyer and the seller expect the relationship to be beneficial.  That presumption alone, though, does not tell us too much about how wholesale sales affect retail competition. According to carriers, such as Verizon, a carrier's relationship with its MVNOs is fundamentally "arm's length." Report n. 102.  And, why wouldn't it be?  Wholesaling at arm's length has long been a routine part of the wired telecommunications world.

Wholesale Confusion--Some Say . . .

Well, the FCC's not so sure.  Take a good look at the FCC's explanation of the wholesale industry (paras. 29-36), read all the footnotes, and it becomes clear that no less than two academic articles (cited in n. 109), and one report by an "industry analyst" (providing his "predictions" for 2011) (n. 110) characterize MVNO "competition" as something less than the real thing.  The only one of these sources freely available on the Internet is the report by the analyst for the Yankee Group, available here.

The Yankee Group report is a relatively short article with some of the analyst's "4G" predictions for 2011, and a brief summary of the analyst's thinking in making the prediction.  Although, the "predictions" don't seem to be much more than the author's personal opinions, the FCC cites the explanation behind a single prediction in order to characterize the nature of MVNO/network operator competition.  

For example, in n. 110, the FCC cites this document as the basis for this insightful gem, "Like a small bird on an elephant's back, if an MVNO can establish a symbiotic relationship with its host and provide some direct commercial benefits, it can flourish." Yankee Group at 7.   See also, n.123 "[I]t's critical the MVNO does not compete to any meaningful degree with the host."  Id.  MVNOs are also cautioned to never look the host carrier directly in the eyes, as this is seen as a sign of aggression by network operators.

With insights like these, I'm sure readers would like to know how this analyst's "predictions" for 2011 worked out.  Well, the prediction backed up by the insights quoted above was this: "MVNO Hype Will Build, But Most of It Will Lead to Nothing."  

In reality?  MVNOs were able to increase connections by 182% between Q 4, 2010 (when the Yankee Group predictions were released) and Q 4, 2011.  FCC Rpt, Chart 13, p. 159.  This was the fastest one year growth in wholesale connections to date.  Suck it, Yankee Group.

But, Maybe Not?  

The FCC seems to regard MVNO competition as somewhere between the "franchisee" characterization of the non-industry sources, and the "real thing" characterization of some carriers. See, e.g., n. 125 where AT&T's assertion that competition between carriers for a portion of TracFone's 19 million customers has led to lower wholesale and retail prices is balanced against this quote from a 3 year old academic paper:

It is found that MNOs host MVNOs if and only if the latter do not exert a competitive constraint on MNOs' retail businesses. Thus, absent access regulation, MVNO entry may happen but is unlikely to reduce consumer prices.     

Report, para. 35, n. 125.  The problem here is not that the carrier disagrees with the theoreticians, or even that the theoreticians' point doesn't make a whole lot of sense for any wholesaler with less than a 50% retail share.  No, the problem is that the FCC does not seem to have an opinion as to which is more credible.

*     *     *     *     *

If you type the term "industry analyst reports" as a search term in the Report, it turns up four results.  Each and every instance is the Commission relying on "industry analyst reports" as an excuse for why it is unable to account for MVNO competition.  There is no excuse for the Commission not to try to understand and account for the competition provided by MVNOs in its next Wireless Competition Report.  The public needs for the Commission to be the "expert agency" on all things wireless--but especially on the fastest growing customer segment in the wireless industry.